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How to Replace a SIMPLE IRA with a 401(k)

How to Replace a SIMPLE IRA with a 401(k)

February 21, 2024

On December 20, the IRS released some important clarifications to Section 332 of SECURE 2.0 in Notice 2024-02. These rules took effect on January 1, 2024. They allow employers to terminate a SIMPLE IRA at any time during a calendar by replacing the plan with a safe harbor 401(k) plan. Previously, employers could only terminate a SIMPLE IRA on December 31.

The SECURE 2.0 rules for terminating a SIMPLE IRA mid-year are generally straightforward. However, the replacement process requires some planning to meet legal requirements. Our 5-step checklist can make the job easy for employers.

Background

All SIMPLE IRAs operate on a calendar basis. Further, a SIMPLE IRA must be the sole retirement plan maintained by an employer.  Before January 1, 2024, employers had to maintain a SIMPLE IRA for the entire calendar year. Now, an employer can terminate a SIMPLE IRA at any time during the year by replacing the terminated plan with a safe harbor 401(k) plan. Employers can choose a traditional or QACA safe harbor plan for this purpose.

However, this replacement process is subject to special timing and contribution limit requirements. Some coordination is necessary to meet these requirements. Below are the steps we recommend for employers.

Step 1: Hire a 401(k) Provider

To terminate a SIMPLE IRA mid-year, an employer must start a safe harbor 401(k) plan “as of the day after the termination date” to meet SECURE 2.0 requirements. To best ensure this timing requirement is met, an employer’s 401(k) provider, SIMPLE IRA provider, and payroll company must be coordinated throughout the replacement process.

As such, employers should hire a 401(k) provider before they start the SIMPLE IRA termination process.

Step 2: Terminate the SIMPLE IRA

To terminate a SIMPLE IRA, employers must specify the termination date in a formal written action. Contributions to the SIMPLE IRA must stop as of the termination date.

Before an employer terminates their SIMPLE IRA, they should confirm the feasibility of the termination date with their 401(k) provider, SIMPLE IRA provider, and payroll company.

Step 3: Notify Employees About the Replacement

To properly notify employees about the plan replacement, employers must distribute two disclosure notices, one related to the SIMPLE IRA and the other related to the safe harbor 401(k) plan:

    • SIMPLE IRA notice – Informs employees about the plan termination, including the date that contributions to the plan will stop. This notice must be distributed to employees at least 30 days prior to the plan’s termination date.
    • Safe harbor 401(k) notice – Informs employees about their rights and obligations under the plan, including information about plan contributions. This notice must be distributed to employees at least 30 days prior to the plan’s start date.

Step 4: Apply a Weighted Limit to Elective Deferrals

When a SIMPLE IRA is replaced mid-year by a safe harbor 401(k) plan, the elective deferrals made to the safe harbor plan by each employee cannot exceed a special weighted limit. This limit must equal:

    • The annual limit for salary reduction contributions made to a SIMPLE IRA plan ($16,000 + $3,500 (if catchup eligible) for 2024) multiplied by a fraction equal to the number of days the SIMPLE IRA plan was in effect for that year divided by 365, plus
    • The annual limit for elective deferrals made to a 401(k) plan ($23,000 + $7,500 (if catchup eligible) for 2024), multiplied by a fraction equal to the number of days the safe harbor plan was in effect for that year divided by 365, minus
    • Any salary reduction contributions made to the SIMPLE IRA during the year.

The plan's safe harbor notice must disclose the weighted limit to employees.

Below is an example of the calculation for a hypothetical employee based on the following assumptions:

    • Calendar year = 2024
    • SIMPLE termination date = March 31, 2024
    • Safe harbor 401(k) start date = April 1, 2024
    • Age of employee = 60
    • SIMPLE IRA contributions for the year = $4,000

In this example, the employee can make elective deferrals to the safe harbor 401(k) plan up to $23,757.53.

Description

Amount

Formula

Weighted average of SIMPLE IRA limit

$4,861.64

= ($16,000 + $3,500 catchup) * (91/365)

Weighted average of 401(k) limit

$22,895.89

= ($23,000 + $7,500 catchup) * (274/365)

Contributions made to the SIMPLE IRA

($4,000.00)

N/A

Safe harbor deferral limit

$23,757.53

= ($4,861.64 + $22,895.89) - $4,000.00

Step 5: Supply SIMPLE Contributions with the 401(k) Year-End Census

Most 401(k) providers require an employee census file from employers to complete a plan’s year-end nondiscrimination and limit testing. Employers should include SIMPLE IRA contributions on their census file for the replacement year so their 401(k) provider can confirm the contributions made to the two plans did not violate legal limits.

Section 332 of SECURE 2.0 is Good News for Retirement Savers!

A SIMPLE IRA cannot match the benefits of a safe harbor 401(k) plan. The advantages of a safe harbor plan include higher contribution limits, more generous employer contribution options, and more flexible distribution. Employers can upgrade a SIMPLE IRA to a safe harbor plan sooner thanks to Section 332 of SECURE 2.0.

However, replacing a SIMPLE IRA with a safe harbor 401(k) plan requires some coordination to best ensure the timing and contribution limit requirements of SECURE 2.0 are met. A basic checklist can make the job easy for employers.