By: Scott M. Cloud, MBA, CPC

There are several different types of retirement plans from which business owners can choose to enable themselves and their employees to save for retirement. For a listing of retirement plan options and a description of each, please see our article Which Type of Retirement Plan is the Best Fit for Your Business? Many business owners start off with a SIMPLE IRA but eventually outgrow it in favor of a Safe Harbor 401(k) Plan for any number of reasons, including:

1) They wish for themselves and their employees to be able to make salary deferral contributions up to the higher limits of a 401(k) plan,

2) They wish for themselves and their employees to be able to make salary deferral contributions on a Roth (post-tax) basis rather than only on a pre-tax basis,

3) They wish to make employer contributions that are higher than those permitted in the SIMPLE IRA,

4) They wish to make additional “profit sharing” contributions on an age-weighted basis to favor business owners,

5) They wish to offer a loan feature and/or limit employee distribution options,

6) They’ve exceeded the SIMPLE IRA limit of 100 eligible employees, and/or

7) They feel that the familiarity and cachet of a 401(k) plan have become important for employee recruiting and retention

Terminating the SIMPLE IRA

First, it should be noted that an employer may not fund any other type of retirement plan during the same calendar year in which it maintains a SIMPLE IRA. Changing from a SIMPLE IRA to a Safe Harbor 401(k) Plan can therefore only be done as of the beginning of the next calendar year as long as employees are notified of the SIMPLE IRA plan termination before November 2nd.

From the bottom of the page on the IRS website here, following are the steps that are involved in terminating a SIMPLE IRA:

Step 1: Notify your employees within a reasonable time before November 2 that you’ll discontinue the SIMPLE IRA plan effective the following January 1.

Step 2: Notify your SIMPLE IRA plan’s financial institution and payroll provider that you won’t be making SIMPLE IRA contributions for the next calendar year and that you want to terminate your contributions.

Step 3: You should keep records of your actions, but you don’t need to notify the IRS that you have terminated the SIMPLE IRA plan.

Starting a new Safe Harbor 401(k) Plan

“As businesses grow and mature, it is common to transition from a SIMPLE IRA to a Safe Harbor 401(k) Plan.”

To start the new Safe Harbor 401(k) Plan, the employer should work with a retirement plan financial advisor. To have the 401(k) plan ready to start accepting contributions at the beginning of the next year, the employer should get started setting up the plan no later than mid-November (sooner if possible) to leave plenty of time to 1) design the plan and prepare its plan document, 2) set up the plan’s “Trust” account and investment arrangement, and 3) complete employee enrollments in time for the first payroll of the next year.

Rollovers from the SIMPLE IRA into the new Safe Harbor 401(k) Plan

Employees cannot be required to roll over their balance from the terminated SIMPLE IRA into their account in the new Safe Harbor 401(k) Plan, but many choose to do so in order to consolidate all of their retirement savings in a single account rather than managing separate retirement accounts. The Safe Harbor 401(k) Plan’s financial advisor can assist employees with completing their rollovers.

It should be noted that any distribution – including a rollover – from a SIMPLE IRA is subject to a 25% early withdrawal penalty if the employee’s account has not been in existence for at least two years from the date on which the first deposit was made to the account. Employees should therefore wait until those two years have elapsed before completing a rollover from their SIMPLE IRA to their 401(k) account.

Summary

As businesses grow and mature, it is common to transition from a SIMPLE IRA to a Safe Harbor 401(k) Plan. When transitioning between plans, employers are encouraged to work with a financial professional to help with terminating the existing SIMPLE IRA, establishing the new 401(k) plan, enrolling employees and assisting them with rollovers, and ensuring that the transition is done within the IRS guidelines.