Converting a SIMPLE IRA to a 401(k) for Greater Contributions and Flexibility

When first starting out, many business owners decide to offer a retirement plan to themselves and their employees. While there are many (many!) options for doing so, one of the easiest to implement is a SIMPLE IRA. However, after a few years in business, while trying to attract and retain employees, some have found that the SIMPLE IRA is not flexible enough to meet all of their business and employee needs. On the other hand, 401(k) plans, especially when paired with a profit sharing plan, offer the most flexibility and higher contribution limits of their defined contribution brethren.

It used to be that to convert from a SIMPLE IRA to a 401(k) you had to wait until the end of the year (and we mean the exact end of the year—December 31st) to terminate it and then adopt a 401(k) on January 1st. But that’s no longer true. SECURE 2.0 allowed mid-year conversions from a SIMPLE IRA to a safe-harbor 401(k) starting in 2024 if a few rules were followed:

  1. You have to terminate the SIMPLE IRA by September 30th of that year, and adopt a safe-harbor 401(k) the next day. For example, you could terminate a SIMPLE IRA on March 31st and begin the safe-harbor 401(k) on April 1st.

  2. You have to provide at least a 30-day in advance notice of the termination of the SIMPLE IRA, and another at least 30-day advance notice of the establishment of a safe-harbor 401(k).

  3. The rules which previously prohibited a participant in a SIMPLE IRA from rolling over their account balance to a 401(k) if the first SIMPLE contributions occurred less than 2 years ago has been revoked. Now, all SIMPLE IRA monies can be directly rolled over to a 401(k) or 403(b) plan.

  4. Employers must continue contributing to the SIMPLE IRA up to the termination date for all eligible participants.

  5. You or your TPA or other advisor must calculate the maximum limit for the conversion year. To do this, you take the number of days from January 1st through the termination date of the SIMPLE IRA, divide by 365, and multiply by the SIMPLE IRA limit for that year (for 2025, that limit is $16,500). Thus, if the SIMPLE IRA terminated on March 31, 2025, the calculation for the SIMPLE contribution limit would be 90 / 365 days x $16,500 = $4,068.49. Similarly, we have to calculate the 401(k) maximum contribution from April 1, 2025 through December 31, 2025. The full year limit is $23,500. Thus, that partial-year limit is 275 / 365 days x $23,500 = 17,705.48. The combined limit for a participant is thus the sum of the SIMPLE IRA and 401(k) calculated limits. In our example, it would be $21,773.97. Of course, if the participant is eligible for a catch-up or the new “super catch-up” contribution, you have to do a bit more math.

How to Decide if Converting a SIMPLE IRA to a Safe-Harbor 401(k) is Right for Your Organization

We always advise employers to examine their organization’s and employee needs simultaneously. Here are some questions that might help drive your thoughts:

  1. Do the owners wish to have more contributed on their behalf?

  2. Is the organization trying to recruit and retain good employees but having difficulty keeping their top performers?

  3. Has the business expanded beyond the 100-employee legal limit to sponsor a SIMPLE IRA?

  4. Has the organization and its employees simply outgrown the SIMPLE?

With these and other answers, we’re finding that many current SIMPLE IRA plan sponsors recognize that a conversion to a safe-harbor 401(k) may be beneficial to both the business and its employees.