Small-business clients often choose a retirement plan based on conditions that exist in the early stages of the business' existence. Starting a business can be stressful, which often means that ease of administration and lower costs are determining factors for business owners who adopt retirement plans when a business is young.
While choices made by these small-business owners may initially fit, conditions change over the life of a business. Business owners who adopted SIMPLE individual retirement accounts may later find that switching to a safe harbor 401(k) can have many benefits — especially when they're trying to attract employees who have become accustomed to the standard 401(k) savings option.
Fortunately, Secure Act 2.0 has made it easier to make the switch starting in 2024. Accordingly, many business clients may have new questions about the differences between SIMPLE IRAs and safe harbor 401(k)s, as well as the technical rules for transitioning from a SIMPLE plan to a 401(k).
Making the Switch
Before Secure Act 2.0, business owners couldn't change from a SIMPLE IRA to a 401(k) before the end of a calendar year. By Nov. 2, an employer was required to provide notice of the switch to employees. The formal termination date was always Dec. 31, and the 401(k) start date was Jan. 1.
This is important, because one of the rules governing SIMPLE IRAs says that business owners cannot maintain any other retirement plan if they choose the SIMPLE IRA option.
Secure 2.0 relaxed the regulation so that employers can terminate a SIMPLE IRA midyear and replace it with a safe harbor 401(k). When that is done, Secure 2.0 simply created an exception to the general rule that an employer cannot maintain plans in addition to the SIMPLE IRA.
Pursuant to Internal Revenue Service guidance issued in December, the employer must take formal written action and specify the termination date. Employees must be given a 30-day notice before the termination date, and the notice must detail that no salary reductions to the SIMPLE IRA will be made based on compensation paid after the termination date. The employer must make matching contributions attributable to employee compensation earned through the termination date.
