SECURE 2.0 permits midyear switch from SIMPLE to safe harbor

Here’s something you might not know: Small employers — generally those with no more than 100 employees — can sponsor a SIMPLE IRA plan (Savings Incentive Match Plan for Employees) for their employees, but historically, a small employer cannot maintain a SIMPLE IRA and a 401(k) plan in the same year. However, the SECURE 2.0 Act of 2022 (“SECURE 2.0”) now lets a small employer convert its SIMPLE IRA to a safe harbor 401(k) plan midyear.

Below, we’ll walk you through the key features of a SIMPLE IRA, the factors you might consider when deciding whether to adopt a SIMPLE IRA or a 401(k) plan, the benefits of a safe harbor 401(k) plan, and what you’d need to do to replace a SIMPLE IRA with a safe harbor 401(k) plan.

SIMPLE IRA features

Let’s start by taking a look at some of the key features that may make a SIMPLE IRA appealing:

• Deferrals. As a general rule, an employee may elect to defer up to $16,000 of their compensation plus $3,500 in catch-up deferrals for 2024 if they are at least 50 years old. In some cases, though, SECURE 2.0 allows for incrementally higher deferral and catch-up limits.
• Employer contributions. As the employer, you must make a matching contribution up to 3% of an employee’s compensation deferred OR a 2% nonelective contribution. SECURE 2.0 also allows you to make a discretionary nonelective contribution in addition to its required contribution.
• Vesting. An employee is always 100% vested in their SIMPLE IRA, including employer contributions.

Why adopt a SIMPLE IRA vs. a 401(k) plan?

Small employers are often attracted to a SIMPLE IRA because it’s easy to establish and maintain. In addition, nondiscrimination testing is not required, and there is no annual Form 5500 filing requirement. Finally, the Employee Retirement Income Security Act of 1974 (“ERISA”) does not apply to a SIMPLE IRA.

On the other hand, small employers that adopt a 401(k) plan appreciate the significantly higher contribution limits compared to SIMPLE IRAs. Additionally, a 401(k) plan offers greater flexibility in connection with eligibility, vesting, and employer contribution provisions. Furthermore, a 401(k) plan must file an annual Form 5500, is subject to ERISA, and must satisfy nondiscrimination testing. However, sound practices and an experienced retirement plan service provider (like your friends on UBT’s Retirement Plan Services team!) can help you navigate these 401(k) plan requirements.

Benefits of a safe harbor 401(k) plan

A safe harbor 401(k) plan is a type of 401(k) plan that automatically satisfies certain annual nondiscrimination tests to ensure compliance with federal law. Because it satisfies nondiscrimination testing, a safe harbor plan allows highly compensated employees to “max out” their elective deferrals as allowed by law.

Similar to a SIMPLE IRA, a safe harbor 401(k) plan requires you to make an employer contribution. In a traditional safe harbor 401(k) plan, you must make a 3% nonelective contribution, or a matching contribution equal to 100% of the first 3% of an employee’s deferred compensation PLUS 50% of the next 2% of an employee’s deferred compensation. An employee must always be 100% vested in their safe harbor employer contribution.

Converting a SIMPLE IRA to a safe harbor 401(k) plan

To terminate a SIMPLE IRA and adopt a safe harbor 401(k) plan mid-year, there are several conditions that must be met:

• You must take formal written action to specify the SIMPLE IRA’s termination date.
• You must notify your employees of the termination of the SIMPLE IRA at least 30 days before the termination date. The notice must explain that no deferrals will be made with respect to compensation paid after the termination date and that the required SIMPLE IRA matching contribution or nonelective contribution will be made based on employees’ compensation earned through the termination date.
• You should notify the SIMPLE IRA plan’s financial institution and payroll provider that you will cease making SIMPLE IRA contributions.
• You must adopt a safe harbor 401(k) plan, effective as of the day after the SIMPLE IRA’s termination, and provide notice to your employees about the safe harbor 401(k) plan if you’ll be making a safe harbor matching contribution.

Finally, SECURE 2.0 also allows SIMPLE IRA participants to directly roll over their SIMPLE IRA distribution to the newly established safe harbor 401(k) plan without incurring a penalty.

This is a lot of information to process, but we’re here for you! If you have questions about terminating your SIMPLE IRA and adopting a safe harbor 401(k) plan, please contact Stacy Gutschenritter at 402.323.1768 or Stacy.Gutschenritter@ubt.com she’ll be happy to help!