SIMPLE IRAs: what to know after SECURE 2.0

SIMPLE IRA plans

In general, a SIMPLE IRA plan must be the only retirement plan sponsored by an employer during a calendar year (i.e., the exclusive plan rule); termination of the SIMPLE IRA plan may only occur as of December 31. Furthermore, contributions to a SIMPLE IRA plan must remain in the SIMPLE IRA for a two-year period, which begins as of the date of the first contribution. Once the two-year period expires, a participant can request a distribution from the SIMPLE IRA and roll it over or transfer it to a qualified retirement plan or an IRA (but not a Roth IRA).

Amounts distributed from a SIMPLE IRA plan directly to a participant are generally subject to a 10% early distribution penalty, unless an exception under Internal Revenue Code (IRC) §72(t) applies; however, amounts distributed from a SIMPLE IRA plan prior to the end of the two-year period may only be rolled over into another SIMPLE IRA. Any distribution, including an attempted rollover or transfer of amounts to any other IRA or retirement plan, before the end of the two-year period is considered a distribution directly to the participant and subject to an increased early distribution penalty of 25% (rather than 10%), unless an exception applies.

Impact of SECURE 2.0 on SIMPLE IRA plans 

SECURE 2.0 provides a limited exemption to the SIMPLE IRA exclusive plan rule. A SIMPLE IRA plan sponsor may now terminate the SIMPLE IRA plan midyear, but only if it’s replaced with a 401(k) plan with a safe harbor feature (including a qualified automatic contribution arrangement (QACA) feature). The effective date of the safe harbor 401(k) plan must be the day following the termination date of the SIMPLE IRA plan. Employees must be notified of the SIMPLE IRA termination at least 30 days before the termination date, and the notice must specify that no salary deferrals will be made to the SIMPLE IRA with respect to compensation earned after the termination date. The required employer contribution (match or profit sharing) is based on compensation through the date of termination.

In addition to the SIMPLE IRA plan termination notice, employees must also be provided with the required safe harbor notice at least 30 days prior to the effective date of the new safe harbor 401(k) plan. Provision of the safe harbor notice, however, is complicated by the requirement that the safe harbor notice must include a detailed explanation of how the pro-rated maximum salary deferral contribution to the new safe harbor 401(k) plan will be determined for the remainder of the calendar year.

A further notable impact of the SECURE 2.0 changes permits amounts in a SIMPLE IRA plan that haven’t yet satisfied the two-year holding period to be transferred into the new safe harbor 401(k) plan. When these amounts roll over/transfer into the safe harbor plan, they become subject to the standard 401(k) restrictions defined in Section 401(k)(2) for the entirety of the time invested in the 401(k) plan. The two-year period is no longer applicable once rolled over/transferred into the 401(k) plan.

Why you might consider replacing your SIMPLE IRA plan with a 401(k) plan

The right type of retirement plan depends on your business’s needs and benefit objectives. Whether you’re hoping to attract and retain talent or are experiencing other signs that you’ve outgrown your existing retirement savings vehicle, there are plan options available to you.

A safe harbor 401(k) plan provides additional benefit options that usually can’t be matched by the benefits available under a SIMPLE IRA plan. These benefits include increased contribution limits for you and your employees, more flexibility in determining employer contribution formulas, and the ability to offer participant loans and expanded distribution options for participants.

Transitioning to a safe harbor 401(k) may also increase employee participation without significantly increasing plan administration because a safe harbor 401(k) plan doesn’t require nondiscrimination testing.

Replacing your SIMPLE IRA with a safe harbor 401(k) plan, however, requires analysis and planning, as you must ensure not only that the timing and contribution limit requirements of SECURE 2.0 are satisfied, but you also fully understand the associated financial and administrative considerations of such a change.