SIMPLE IRAs - can employer terminate?

[Guest KFI]

Suppose an Employer sets up a SIMPLE IRA Plan. Before two years have passed, the Employer sets up a 401(k) Plan. Does the exclusive plan requirement apply to SIMPLE IRAs? Assuming that it does, then what happens to the SIMPLE IRA when the Employer sets up the 401(k) Plan? Is it terminated? Is it frozen? Does it convert to individual IRAs? If the Employer does not "officially" terminate or freeze the IRA, is he obligated (or even permitted) to continue making contributions to it after the 401(k)plan is in place?

Part two of this scenario: Suppose that the above occurs before the SIMPLE IRA has been in place for two years. What can the participants do with respect to their SIMPLE IRA accounts? If they roll them into individual IRAs, are they still penalized the 25% (because it is being rolled over earlier than two years)? If so, can they leave the money where it is until two years have passed, and then roll it over and avoid the penalty?

Thanks for any help you can provide.

[Guest Fishchick]

An employer cannot fund both a SIMPLE IRA and a 401k in the same year. If the employer wants to setup a 401k, it should not fund the SIMPLE, or it should wait until the beginning of the next year to start funding the 401k. The SIMPLE IRA plan doesn't require annual contributions and the employer does not have to "terminate" or "freeze" the SIMPLE IRA like it would with a qualified plan. The employer simply stops funding the SIMPLE IRA at the end of the year and that's the end of it.

Participants in the SIMPLE IRA don't have to do anything with their accounts. They cannot roll them over to the new 401k. After the first two years, the participants can consolidate their SIMPLE IRA's with other Traditional IRA's they might have. If they do so within the first two years, however, it would be considered a distribution from the SIMPLE IRA, potentially subject to the 25% penalty. The deposit in the Traditional IRA would be a contribution, not a transfer or rollover.

[Gary Lesser]

I don't entirely agree. If the SIMPLE goes bad because of the 401(k) then the amounts in the SIMPLE are excesses and to avoid the 6% penalty must be removed (with gain) before return due date, or after due date (with penalty, and my best guess is no gain). Amount can not be treated as an IRA contribution ever. The law itself does not treat the SIMPLE as a traditional IRA after 2 years. The money would have to be removed in a correcting distribution to avoid the penalty. Many trustees have problem with this and report it as a 25% penalty situation. I think a heart to heart conversation might cause them to think otherwise, especially if a letter from employer was forwarded to trustee. The coding for a distribution within 2 years contemplates that there are exceptions AND (IMO) this is one of them. [iRC 408(d)(4) & (d)(5) made applicable by 408(p)(1) and 7701(a)(37). Explain to them also how you will hold them liable for all fees and service charges levied by your professional advisors if they report it one way and you report it properly (with explanation if needed). Wickersham also indicated same informally at an ASPA seminar we co-chaired. A SIMPLE is an IRA that can't hold traditional IRA, SEP, or SARSEP assets.

[This message has been edited by Gary Steven Lesser (edited 07-09-99).]

[Guest cdaly]

Can an Employer terminate (or freeze) a Simple IRA plan midyear under the following:

Employer A (with a Simple IRA) merges with Employer B (with a 401(k)). Due to the acquisition (now 2 plans and > 100) can the Simple be terminated midyear and all employees either picked up on B's 401(k) or a replacement 401(k)?

I realize that 408(p)(5)© requires changes in elections & modifications to meet the 60-day notice requirement. I am unable to find a cite to support various message board comments that only year-end plan terminations are permitted. Does the occurrence of the acquisiton change the outcome? Thanks for you help.

[Gary Lesser]

I do not believe that the effective date of a SIMPLE termination (in a valid plan) can be made any sooner than the next CY. The grace period rules only allow the plan to continue without violating the otherwise applicable rules (in case of merger...).

[Guest Fishchick]

Mr Lesser, where do we find backup for treating the SIMPLE IRA contributions as excesses, and removing them. There doesn't seem to be any guidance in 408(p),Notice 98-4, or IRS Models on what to do with excess deferrals, in a normal SIMPLE IRA plan situation, let alone in a termination.

If money is transferred or rolled over to an IRA from a SIMPLE before two years, it is not eligible to be treated as a transfer or rollover, therefore, it would be an IRA contribution, subject to the $2000 annual limit. If the amount were greater than $2000, it would create an excess contribution.

A rollover or transfer from a SIMPLE IRA to another IRA (not Roth, except as a conversion) after two years is permitted. (Notice 98-4, Q&A 1-3 and 408 (d)(3)(G) IRC)