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Completing A SIMPLE IRA Rollover to a 401k: Tips for The Conversion

by Kevin Schuler on Oct 20, 2022 8:36:40 AM

As a company offering a SIMPLE IRA as part of your employee benefits package, you’ve likely reached a point where you’ve realized a 401k may be a better retirement plan option for your organization. Whether you’re growing in size, want to add a loan feature, or are interested in allowing higher contributions, it’s time to consider a SIMPLE IRA rollover to a 401k. But just what are the steps to a conversion? Let’s find out.

In this article, we’ll explain what’s involved when completing a SIMPLE IRA rollover to a 401k, when you can convert, and any tax implications to your business or your employees. After reading this, you’ll know how to make the switch and all the rules you need to follow to be able to offer a 401k at your company.

What are the pros and cons of a SIMPLE IRA vs a 401k?

Before making the  switch from a SIMPLE IRA to a 401k, it’s a good idea to review the pros and cons of each to make sure your decision is right for your company.

SIMPLE IRA Pros

  • Fewer administrative tasks. There’s no annual compliance testing or filing requirements with these plans. All you’ll need to do is send an annual notice to employees.
  • Lower cost. You probably pay a per employee fee of around $10 to $25 a year with a SIMPLE IRA compared to $15 to $60 for a 401k.
  • Reduced compliance risk. Since SIMPLE IRAs are not under the same level of regulation, you have a lower risk of violations and potential penalties.

SIMPLE IRA Cons

  • Less plan flexibility. A SIMPLE IRA can’t have a loan feature nor can they allow profit sharing contributions. You also don’t have a Roth option.
  • Lower contribution maximums. The contribution limits for a SIMPLE IRA are lower than those for a 401k.
  • Size limit. You can only have a SIMPLE IRA if you have 100 or fewer employees.
  • Required employer match. You must contribute either 2% of an employee’s compensation or a dollar-for-dollar match of up to 3% of the employee’s contribution, and your employees are 100% vested in your employer contributions immediately, which doesn’t encourage retention.

401k Pros

  • Greater savings potential. Your employees will be able to contribute more each year because the annual maximums are higher; for 401ks in 2022, employees can contribute up to $20,500 compared to $14,000 with a SIMPLE IRA.
  • Optional match. You’re not required to contribute to your employees’ accounts every year but can choose to if you’d like.
  • Flexible vesting schedule. You can design your plan with a graded vesting schedule to encourage retention or choose a safe harbor match that allows employees to be fully vested in your contributions immediately.

401k Cons

  • Bigger administrative burden. There are more requirements with these highly regulated plans that can require technical expertise to complete correctly, which is why many companies choose to use a third-party administrator (TPA) to handle the tasks.
  • Higher expenses. If you move forward with a SIMPLE IRA rollover and convert to a 401k, you’ll have to pay start up costs between $500 and $2,000, a per-participant fee of $15 to $60 a year, and TPA fees if you choose to outsource administration.
  • Employee eligibility restrictions. If you limit the ability of employees to participate by having length of service rules, you could risk lowering their satisfaction with your benefits, which could impact recruiting.

How do I convert a SIMPLE IRA into a 401k?

If you’ve reviewed the pros and cons of both types of plans and still feel like switching to a 401k is the best choice for your business at this time, then there are several SIMPLE IRA rollover rules you’ll need to follow to complete the transition.

  1. Terminate your SIMPLE IRA. Let your provider know before November 2 (60 days in advance) that you’ll be discontinuing your plan as of December 31. But be sure to continue your contributions through the end of the year.
  2. Establish a 401k plan. Design a 401k plan that works best for your business and set it up to be effective on January 1. Since setting up a new plan can take a couple of months, give yourself plenty of lead time.
  3. Notify employees. Before November 2, inform workers that you’ll discontinue your SIMPLE IRA effective December 31. Let them know what happens next with their funds and what they’ll need to do to get started with your newly-formed 401k plan.
  4. Update your payroll provider, if applicable. If you use an outsourced payroll provider, inform them that you’re terminating your plan and that you’ll be starting a 401k effective January 1.
  5. Help participants transition their assets. Once your SIMPLE IRA is terminated, your employees can complete a tax-free rollover into your 401k as early as January 1. Keep in mind that during the first 2 years an employee contributes to a SIMPLE IRA, their assets can only be rolled over into another SIMPLE IRA and not into a 401k. If you have employees with accounts that are less than 2 years old, you’ll need to track them and reach out to participants as they near the 2-year mark.

When can a SIMPLE IRA rollover occur?

While there is no absolute deadline for completing the conversion process, it’s important to understand that SIMPLE IRAs are calendar-year plans and can’t be terminated mid-year. Moreover, since you can’t have a SIMPLE IRA and another retirement plan in place at the same time, that means if you want to convert to a 401k for next year, you’ll have to terminate your SIMPLE IRA before the end of the current year. Employees can then start contributing to their new 401k starting January 1.

Are their tax implications of performing a SIMPLE IRA rollover?

Both SIMPLE IRAs and 401ks are tax deferred plans that allow workers to make pre-tax contributions from their paychecks. Workers then have to pay income tax on the funds when they’re withdrawn (except in the case of a Roth 401k) and possibly an additional tax if they’re not at least age 59 ½.

When employees rollover their SIMPLE IRA balances into a 401k, the transfer is tax free except in certain situations. As we mentioned earlier, employees can complete a tax-free rollover into your new 401k as long as they have participated in the SIMPLE IRA for 2 years. If they don’t comply with this rule and transfer the money sooner, they’ll have to include the amount of their withdrawal in their taxable income for the year and pay taxes on it.

How to Best Rollover a SIMPLE IRA into a 401k

After reading this, if you’re ready to convert your SIMPLE IRA to a 401k, there are several steps to get your new retirement plan set up correctly. Before completing your SIMPLE IRA rollover, read our next article on starting a 401k to learn how to establish a plan, whether you choose to set it up yourself or partner with a TPA.

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