Secure Act 2.0 Smooths Path for Small-Business Retirement Plan Do-Overs

The law makes it easier to switch from SIMPLE IRAs to a safe harbor 401(k).

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.

During the year of transition, the total amount contributed as salary reduction contributions under the terminated SIMPLE IRA plan and as elective contributions under the safe harbor 401(k) plan cannot exceed the weighted average of the salary reduction contribution and elective contribution limits for each of those plans. This is based on how many days in the transition year that each plan was in effect.

SIMPLE vs. Safe Harbor

Initially, SIMPLE plans were limited to businesses with fewer than 100 employees who earned at least $5,000 in compensation. 

The contribution limits that apply to 401(k)s are higher than those applicable to SIMPLE IRAs. In 2024, for example, the 401(k) limit is $23,000 with a $7,500 catch-up option vs. $16,000 with a $3,000 catch-up option for SIMPLE IRAs.

A safe harbor 401(k) plan must receive 100% vested employer contributions, which can be made in the form of nonelective contributions equal to 3% of compensation, regardless of whether the employee chooses to contribute. In the alternative, the employer can elect to make matching contributions of 100% on the first 3% of compensation and 50% on the next 2% of compensation. When compared to a traditional 401(k), however, the safe harbor 401(k) offers lower administrative costs.

Employers must also make mandatory contributions to SIMPLE IRAs each year — either a 100% match of 3% of the employee’s contributions or a 2% non-elective contribution.

Before Secure Act 2.0, participants in SIMPLE IRAs could not roll contributed amounts over to the SIMPLE IRA for the first two years of participation. When an employer replaces the SIMPLE plan with a safe harbor 401(k), the amounts can be immediately rolled over to the replacement plan so long as that plan is subject to the same distribution restrictions that apply to 401(k)s.

Conclusion

Safe harbor 401(k)s can provide many benefits that the SIMPLE IRA option simply doesn’t offer. Higher contribution limits alone can be powerful when attracting and retaining employees. Now that making the transition has become easier, many employers may wish to evaluate the safe harbor 401(k) option going forward.

Recommended Stories