Is it time to replace your SIMPLE IRA Plan or SEP-IRA with a 401(k)?

If your business or workforce is changing, it may be time to consider whether a 401(k) is now a better option for you and your employees than the SIMPLE IRA Plan or SEP you currently offer. 

Why consider a 401(k)?

A 401(k) Plan can offer you more options so that you can elect plan provisions that fit your situation. And, since a 401(k) Plan can be amended it provides you with more flexibility to make changes to the plan in the future as circumstances for your business or workforce change. The chart below compares some of the key features and differences of a 401(k) Plan, a SIMPLE IRA Plan and a SEP-IRA. 

Here are some of the key features under a 401(k) Plan that may make it more beneficial to you and your employees than a SIMPLE IRA Plan or a SEP-IRA:

  • Allows participants to contribute to the plan thus increasing savings.
  • The plan sponsor may make a matching or profit sharing contribution that is fixed or discretionary, unless adopting a safe harbor plan requiring a fixed contribution.
  • Allows for eligibility conditions that can help reduce plan administration costs where there is frequent turn-over, subject to the SECURE Act's Long Term Part Time Employee rules.
  • Permits exclusion of certain employee groups when coverage testing is passed.
  • Vesting may be earned over time, for certain contributions, saving the employer money and helping to retain employees.
  • Participant elective deferral contribution limits are higher than IRA limits.
  • Plan distribution rules are restrictive keeping assets in the plan and helping protect retirement savings.

How to make the change

SIMPLE IRA Plan to a 401(k) Plan

The SECURE 2.0 Act of 2022 relaxed the rules for replacing a SIMPLE IRA Plan with a 401(k) Plan – as long as it's a safe harbor 401(k) plan. Starting in 2024, converting from a SIMPLE IRA to a safe harbor 401(k) is allowed midyear, and the 2-year rollover limitation for SIMPLE IRAs converting to a 401(k) or 403(b) plan is waived under certain conditions. Prior to 2024, mid-year conversions were not allowed because of SIMPLE IRA exclusive plan rules. NOTE: conversions to regular (non-safe-harbor) 401(k)s are still allowed, but don't qualify for the mid-year waiver.

Moving from a SIMPLE IRA Plan to a 401(k) Plan requires the plan sponsor to contact their SIMPLE IRA plan financial institution and payroll vendor and advise them that contributions will cease at the determined time. The financial institution will inform the plan sponsor of any additional steps that may be required to cease contributions and terminate the plan. The plan sponsor should document the actions taken but there is no requirement to contact the Internal Revenue Service (IRS).

For conversions to a safe harbor 401(k) plan, participants in the SIMPLE IRA Plan must be notified at least 30 days in advance of the effective date of the discontinuance of contributions to the SIMPLE IRA Plan. For example, for a SIMPLE IRA Plan that ceases contributions effective July 1, 2024, the participants must generally receive notice of plan termination by June 1, 2024. Participants in the SIMPLE IRA Plan may elect to leave their assets in the SIMPLE IRA or roll them over to the employer's newly established 401(k). New under SECURE 2.0, participants no longer need to wait until two years have passed since the participant first participated in the employer's SIMPLE IRA Plan to do this provided the rollover is made into the new 401(k) plan which is subject to the 401(k) elective deferral distribution restrictions. The elective deferral limits for the 401(k) will be prorated for the year of conversion.

SEP-IRA to a 401(k) Plan

Moving from a SEP-IRA to a 401(k) Plan requires the plan sponsor to contact their financial institution to inform them the SEP-IRA contributions will cease. The financial institution will inform the plan sponsor of any additional steps that may be required to terminate the plan. Generally, it’s prudent to notify employees that the SEP-IRA is being discontinued. The plan sponsor should document the actions taken but there is no requirement to contact the Internal Revenue Service (IRS). SEP-IRA holders may choose to leave their assets in their SEP-IRA account or rollover their balance to the employer’s newly established 401(k) Plan.

Setting up a new 401(k) 

If you’re interested in pursuing a 401(k) Plan, talk to your financial or tax advisor to help determine if moving to a 401(k) Plan is right for your business. Keep in mind it’s best to get the wheels in motion a few months before you want the plan to go live – in order to meet required participant notification requirements. And, if your new plan will benefit from certain 401(k) Plan provisions such as safe harbor or automatic enrollment – those require advance participant notification as well.

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2024 401(k) Plan SIMPLE IRA Plan SEP-IRA
Eligibility

Generally, age 21 and 1000 hours of service in 12 months or any more liberal conditions. 

May exclude certain classes of employees if minimum coverage testing can be passed.

For long term part time employees, 500 hours/year in a 3 year period, reduced to a 2 year period beginning in 2025.

Employees earning at least $5,000 in any 2 preceding years and expected to earn at least $5,000 in the current year (or any less restrictive conditions defined by the employer). 

May exclude only union employees and nonresident aliens with no U.S. income from the employer.

Age 21, has worked for the employer in at least 3 of the last 5 years, and received at least $750 in compensation from the employer during the year. 

May exclude only union employees and nonresident aliens with no U.S. income from the employer.

Contributions

Participants: pre-tax elective deferrals, Roth deferrals or post-tax voluntary.

Employer: discretionary or fixed* match based on elective or Roth deferrals and/or a profit sharing contribution.

*Safe harbor 401(k) employer contributions must be fixed generally up to a 4% match or a 3% non-elective.

Participants: pre-tax salary reduction contributions and Roth deferrals.* 

Employer (required): (1) match that is dollar for dollar on deferrals up to 3%, or (2) a nonelective contribution that is 2% of each eligible employee’s compensation. SECURE 2.0 allows an additional discretionary employer contribution of 10% of compensation up to $5,000 adjusted for the cost of living each year.

*SECURE 2.0 allows participants to designate SIMPLE IRA contributions as Roth amounts beginning in 2023.

Participants: no contributions are permitted.*

Employer: discretionary contribution allocated uniformly to all eligible employees or an integrated formula.

*SECURE 2.0 allows participants to designate SEP IRA contributions as Roth amounts beginning in 2023.

2024 Contribution Limit

Aggregate of pre-tax and Roth deferrals can’t exceed $23,000 plus $7,500 for participants eligible to make age 50 and older catch-up contributions. 

Total employee and employer contributions cannot exceed the lesser of 100% of compensation or $69,000 per employee (plus the additional catch-up for eligible employees).

Salary reduction contribution limit is the lesser of 100% of gross compensation or $16,000 plus $3,500 for participants eligible to make age 50 and over catch-up contributions.

SECURE 2.0 allows Qualified employers sponsoring SIMPLE plans to increase the deferral and catchup limits to 110% of the 2024 limits adjusted each year for cost of living. Qualified employers include those with: (1) 25 or fewer employees, or (2) more than 25 employees who make either a 4% match or 3% non-elective contribution.

No salary reduction contributions or elective deferrals are permitted.

Employer contribution cannot exceed the lesser of 25% of total gross compensation of eligible participants or $69,000.  

Vesting

Six-year graded or three-year cliff or any vesting that is more liberal.

Safe harbor contributions are generally subject to 100% immediate vesting.

100% immediate

100% immediate

Distributions

Severance from employment, death, disability, at age 59½ or at plan termination. 

In-service withdrawal of deferrals for hardship or for other contributions at a stated age or after a fixed number of years.

Any time upon request.

Any time upon request.

Early Withdrawal Penalty

10% Early Withdrawal Penalty on pre-tax cash distributions unless the participant is age 59½ or older (or another exception applies).

25% Early Withdrawal Penalty on pre-tax distributions taken within two years of the date the individual first begins participating in the SIMPLE IRA unless the IRA holder is age 59½ or older, rolls into another SIMPLE IRA plan, (or another exception applies). Beginning in 2024, this penalty is waived if rolled to 401(k) or 403(b) plan maintained by employer. 

10% Early Withdrawal Penalty on pre-tax cash distributions taken after the initial two year period unless the IRA holder is age 59½ or older (or another exception applies). 

10% Early Withdrawal Penalty on pre-tax cash distributions unless the participant is age 59½ or older (or another exception applies).

 

 

 

 

 

 

 

 

 

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Any tax discussion contained in this communication was not intended or written to be used, and cannot be used by the recipient or any other person, for the purpose of avoiding any Internal Revenue Code penalties that may be imposed on such person. Any tax discussion contained in this communication was written to support the promotion or marketing of the transactions or matter discussed herein. Any taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.

Neither Voya Financial® or its affiliated companies or representatives offer legal or tax advice. Please seek the advice of a tax attorney or tax advisor prior to making a tax-related insurance/investment decision.

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