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6 Reasons for Advisors to Convert SIMPLE IRAs to Safe Harbor 401(k) Plans   


Many investment advisors recommend SIMPLE IRAs for their small business clients because they are easy to establish, easy to maintain and inexpensive to administer. SIMPLE IRA plans allow businesses with no more than 100 employees to establish individual IRAs for each of their employees. Once the plan is established, each employee can elect up to $12,500 of salary deferrals into their account. Employees age 50 and older may defer an additional $3,000 catch-up contribution each year.

In addition, employers are required to make fully vested contributions to employee accounts, either in the form of a 3% matching contribution for those who participate, or a 2%-of-salary profit sharing contribution for all employees, including those who do not contribute.

While SIMPLE Plans often seem like a good choice, knowledgeable advisors have learned there are a number of reasons that make Safe Harbor 401(k) Plans a better option for many of their clients. Below are 6 reasons advisors should consider converting their SIMPLE Plans to Safe Harbor 401(k) Plans.


Larger Contributions

A Safe Harbor 401(k) Plan allows for larger contributions compared to SIMPLE Plans. The chart below illustrates this difference.


Increase Tax Savings

Larger contributions mean greater tax savings. By funding an additional $20,000, an employer with a 40% tax rate will save $8,000 in income tax every year.

Save Even More by Adding a Vesting Schedule

Employer contributions to SIMPLE IRAs are 100% vested as soon as they are contributed. Safe Harbor 401(k) Plans also require a fully vested employer contribution, but they also permit additional discretionary employer contributions which can be subject to vesting. When employees quit after working only a few years, any non-vested balances are forfeited and can be used to pay plan expenses or reduce future employer contributions. Because amounts can vest over a period of up to 6 years, forfeitures can often be enough to cover the costs of plan administration or be used to offset or reduce future employer contributions.

Gain Access to Funds Before Reaching Retirement Age

Unlike SIMPLE IRAs, Safe Harbor 401(k) Plans provide several ways for business owners and employees to access their funds before reaching retirement age. First, Safe Harbor 401(k) Plans can include a tax-free loan provision where employees can borrow 50% of their vested account balance up to a maximum of $50,000. Loan proceeds are not taxed as long as the loan is repaid within 5 years. Second, Safe Harbor 401(k) plans can include a withdrawal feature in the event of certain types of financial hardship. These options are not permitted in SIMPLE IRAs.

Add a Roth Feature to Increase Tax Savings

Employee salary deferrals to a SIMPLE IRA are pre-tax deferrals, meaning contributions and earnings are not subject to income tax until they are withdrawn. Roth accounts are not permitted in a SIMPLE IRA. Safe Harbor 401(k) Plans include pre-tax deferrals as well, but they can also include a Roth contribution option allowing employee accounts the opportunity for tax-free withdrawal of all balances, including investment growth. Many financial planners advise that younger employees may especially benefit from a Roth contribution feature.

Owners Benefit More from Advanced Plan Design

Safe Harbor 401(k) Plans can significantly increase owner contributions by taking advantage of advanced plan design including options such as a New Comparability profit sharing or pairing the Safe Harbor 401(k) Plan with a Cash Balance Plan. SIMPLE IRA Plans do not allow this flexibility. Each of these options allows for plan designs that target contributions for highly compensated employees or owners. With a Cash Balance combo plan, business owners can receive an annual contribution of as much as $200,000.

While the cost of administering a Safe Harbor 401(k) Plan can be as much as several thousand dollars, the savings mentioned above exceed this cost, several times over. SIMPLE IRA Plans may only terminate at December 31. For advisors wishing to take advantage of the benefits of Safe Harbor 401(k) Plans for existing SIMPLE IRA clients, the SIMPLE IRA Plan is required to give employees notice of the intent to terminate by November 2. The Safe Harbor 401(k) Plan can be implemented the following year. For more information on the benefits of a Safe Harbor 401(k) Plan, contact your JULY Regional Sales Consultant.

John M. Humphrey, COO, July Business Services