If your business is growing or your 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.
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 SIMPLE IRA Plan, a SEP and a 401(k) Plan.
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:
- 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.
- Allows for eligibility conditions that can reduce plan administration costs where there is frequent turn-over.
- Permits exclusion of certain employee groups when coverage testing is passed.
- Vesting may be earned over time, 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 protecting retirement savings.
HOW TO MAKE THE CHANGE
SIMPLE IRA Plan to a 401(k) Plan – The SIMPLE IRA Plan rules include an exclusivity requirement that states the SIMPLE IRA Plan must generally be the only qualified plan the plan sponsor contributes to during the calendar year. Therefore an employer may not make contributions to a SIMPLE IRA Plan and a 401(k) Plan in the same calendar year. Further a SIMPLE IRA Plan cannot be terminated mid-year; the employer must make all contributions promised to employees for the entire calendar year.
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 end of the calendar year. 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).
Participants in the SIMPLE IRA Plan must be notified at least 60 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 January 1, 2024, the participants must generally receive notice of plan termination before November 2, 2023. Participants in the SIMPLE IRA Plan may elect to leave their assets in the SIMPLE IRA or roll them over to another SIMPLE IRA. After two years have passed since the participant first participated in the employer’s SIMPLE IRA Plan, the participant may also rollover their SIMPLE IRA balance to the employer’s newly established 401(k) Plan.
SEP to a 401(k) Plan – Moving from a SEP to a 401(k) Plan requires the plan sponsor to contact their financial institution to inform them the SEP 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 the SEP IRA 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 year end – in order to meet required participant notification requirements noted above. It also can take 3-4 months to get the 401(k) Plan paperwork signed and new plan set up. 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.
| 401(k) Plan | SIMPLE IRA Plan | SEP | |
| Eligibility | 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. |
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 $600 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. |
Participants: pre-tax salary reduction contributions.
Employer alternatives: (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. |
Participants: no contributions are permitted.
Employer: discretionary contribution allocated uniformly to all eligible employees or an integrated formula. |
| 2023 Contribution Limit | Aggregate of pre-tax and Roth deferrals can’t exceed $22,500 plus $7,500 for participants eligible to make catch-up contributions.
Total contributions to the plan cannot exceed the lesser of 100% of compensation or $66,000. |
Salary reduction contribution limit is the lesser of 100% of gross compensation or $15,500 plus $3,500 for participants eligible to make catch-up contributions | 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 $66,000. |
| Vesting | Six-year graded or three-year cliff or any vesting that is more liberal. | 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. |
| Taxation of distributions | 0% Withholding if the distribution is directly rolled over to another eligible plan or IRA.
20% Withholding from a cash distribution that is eligible for rollover. 10% Withholding from a cash distribution not eligible for rollover unless the participant opts out or elects a higher percentage. 10% Early withdrawal penalty on pre-tax cash distributions unless the participant is age 59½ or older (or another exception applies). |
0% Withholding if the distribution is directly rollover to another eligible plan or IRA.
10% Withholding from a cash distribution that is eligible for rollover unless IRA holder opts out or elects a higher percentage. 10% Withholding from a cash distribution not eligible for rollover unless IRA holder opts out or elects a higher percentage. 25% Early withdrawal penalty on pre-tax cash 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 (or another exception applies). 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). |
0% Withholding if the distribution is directly rolled over to another eligible plan or IRA.
10% Withholding from a cash distribution that is eligible for rollover unless the participant opts out or elects a higher percentage. 10% Withholding from a cash distribution not eligible for rollover unless the participant opts out or elects a higher percentage. 10% Early withdrawal penalty on pre-tax cash distributions unless the participant is age 59½ or older (or another exception applies). |