Four common questions small business owners have about converting their SIMPLE IRA to a 401(k) plan

Small business owners looking to implement a retirement plan for their small business commonly decide a SIMPLE IRA is a good savings vehicle for them to start out with; it’s a low-cost option that is pretty easy to run and offers employees a place to save for retirement. However, as the business grows and business owners start to experience limitations in the plan, many outgrow their SIMPLE IRA and begin to think about upgrading to a 401(k) plan.

This leads to a variety of questions that business owners need answered before they can decide what to do and which option makes the most sense for their specific situation. Here are four of the most common:

1. Does a SIMPLE IRA or a 401(k) make more sense for my small business?

Unfortunately, there’s no universal answer when it comes to whether a SIMPLE IRA or a 401(k) plan will be the best fit for your small business. However, business owners can make an informed decision on which option better suits their company when they understand the key benefits and limitations of both retirement savings vehicles.

A SIMPLE IRA can be a great cost-effective option for business owners looking to offer a retirement plan for employees to save in. They are also easy to administer and don’t require discrimination testing like 401(k) plans do. However, there are quite a few limitations of a SIMPLE IRA plan sponsors should be aware of:

• Requires employer dollar-for-dollar matching contributions up to 3 percent of compensation or 2 percent non-elective for all eligible employees
• Immediate vesting schedules
• No Roth or loan options
• Must be the only retirement plan the employer has
• Only employers with less than 100 employees are eligible, which may mean growing businesses need to look at other retirement savings options for employees
• Contribution limits are significantly lower than other retirement savings vehicles

In turn, a 401(k) plan offers small business owners a powerful employee attraction and retention benefit, added flexibility in plan design and contribution options, and the highest contribution limits among any retirement savings vehicle.

Take a look at a few more key differences between SIMPLE IRA and 401(k):

SIMPLE IRA vs. 401(k)

• Maximum employee contribution limits (2023):

• • SIMPLE IRA: $15,500, plus $3,500 in catch-up contributions for those 50 and older
  • 401(k): $22,500, plus $7,500 in catch-up contributions for those 50 and older

• Maximum total contributions (includes employer contributions):

• • Simple IRA Match: $38,000 ($15,500 employee contribution, plus $3,500 catch-up and $19,000 match. Note: requires compensation of $633,333 or greater)
  • Simple IRA Non-Elective: $25,600 ($15,500 employee contribution, plus $3,500 catch-up and $6,600 non-elective. (Note: requires compensation of $330,000 or greater)
  • 401(k): $73,500 ($66,000, plus $7,500 in catch-up contributions)

• Tax advantages:

• • Both offer a variety of tax savings opportunities to employers including a tax credit of up to $5,000 per year for the first three years of the plan’s life (if it’s your company’s first retirement plan) as well as tax deductible employer matching contributions

• Flexibility for plan sponsors:

• • SIMPLE IRA: Inflexible plan design options; required pre-determined employer matching agreement, immediately vested employer contributions, and no Roth or loan options allowed
  • 401(k): More robust plan design features; allowing business owners to add vesting schedules, safe harbor provisions, profit sharing options, and more

2. Is there a deadline for converting my SIMPLE IRA to a 401(k) plan?

While there is no true conversion process involved, there are a few rules and deadlines small business owners will need to adhere to when discontinuing their existing SIMPLE IRA and opening a new 401(k) plan. Since SIMPLE IRAs run on the calendar year, it must be the only retirement plan in operation that year, and cannot be terminated mid-year, the soonest you can start contributing to your 401(k) plan is January 1. However, you’ll need to take action to terminate the SIMPLE IRA to allow for a 401(k) to be in effect as of January 1.

That means October is a great time to start thinking about discontinuing your SIMPLE IRA plan in order to start a 401(k). You’ll want to begin discussing the process with your financial advisor so you’re ready to provide employees with the required notice that the SIMPLE IRA will be terminating and you’ll be starting a 401(k) by the November 2 deadline.

SIMPLE IRA rollover and withdrawal rules

There’s another rule small business owners will want to keep in mind when thinking about converting their SIMPLE IRA to a 401(k) plan: the two-year rollover rule. For the first two years a participant is contributing to their SIMPLE IRA, their assets can only be rolled into another SIMPLE IRA. This means that if your SIMPLE IRA has been in operation for less than two years, your contributions cannot be rolled over to a 401(k) until the two-year period has ended.

Learn more about IRS rules on SIMPLE IRA withdrawals and transfers here.

3. What happens to employees when changing a SIMPLE IRA to a 401(k)?

Once the new 401(k) plan is up and running, employees will be able to decide if they’d like to keep their assets where they are (and have the accounts transitioned into a traditional IRA) or roll them over to the new 401(k) plan available to them. However, the rollover can be time-sensitive if employees want to avoid taxes and penalties.

Since the two-year rule is also in effect for employee accounts, if the employee has participated for less than two years, they’ll need to leave their assets in the SIMPLE IRA until they’ve reached the end of the two-year period. If they choose not to leave their assets in the account for the required two years, they will be subject to tax penalties.

On the flipside, if the employee has participated in the SIMPLE IRA for two years or more, they can choose to roll their funds over to the 401(k) plan tax-free.

4. How do I change my retirement plan from a SIMPLE IRA to a 401(k) plan?

We’re proud to offer a simple process for small business owners who choose to discontinue their SIMPLE IRA and start a 401(k) plan. You’ll receive a designated Installation and Conversion representative who will help ensure your plan gets off the ground running smoothly. From there, you’ll have access to our customer care team who is available to answer any questions you or your employees may have.