The SIMPLE IRA Isn’t So Simple After All

SIMPLE IRAs, first offered in 1997, were created with the intent to be a low-cost, easy-to-administer, employer-sponsored retirement plan for small businesses. For more than 25 years, SIMPLEs have helped small business owners and their employees save for retirement. The wide-ranging retirement legislation known as SECURE Act 2.0 includes several new features affecting these plans—making SIMPLE IRAs a lot less “simple.”

The Small Business Job Protection Act of 1996 saw the creation of the Savings Incentive Match Plan for Employees (SIMPLE) IRA. A SIMPLE plan is available for employers with 100 or fewer employees who received at least $5,000 in compensation from the employer in the prior year. SIMPLEs are designed to be administratively easier and lower cost versus a 401(k) plan. An employer can establish a SIMPLE by completing an IRS form (5305-SIMPLE or 5304 SIMPLE), while each eligible employee completes SIMPLE-IRA enrollment paperwork.

All SIMPLE plans must operate on a calendar year basis (January 1 − December 31), and it must be the sole retirement plan maintained by the employer (referred to as “exclusive plan rule”). Before January 1, 2024, an employer had to maintain a SIMPLE plan for the entire calendar year. Now, an employer can terminate a SIMPLE plan at any time during the year by replacing a terminated plan with a Safe Harbor 401(k).

SIMPLEs allow for both participant elective deferrals and employer contributions. An employer contribution can be a fully vested 3% matching contribution or a 2% non-elective contribution. Each eligible participant can defer (it’s optional) a portion of their compensation into their SIMPLE account. For 2024, the employee salary deferral limit is $16,000, plus an additional $3,500 catch-up contribution (for those participants age 50+).

These rules were both straightforward and simple. Then came SECURE Act 2.0, whereby an employer could allow for increased employee deferrals and/or employer contributions. Plus, participants can now contribute deferrals and/or employer contributions on a Roth basis into a SIMPLE Roth IRA.

Here is what you need to know about SECURE Act 2.0 and SIMPLE IRAs.

Increased Employee Deferral Limits

Secure 2.0 increases the SIMPLE IRA annual salary deferral limit and the age 50 catch-up contribution for certain SIMPLE plans by 10%. Starting in 2024, both under-50 limits and catch-up limits will increase by 10% above the $16,000 and $3,500 limits—but only for those employers with 25 or fewer employees in the preceding calendar year.

This increased participant deferral limit applies automatically for those employers with up to 25 employees (those employees who received at least $5,000 of compensation in the preceding calendar year). For small employers (up to 25 employees), the 2024 deferral limit for is increased to $17,600 ($16,000 x 10%), and the age 50+ catch-up limit is $3,850 ($3,500 x 10%) totaling $21,450.

Employers with more than 25 employees can elect to apply the increased deferral limits. Such employers (those with 26 or more employees) can allow for the additional 10% only if they provide for a fully vested 4% (instead of 3%) matching contribution or a 3% (instead of 2%) non-elective contribution. Furthermore, an employer making an election to apply increased deferral limits must notify eligible employees of such increased limits.

A two-year grace period is generally allowed for an employer that increases its employee count to more than 25.

Increased Employer Contributions

Also beginning in 2024, an employer can make an additional non-elective contribution to all eligible employees who have at least $5,000 of compensation for the year. This (additional) contribution can be up to 10% of compensation, but no more than $5,000. It’s even available to those employers making their “normal” employer contribution as a matching contribution.

Increased Catch-Up Contribution Limit (Certain Employees)

The catch-up limit for certain older participants, specifically those age 60-63, will increase effective January 1, 2025. While the age 50 catch-up limit for participants (up to age 59) will remain somewhat easy to determine; the catch-up limits will need to be closely watched for those participants aged 60, 61, 62, and 63 by the end of each year. Increased catch-up limits will revert (back) to generally applicable “age 50” limits beginning with the taxable year in which the eligible participant attains age 64. Therefore, a Plan or their SIMPLE IRA provider will need to track not only when a participant attains age 50 (age 50 catch-up), but also ages 60-64 for the new, increased catch-up limit.

The increased catch-up limit (age 60-63) is the greater of $5,000 (indexed) or 150% of the “regular” age 50 catch-up limit (indexed). For those four tax years (age 60-63), eligible individuals will be permitted to make catch-up contributions in an amount equal to the greater of $5,000 or 150% of the catch-up limitation that would be in effect. For example, if the SIMPLE IRA age 50 catch-up limitation is $4,000 in 2025, the limitation for someone age 60-63 would be $6,000 in that same year. The increased limit applies to the calendar years in which an individual turns 60, 61, 62, or 63. The higher limit no longer applies to the calendar year in which an individual turns age 64.

Roth SIMPLE IRA (Employee and Employer Contribution)

Simple IRA participants, effective January 1, 2023, have had the ability to make salary deferral contributions (to their SIMPLE IRA) on a Roth basis. Like a Roth 401(k) deferral, a SIMPLE participant must make an election to have the contribution treated as a Roth; contributions are irrevocable and considered taxable income.
Also, effective January 2023, SIMPLE IRA participants can elect to have employer contributions (match or non-elective) made on a Roth basis.
Both employee and employer Roth contributions are an optional plan provision.
Employee salary reduction contributions are reported on Form W-2.
Employer-matching or nonelective contributions are reported on Form 1099-R.
It appears SIMPLE IRA contributions seemingly count toward a participant’s Roth IRA contribution limit. The IRS has stated this will be addressed in future guidance.

The creation of SIMPLE IRA employee and/or employer Roth contributions speeds up as opposed to creating a new tax planning opportunity. Why? SIMPLE IRA funds have always been eligible to convert to a Roth IRA, although there was a “holding” period. A participant needed to wait two years (referred to as the “two-year hold rule”) or be assessed a 25% penalty tax before converting SIMPLE funds to a Roth IRA. Now, SIMPLE participants, if the plan offers, can direct their salary deferrals and/or direct employer contributions into a SIMPLE Roth account, thereby bypassing the two-year holding period.

Qualified Student Loan Payments Eligible for Match.

Effective for plan years starting after Dec. 31, 2023, SIMPLE Plans can (it’s optional) make matching contributions with respect to a participant’s Qualified Student Loan Match as if loan repayments were being made directly to the plan.

Replacement of SIMPLE IRA Mid-Year with Safe Harbor 401(k) Plan

A SIMPLE IRA must be the only plan an employer maintains for the year—referred to as the “exclusive plan rule.” SECURE Act 2.0, however, effective for 2024, allows for a SIMPLE IRA plan to be terminated and replaced mid-year with a Safe Harbor 401(k) or Safe Harbor 403(b). In other words, a plan sponsor can now terminate their SIMPLE IRA plan at any time during the year and thereby replace the plan with a Safe Harbor 401(k).

What you need to know about terminating a SIMPLE IRA plan and replacing it with a Safe Harbor 401(k):

An employer must formally terminate a SIMPLE IRA plan in writing and specify the termination date.
An employer must notify participants about the plan termination at least 30 days before plan termination.
An eligible replacement plan can be a SIMPLE 401(k), Safe Harbor 401(k), 401(k) with a qualified automatic contribution arrangement (QACA), or a Starter 401(k). Establishing a replacement plan is an exception to the exclusive plan rule prohibiting both a SIMPLE IRA and another retirement plan in the same calendar year, as long they are not active simultaneously.
An employer must also issue participants a Safe Harbor 401(k) notice. This notice must be distributed to eligible employees at least 30 days prior to the plan’s start date and disclose the weighted salary deferral limits.
Participant salary deferrals are not permitted after the determination date. However, the employer must still make matching compensation (based on the participant’s compensation through the termination date).
Under current law, participants cannot roll over assets from their SIMPLE IRA to another plan within the first two years of participation without being hit with a 25% penalty tax, unless an exception applies. Starting with the 2024 plan year, SECURE 2.0 will, under certain circumstances, waive the penalty. For example, when an employer terminates their SIMPLE Plan and establishes a Safe Harbor 401(k) (or another eligible replacement plan), a rollover between the SIMPLE IRA plan (now terminated) and the new plan is permitted if the funds rolled over are subject to 401(k) distribution restrictions (e.g., age 59 ½, death, severance of employment, etc.).
When a SIMPLE IRA plan is replaced by a Safe Harbor 401(k) plan mid-year (or another eligible replacement plan), the total participant’s elective deferrals must not exceed a special weighted average of the limits applicable for each plan type during the transition year. In other words, the annual salary deferral limits are different for each of the two plan types. Therefore, under these new rules, a participant’s annual deferrals limit will be prorated (by day) between the SIMPLE IRA plan and 401(k) replacement plan for the year.

This excerpt from IRS notice 2024-02 provides additional details:

Q: When a SIMPLE is replaced by Safe Harbor 401(k) mid-year, how are elective contribution limits determined under SH 401(k)?

A: When a SIMPLE plan is replaced by Safe Harbor 401(k) mid-year, the total amount that may be contributed as salary reduction contributions under terminated SIMPLE plan and elective contributions under Safe Harbor 401(k) may not exceed the weighted average of the salary reduction contribution and elective contribution limits for each of those plans (weighted by how many of the 365 days in the transition year each plan was in effect). Thus, the total amount that may be contributed as elective contributions to the safe harbor section 401(k) plan is equal to:

Annual limit on salary reduction contributions under a SIMPLE plan for year (taking into account catch-up contributions, multiplied by a fraction = to the number of days SIMPLE was in effect for that year divided by 365, plus
Annual limit on elective contributions under a 401(k) for the year, under 402(g), multiplied by a fraction = to the number of days Safe Harbor plan was in effect for that year divided by 365, minus
Any salary reduction contributions under SIMPLE IRA for the year.

Questions? Please contact your Lord Abbett representative at 888-522-2388.

LCRAX

Class A

Core Fixed Income Fund

The Lord Abbett Core Fixed Income Fund seeks to deliver current income and the opportunity for capital appreciation. View portfolio and performance info.

Learn More

LAPLX

Class A

Core Plus Bond Fund

The Lord Abbett Core Plus Bond Fund invests in a wide range of fixed income securities with select allocations to non-U.S. debt securities. View portfolio.

Learn More

About the Author

Brian Dobbis, QKA, QPA, QPFC, TGPC

Retirement Solutions Lead

Important Information

The value of investments and any income from them is not guaranteed and may fall as well as rise, and an investor may not get back the amount originally invested. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon, and risk tolerance.

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, recommending to another party any transaction, arrangement, or other matter.

The information presented in this section is intended for general information and is not intended to be relied upon and should not be relied upon, as financial, legal, tax, or accounting advice for any particular investor. We strongly recommend that you contact your financial, legal or tax advisor regarding your particular tax situation.

A 401(k) plan is a qualified plan that includes a feature allowing an employee to elect to have the employer contribute a portion of the employee’s wages to an individual account under the plan. The underlying plan can be a profit-sharing, stock bonus, pre-ERISA money purchase pension, or a rural cooperative plan. Generally, deferred wages (elective deferrals) are not subject to federal income tax withholding at the time of deferral, and they are not reported as taxable income on the employee’s individual income tax return. A safe harbor 401(k) plan is similar to a traditional 401(k) plan, but, among other things, it must provide for employer contributions that are fully vested when made.

A 403(b) plan, also known as a tax-sheltered annuity plan, is a retirement plan for certain employees of public schools, employees of certain Code Section 501(c)(3) tax-exempt organizations, and certain ministers. A 403(b) plan allows employees to contribute some of their salary to the plan. The employer may also contribute to the plan for employees. A safe harbor 403(b) plan is similar to a traditional 403(b) plan, but, among other things, it must provide for employer contributions that are fully vested when made.

Plans of deferred compensation described in IRC section 457 are available for certain state and local governments and non-governmental entities tax-exempt under IRC Section 501. They can be either eligible plans under IRC 457(b) or ineligible plans under IRC 457(f). Plans eligible under 457(b) allow employees of sponsoring organizations to defer income taxation on retirement savings into future years.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years, and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax-deductible, but withdrawals during retirement are generally tax-free.

A SIMPLE IRA is a retirement plan that may be established by employers, including self-employed individuals. The employer is allowed a tax deduction for contributions made to the SIMPLE. The employer makes either matching or nonelective contributions to each eligible employee’s SIMPLE IRA, and employees may make salary deferral contributions.

A Traditional IRA is an individual retirement account (IRA) that allows individuals to direct income, up to specific annual limits, toward investments that accumulate tax-deferred. Contributions to the traditional IRA may be tax-deductible depending on the taxpayer’s income, tax-filing status, and other factors.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.