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A recent call with a financial advisor in Florida is representative of a common question on replacing a SIMPLE plan with a safe harbor 401(k) plan mid-year and the two-year rollover rule.
Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans, and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security, and Medicare. This is where we highlight the most relevant topics affecting your business.
“If a client terminates their SIMPLE IRA Plan mid-year and starts a safe harbor 401(k) plan, how are funds that are rolled into the 401(k) plan treated if the participant has not participated in the SIMPLE IRA plan for two years? ”
Generally, any withdrawal from a SIMPLE IRA within two years of the individual’s initial participation in the SIMPLE IRA plan is subject to a 25% early distribution penalty. Further, the amount is not eligible for rollover to a non-SIMPLE IRA during the two-year waiting period. However, Section 332 of the SECURE Act 2.0 (S 2.0) modified this rule for an employer that replaces its SIMPLE IRA plan mid-year with a safe harbor 401(k). (1) In that specific scenario, the SIMPLE IRA owner can roll over the account to the newly established safe harbor 401(k) without triggering the early distribution penalty, regardless of the two-year waiting period. Distribution restrictions in the new plan, however, apply to the rollover.
In some plans, depending on the language in the plan document, assets rolled into a 401(k) plan may be distributed at any time. However, Section 332(b) of S 2.0 requires that amounts rolled into a 401(k) [or 403(b) plan] from a terminating SIMPLE IRA plan within the first two years of participation must be subject to the distribution limitations that apply to elective deferrals outlined in IRC §401(k)(2)(B) or 403(b)(11) (see Notice 2024-2, Q&A G-4). Specifically, these rules provide that the amount rolled over can only be distributed, as long as permitted by the plan document, for the following purposes:
Age 59 ½;
Hardships;
A qualified reservist distribution;
Severance from employment;
Death;
Disability;
Plan termination;
For certain lifetime income investments; and
As qualified long-term care distributions.
The plan would have to separately account for the SIMPLE IRA rollover to ensure compliance with the restrictions.
It is important for plan sponsors who are terminating their SIMPLE IRA plan mid-year and starting a new safe harbor 401(k) plan to make sure that any rollovers from the SIMPLE IRAs are being treated, for distribution purposes, the same as elective deferrals.
(1) A replacement "safe harbor plan" means a qualified cash or deferred arrangement which meets the requirements of paragraph (11), (12), (13), or (16) of IRC §401(k).