How to switch a SIMPLE IRA to a 401(k)
Some small businesses chose to start a retirement plan for their business with a Savings Incentive Match Plan for Employees IRA, better known as a SIMPLE IRA. SIMPLE IRAs, until the SECURE 2.0 change went into effect in 2024, were year long, calendar year commitments and did not allow for the conversion to a 401(k) until year end. That’s now all changed as of January 1, 2024. Employees may now transition at any point during the year.
Why Do Businesses Switch to a 401(k)?
Many small business owners see the added benefits of a 401(k) and look to switch to gain features such as a Roth 401(k) option, loan option, and significantly higher contribution limits as highlighted below:
| **Core Feature Differences ** | **SIMPLE IRA ** | 401(k) |
|---|---|---|
| Employee Contribution Limit - 2024 | $16,500 | $23,000 |
| Age 50 or Older Catch-Up Contribution Limit | $3,500 (for a total of $20,000) | $7,500 (for a total of $30,500) |
| Roth Option | Not applicable | Yes – no income limit to use |
| 401(k) Loans | Not applicable | Available to withdraw with no taxes or penalties, 50% of your savings (up to $50,000). Accrues interest and must be paid back within 5 years.* |
| Employer Matching / Contribution | 3% of salary to all those contributing and at least 2% to those who are not | Various options – Safe Harbor designs are typically 3% or 4% of salary depending on needs. |
What are the steps to replace your SIMPLE IRA with a 401(k)?
You will need to plan a few things to ensure your transition to a 401(k) goes smoothly.
- You will need to identify your preferred 401(k) provider and start a Safe Harbor 401(k). Like a SIMPLE IRA, an immediate vesting match is required and this 401(k) plan design is quite similar to the SIMPLE IRAs. As you prepare the new 401(k), you’ll want to plan the following with your 401(k) provider:
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Verify an appropriate termination date for the SIMPLE IRA and ensure your SIMPLE IRA and 401(k) provider are both aligned on this timing.
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If you have payroll integration, you will want to know the requirements and ensure your 401(k) provider supports you as you prepare to switch. If you do not have payroll integration, just be familiar with the input or upload process, so it goes smoothly. You will need to ensure your employee information is loaded with your 401(k) provider during the install process.
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We also suggest having your 401(k) provider conduct an employee education kick-off meeting at launch.
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When you replace a SIMPLE IRA with a 401(k) during the year, you will need to work with your 401(k) provider to determine the contribution limit that employees may put away during the current year. It is basically a weighted average of the SIMPLE IRA and 401(k) contribution limits for the year the plan is converted. As the next calendar year kicks off, only the 401(k) contribution limits will apply.
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As you are set to roll out the 401(k) plan, you will need to provide two notices to employees; one that states the SIMPLE IRA termination and one that announces the Safe Harbor 401(k). Your provider likely has notices you can use or tailor for your needs.
Once your 401(k) is live and you get near year end, most providers have a year-end census process, and you’ll want to ensure you include the SIMPLE IRA contributions made during the year. This will ensure your plan is in compliance; or you can make adjustments to ensure it is.
Any retirement plan conversion takes a little planning, but the benefits to owners and employees can make a big difference in saving more for retirement and for better managing of personal taxes, too.
Takeaways:
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SECURE 2.0 now enables small businesses with a SIMPLE IRA to switch to a 401(k) plan at any time during the year.
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Businesses that switch will benefit from the higher contribution limits, Roth 401(k) option, and 401(k) loan feature to enable better retirement planning as well as money and tax management.
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Small business owners will want to plan with their newly selected 401(k) provider to manage the timing of the transition to ensure payroll is set up to support the 401(k) and that the rollout to employees goes smoothly. There will also be a weighted average contribution limit determined for the first year before moving to the 401(k) contribution limits going forward.
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Small business employers will need to provide notices to employees of the change and ensure SIMPLE IRA contributions are added to the year-end census process.
*Loan balances must be paid off in five years and if you leave your job, you may be required to pay back the full balance within a short-time frame or pay penalties and taxes. Most important, borrowing from your 401(k) can significantly reduce your retirement savings.