January 1, 2024
Summary: While both plans have distinct advantages, growing firms will often convert their SIMPLE IRA offerings to 401(k) plans due to the higher contribution limits and increased flexibility.
Comparing your organization’s retirement planning options
Growing companies that offer SIMPLE IRA plans to their employees will frequently find that they have outgrown the requirements for this strategy, meaning they’ll have to transition to a new solution.
Often, as your company grows, converting your SIMPLE IRA to a 401(k) plan might make more sense for your business, particularly due to the numerous advantages 401(k) plans have over other retirement saving options.
For this reason, it’s critical for business leaders to understand the different pros, cons and requirements that surround each retirement planning option.
What is a SIMPLE IRA?
A savings incentive match plan for employees (SIMPLE) IRA is a retirement savings plan that allows employees and employers to contribute to a traditional IRA as a benefit for employees.
SIMPLE IRAs are like a cross between a traditional IRA and a 401(k), incorporating all the benefits of a normal IRA plan while empowering employers to make tax-advantaged contributions to employee accounts.
Generally, SIMPLE IRAs are advantageous for small employers who are not currently sponsoring another retirement plan, such as a 401(k), because they are easy to set up and relatively inexpensive to maintain.
What is a 401(k)?
A 401(k) is a type of qualified profit-sharing retirement plan that allows employees to contribute a portion of their wages to their individual accounts, usually in conjunction with a contribution from their employer.
401(k)s are especially flexible and advantageous for employers because they offer tax-advantaged financial incentives to employees through retirement benefits. Similarly, they act as a means for the business’s ownership to draw from its equity in a way that defers taxes until retirement.
What are the key differences between a SIMPLE IRA and a 401(k) plan?
| 401(k) | Simple IRA | |
|---|---|---|
| Number of employees required | 1 or more | 100 or less |
| Employee contribution limits (2023) | $23,000 | $16,000 |
| Age 50 and over catch-up | $7,500 | $3,500 |
| Employer contributions | Discretionary | Required |
| Employer contribution vesting | May be subject to vesting | Vested immediately |
| Roth contributions permitted | Yes | Yes |
| Loans permitted | Yes | No |
| Profit-sharing contributions | Yes | No |
| May be paired with other plans | Yes | No |
| Annual compliance testing* | Required | Not required |
| Annual tax filing | Form 5500 | N/A |
*A Safe Harbor 401(k) plan requires employers to make a fully vested mandatory match or non-elective contribution. A 401(k) Safe Harbor plan is exempt from annual ADP/ACP testing and may avoid Top-Heavy requirements if the plan allows for only deferrals and Safe Harbor Match or Non-Elective contributions.
The key difference between these two retirement plans is that SIMPLE IRAs are intended as a stop-gap for small businesses who don’t want to commit to a more cost-intensive retirement plan like a 401(k).
For this reason, SIMPLE IRAs have an upper limit on the number of employees they will cover and stricter requirements for qualifying for the trade-off of less overhead, such as no annual tax filing requirements, no annual compliance testing, minimal account fees and overall lower setup costs.
Meanwhile, 401(k) plans are intended to be used by employers who want a greater degree of control over the benefits offered to employees, meaning you will have more flexibility in how you contribute to your employee’s accounts, whether loans or profit-sharing are available and more.
Key benefits of switching from a SIMPLE IRA to a 401(k)
| 401(k) | Simple IRA |
|---|---|
| Many employer-match and non-elective contribution formulas. | Employer match: required to match each employee's salary reduction up to 3% of the employee's compensation OR |
| Combined employee/employer annual contribution limit: $69,000. | A non-elective contribution of 2% of each eligible employee's compensation (regardless of if employee is contributing) |
Typically, 401(k)s are advantageous over SIMPLE IRAs when higher contribution limits or flexibility in how you structure your plan are vital considerations.
For this reason, there are several important topics you should consider when deciding whether to switch from a SIMPLE IRA to a 401(k):
- Continued retirement saving availability — Employers who grow beyond 100 employees will no longer be eligible to maintain a SIMPLE IRA, meaning the most immediate benefit of a 401(k) plan is the ability to continue providing retirement benefits to your employees as you scale.
- Higher contribution limits for employees and owners — The employee contribution limits for 401(k) plans ($23,000 for 2024) are significantly higher than those for SIMPLE IRAs ($16,000). Additionally, SIMPLE IRAs place a cap of 2-3% on employer contributions, while 401(k)s allow for additional flexibility in how you contribute to your employees’ retirement plans.
- Greater flexibility in plan design and benefits — In addition to the increased contribution limits, 401(k) plans allow for additional flexibility in meeting your needs as well as the needs of your employees. For example, 401(k)s give employers more options for vesting schedules, allow for profit-sharing components and even allow participants to take out loans against their retirement funds.
How to convert a SIMPLE IRA into a 401(k) plan
Most SIMPLE IRAs operate on an annual basis, meaning that they are active from January to December of the calendar year and need to be renewed for the following year. Historically, converting your business from a SIMPLE IRA plan to a 401(k) plan was generally a process that would begin in Q4 in preparation for the start of the next calendar year.
However, the SECURE 2.0 Act passed in 2022 made several changes to SIMPLE plans that affected the conventional conversion process.
In addition to adjustments to employee matches and annual contribution limits, the Act specifically notes the following change:
The SECURE 2.0 Actallows an employer to replace a SIMPLE IRA plan with a SIMPLE 401(k) plan or other 401(k) plan that requires mandatory employer contributions during a plan year, and is effective for plan years beginning after December 31, 2023.
With this new rule in place for the 2024 calendar year, employers that currently offer SIMPLE IRA plans can now elect to replace their SIMPLE IRAs with either a traditional or a qualified automatic enrollment arrangement (QACA) safe harbor 401(k) plan at any point during the year.
Note, however, that while it has yet to be explicitly stated by the IRS, it’s still wise to provide the conventional 60-day notification period to your employees even if you elect to make the switch mid-year.
For this reason, you’ll want to plan ahead for when and how you intend to convert your SIMPLE IRA plan into a 401(k).
Additionally, you should note that employees are restricted to an aggregate elective deferral limit (including for catch-up contributions) during the year you make the switch.
This means you’ll have to take the time your employees are covered by the SIMPLE IRA plan and split the difference with the time they will be covered by the 401(k) plan to determine their maximum elective deferral limit.
For example, if you choose to switch plans at the very start of Q2, you will take the percentage of the number of days in Q1 (90/365 days) and multiply it by the SIMPLE IRA plan’s limit ($16,000), then add that to the percentage of the number of days in the rest of the year (275/365) multiplied by the 401(k) plan’s deferral limit ($23,000).
Or, put another way:
Aggregate Elective Deferral Limit per Employee
- Calculate the percentage of days in Q1
(90 days / 365 days = 0.2465) - Multiply the percentage by the SIMPLE IRA plan's limit
($16,000 x 0.2465 = $3,944) - Calculate the percentage of the number of days in the rest of the year
(275 days / 365 days = 0.7534) - Multiply that percentage by the 401(k) plan's deferral limit
($23,000 x 0.7534 = $17,328.20) - Add the 2 dollar amounts together
($3,944 + $17,328.20 = $21,272.20)
Rolling over or converting your employee’s funds from a SIMPLE IRA to a 401(k)
Once you decide to switch retirement plans, the process of replacing the plan isn’t particularly complicated. In essence, it comes down to a few key steps:
- Decide to switch retirement plans.
- Provide notice to your employees and your SIMPLE IRA provider.
- Help your employees roll their existing SIMPLE IRA funds either (a) into their new 401(k) account, (b) into any non-Roth IRA, or (c) into a Roth IRA, with the added requirement of including any untaxed money rolled over in your income.
Speak with an advisor to make the best choice for your business and employees
Both SIMPLE IRAs and 401(k) plans are excellent choices for helping your employees plan for their retirement. However, there can be certain factors that may make one plan more advantageous for your business and employees over the other.
For example, growing firms that are approaching the 100-employee cap on SIMPLE IRAs should strongly consider switching to ensure they remain compliant. Similarly, firms that want to contribute more to employee funds, or who want to prioritize flexibility in their benefit offerings, may find the inherent flexibility of 401(k) plans more appealing.
Whatever your situation, it’s important to note that choosing a retirement plan for your employees is a decision that could benefit from the advice and guidance of an experienced financial professional.
By speaking with a financial advisor with a deep knowledge of your business and your financial needs, you can better determine which plan will work best for you.
To learn more about how Associated Bank can provide guidance on, and support for, your retirement plan options, find a Retirement Plan Consultant near you.
