A Guide to SIMPLE IRAs and 401(k)s for TPAs

By David J. Kupstas, FSA, EA, MSEA

David J. Kupstas, FSA, EA, MSEA

David J. Kupstas, FSA, EA, MSEA Chief Actuary

In the retirement plan world, SIMPLE stands for Savings Incentive Match PLan for Employees. There are SIMPLE IRAs and SIMPLE 401(k)s. Note how the L is from the word Plan and is not the first letter of its own word. That way it’s SIMPLE and not SIMPE. Note also that the term “SIMPLE plan” is redundant since PLan is already part of the SIMPLE acronym. It’s like saying PIN number or ATM machine.

Anyway, an arrangement called SIMPLE ought to be, well, simple, right? As in, the employer ought to be able to administer these themselves or with the help of a financial advisor rather than needing to go out and hire a Third Party Administrator and pay a bunch of fees. As a result, TPAs often are not well-versed on the rules related to SIMPLEs. Why should they be? No one’s going to hire a TPA to help administer their SIMPLE. If you’re going to use a TPA, you might as well have a regular qualified plan and enjoy more flexibility than SIMPLEs afford.

Still, your average TPA will from time to time be faced with questions about SIMPLEs, if for no other reason than to compare them with ordinary qualified plans. With that in mind, we have prepared these notes about SIMPLEs with the hope that they might come in handy next time a TPA needs to answer a “SIMPLE question.” This article covers a lot, but not every single thing.

By the way, SIMPLEs are different from SEPs. Although SEP stands for Simplified Employee Pension, they are not the same thing as SIMPLEs. SEPs are not covered in this article, but they are covered here. SIMPLE IRAs can be thought of as a crude replacement for SARSEPs, which were phased out in the late 1990s.

Fun fact: SIMPLE 401(k)s are technically not even SIMPLE plans. They are qualified plans designed to limit contributions to whatever is available under a SIMPLE IRA. However, we will not be bothered by that distinction and will continue to lump SIMPLE 401(k)s and SIMPLE IRAs together. Throughout this article, we will refer to non-SIMPLE 401(k) plans as “regular 401(k)s.”

SIMPLE IRAs are, of course, not qualified plans. They are IRAs, albeit a special kind.

How SIMPLE IRAs and 401(k)s Are Similar

There are a number of differences between SIMPLE IRAs and SIMPLE 401(k)s. Let’s first talk about how they’re alike. The motivation behind adopting either is to provide a way for employees to save money on a tax-advantaged basis and receive contributions from the employer without having to go through painful, complicated compliance testing.

SIMPLEs are available to employers that had 100 or fewer employees in the prior calendar year who had compensation in excess of $5,000. Employer means the whole controlled group or affiliated service group. A SIMPLE is invalid if one member of the controlled group does not participate. If an employer goes over 100 employees, there is a two-year grace period during which the SIMPLE may continue. For example, if the count exceeds 100 starting in 2023 and stays above 100, the SIMPLE may be maintained in 2024 and 2025 but must stop by 2026. If the employer acquires another company or group of employees, the criteria under Internal Revenue Code Section 410(b)(6)(C) have to be met in order to keep the two-year grace period. (Basically, this means there can’t be a dramatic shift in the employee population other than what occurred through the acquisition, and the 100-employee test would be satisfied if the employer had continued to be a separate employer.) The grace period applies only to SIMPLEs in existence at the time of the acquisition. You can’t start a new SIMPLE after the acquisition and expect to get the grace period.

For any year an employee makes or receives contributions under a SIMPLE, the employee cannot receive contributions under any other qualified plan, SEP, or SIMPLE. This is called the exclusive plan rule. Interestingly, you can receive forfeitures in a qualified plan and not violate this rule. Often, SIMPLE clients will figure out late in the year that they’d like to adopt a defined benefit plan in order to get higher tax deductions. Because of the exclusive plan rule, they will have to wait until the following year. (This sometimes leads to questions about how to “undo” the SIMPLE for that plan year so the DB plan can be adopted. We are not aware of any legitimate way to do this unless the SIMPLE is somehow invalid. Merely wanting a higher deduction does not make the SIMPLE invalid.)

Employees may make elective contributions, also called salary deferrals, to SIMPLEs. For 2023, the limit is $15,500. A catch-up contribution for individuals age 50+ of up to $3,500 may be made. Both of these limits are lower than in regular 401(k) plans. An employee needs to make sure the SIMPLE deferrals plus deferrals in a 401(k) at another job don’t exceed the regular 401(k) deferral limit ($22,500 in 2023). Employees must be given 60 days before the plan year to decide on their contributions for the upcoming year. Additional election periods may be provided. The SIMPLE may have an automatic enrollment feature. Lower-income workers may qualify for a tax credit on elective contributions.

The employer must make either (i) a 2.00%-of-pay nonelective contribution or (ii) a dollar-for-dollar matching contribution up to 3.00% of pay. These amounts are lower than the respective 3.00% and 4.00% contributions found in regular safe harbor 401(k) plans. The plan cannot have both types of contributions. Whether to make the match or the nonelective contribution has to be decided before the employees elect their deferrals; if no election is made, then contributions will be matches. As with regular safe harbor 401(k)s, the SIMPLE employer contribution cannot have a last-day rule or year-of-service requirement. The 3.00% match may be reduced to as little as 1.00% in a SIMPLE IRA in two of every five years. The match must always be 3.00% in a SIMPLE 401(k).

The SIMPLE plan year must be the calendar year. You can’t have a plan year ending, say, June 30 or September 30. Nondiscrimination testing is not required. All contributions must be 100% vested. The top-heavy rules do not apply. There is no overall 25%-of-pay deductible employer contribution limit like the one that applies in regular 401(k)s – only the individual contribution limits described above.

SIMPLE participants are “active participants” for IRA purposes. Thus, contributions to traditional IRAs for SIMPLE participants probably may not be deducted except by the lowest-income employees.

How SIMPLE IRAs and 401(k)s Differ

Some of these differences between SIMPLE IRAs and SIMPLE 401(k)s are significant, while others are relatively minor.

A SIMPLE IRA must cover all employees who have received $5,000 of compensation in any two prior years and are expected to receive $5,000 in the current year. You cannot carve out groups of employees or have an age requirement or an hours of service requirement. On the other hand, the regular qualified plan eligibility rules apply to SIMPLE 401(k)s, which includes the ability to have age or hours requirements or a carveout of selected employee classes. As a result, SIMPLE 401(k)s have to perform Section 410(b) coverage testing, while SIMPLE IRAs do not. A SIMPLE 401(k) may choose not to give nonelective contributions to any eligible employee making less than $5,000 for the year.

The compensation dollar limit ($330,000 in 2023) applies to all SIMPLE 401(k) contributions, but only to nonelective contributions in the SIMPLE IRA.

The Section 415 limits apply to SIMPLE 401(k)s but not to SIMPLE IRAs. This means the total contributions (besides the catch-up contributions) in the SIMPLE 401(k) may not exceed 100% of the employee’s compensation. In theory, it is possible in a SIMPLE IRA for someone with relatively low compensation to exceed the 100%-of-pay limit. In practice, because FICA withholding will have to come off the top, 100% of pay is either not attainable or can be exceeded by only a couple hundred dollars in an extreme case. The annual addition dollar limit ($66,000 in 2023) is not attainable in either type of SIMPLE.

A SIMPLE 401(k) has to have a Form 5500 prepared each year, while a SIMPLE IRA doesn’t.

There is a slight difference in when salary deferrals have to be deposited. For the SIMPLE 401(k), you might have until the 15th business day of the month following withholding from the paycheck, while with the SIMPLE IRA you might have until 30 days after the close of the month of the pay date. In both cases, contributions really need to be made as soon as you are able to do it, which is probably way sooner than the deadlines just described.

Withdrawals are permitted from a SIMPLE IRA at any time. Meanwhile, the normal 401(k) withdrawal rules apply to SIMPLE 401(k)s, which may include hardship and in-service distributions. A 10% early withdrawal excise tax usually applies for distributions taken from SIMPLEs before age 59½. The tax is increased to 25% for distributions taken from SIMPLE IRAs (but not 401(k)s) within two years after the first employer deposit to the SIMPLE IRA.

In a SIMPLE IRA, minimum distributions must begin at age 72 without exception. In a SIMPLE 401(k), active employees who are not more-than-5%-owners do not have to take distributions until they retire. More-than-5% owners and retired employees have to start at age 72.

A SIMPLE IRA cannot be a Roth IRA. On the other hand, Roth deferrals may be made to a SIMPLE 401(k), just as they can be made to a regular 401(k), assuming the plan allows them.

These days, rollovers are permitted fairly freely across most plan types. There are a couple of exceptions with SIMPLE IRAs. If a rollover from a SIMPLE IRA is done within two years after the first employer deposit, the rollover may be only to another SIMPLE IRA. Otherwise, it’s a taxable distribution. A SIMPLE IRA may receive a rollover from a qualified plan only after that two-year period expires. And, after the two-year period, a SIMPLE IRA may be converted to a Roth IRA. A new non-Roth SIMPLE IRA account would have to be established if any future contributions were being made under the SIMPLE. The contributions could not be made to the SIMPLE IRA account that was converted to Roth.

Other differences between SIMPLE IRAs and SIMPLE 401(k)s are as follows:

  • Loans may be permitted in SIMPLE 401(k)s, not in SIMPLE IRAs.
  • Periodic benefit statements must be issued in SIMPLE 401(k)s, not in SIMPLE IRAs.
  • The joint and survivor rules could apply in SIMPLE 401(k)s, not in SIMPLE IRAs.
  • A SIMPLE 401(k) may be converted to a regular 401(k), and vice versa. A SIMPLE IRA may not be converted to or from a SIMPLE 401(k) or a regular 401(k).

Conclusion

Think of the SIMPLE IRA as a retirement plan with training wheels. It may be appropriate for an employer who has never had a retirement plan. After a few years, such an employer might be willing to graduate up to a more complicated qualified plan. The SIMPLE 401(k), in our view, does not seem to have much appeal since it is not much more than a regular 401(k) with stripped-down contribution limits. Why not just have a regular safe harbor 401(k) plan?

It should be mentioned that there are a number of issues that have not been addressed in this article, including leased employees, union employees, plan documents, notice requirements, violation corrections, fiduciary standards, and more. An employer wishing to adopt a SIMPLE may still need access to a qualified expert to help it navigate through some of the thornier issues. Still, SEPs, SIMPLE IRAs, and SIMPLE 401(k)s may present an appealing option for employers desiring a relatively easy, no-frills retirement plan. Once it decides it wants more flexibility or higher deductible contributions, then the employer will wish to partner with a TPA or actuary and explore a profit sharing, regular 401(k), traditional defined benefit, or cash balance plan.

— Topics: 401(k), Retirement, Financial Planning, Third Party Administration, TPA, SIMPLE, IRA, SEP, Roth