Client with SIMPLE IRA wants to start a 401(k) Plan

[RatherBeGolfing]

Prospective client started SIMPLE IRA in early 2018, but wants to start a 401(k) plan for 2019.

The problem we are faced with is the 2 year rule for distributions from the SIMPLE.  

Can they start the 401(k) for 2019, cease contributions to the SIMPLE as of 12/31/2018, and just not terminate it until the 2 year clock has run on the contributions to the SIMPLE?  

[Bird]

Just tell the participants to leave the money alone.  The answer to your question is "yes, sort of."  They can "terminate" it now but then it is up to participants to not take their money out, just like it is whether a SIMPLE is ongoing or not.

Terminating a SIMPLE has nothing to do with distributions.

[RatherBeGolfing]

Perfect! That was the solution I wanted but it almost sounded to simple to work :)

[Larry Starr]

57 minutes ago, RatherBeGolfing said:

Prospective client started SIMPLE IRA in early 2018, but wants to start a 401(k) plan for 2019.

The problem we are faced with is the 2 year rule for distributions from the SIMPLE.  

Can they start the 401(k) for 2019, cease contributions to the SIMPLE as of 12/31/2018, and just not terminate it until the 2 year clock has run on the contributions to the SIMPLE?  

Just to be clear, it is only the DISTRIBUTIONS that are subject to the excise tax if made prior to two years.  There is NO prohibition on withdrawals (the participant can do them whenever he wants), there is just a higher tax rate if you take them out before the penalty period has expired.

The employer can terminate the SIMPLE after one year with no problem and start the 401(k).

[Belgarath]

But you don't have much time to get the termination notice out. According to the IRS, the notice must be sent out before November 2.

[Gary Lesser]

Agreed. 

"How do I terminate my SIMPLE IRA plan?

"Step 1: Notify your employees within a reasonable time before November 2 that you’ll discontinue the SIMPLE IRA plan effective the following January 1.

"Step 2: Notify your SIMPLE IRA plan’s financial institution and payroll provider that you won’t be making SIMPLE IRA contributions for the next calendar year and that you want to terminate your contributions.

"Step 3: You should keep records of your actions, but you don’t need to notify the IRS that you have terminated the SIMPLE IRA plan.

"Example: Acme Company decided on November 18, 2014, to terminate its SIMPLE IRA plan as soon as possible. The earliest effective date for the termination is January 1, 2016. Acme must notify its employees before November 2, 2015, that it won’t sponsor a SIMPLE IRA plan for 2016."

[Source: https://www.irs.gov/retirement-plans/terminating-a-simple-ira-plan]

[RatherBeGolfing]

Thanks all!

Termination notices went out to SIMPLE IRA participants today. 

[Sully]

What would happen if the SIMPLE termination notices did not go out on time and the employer installs a new 401(k) Plan effective at the beginning of the next year?

 For example, a SIMPLE plan is in place for 2018. Employer decides on 12/1/2018 that they want a 401(k) Plan effective 1/1/2019. It is too late to send out the SIMPLE termination notice for 2019, but the installation of the 401(k) on 1/1/2019 will disqualify the SIMPLE for 2019. The IRS website says to ‘stop all employer and employee contributions to the SIMPLE IRAs if the business sponsors another qualified retirement plan’.  

Does this effectively give you additional time to terminate the SIMPLE if you are installing a new plan?

[Larry Starr]

2 hours ago, Sully said:

What would happen if the SIMPLE termination notices did not go out on time and the employer installs a new 401(k) Plan effective at the beginning of the next year?

 For example, a SIMPLE plan is in place for 2018. Employer decides on 12/1/2018 that they want a 401(k) Plan effective 1/1/2019. It is too late to send out the SIMPLE termination notice for 2019, but the installation of the 401(k) on 1/1/2019 will disqualify the SIMPLE for 2019. The IRS website says to ‘stop all employer and employee contributions to the SIMPLE IRAs if the business sponsors another qualified retirement plan’.  

Does this effectively give you additional time to terminate the SIMPLE if you are installing a new plan?

You have hit on the basic issue with SIMPLEs.  There is no practical penalty for missing the 60 day notice period for plan termination. You  have to give an annual notice before 60 days about the ability to make an election.  Suppose you do that on October 1, 2018 for 2019. Suppose you decide to terminate the plan for 2019 on 12/15/18 and you notify the employees at that point.  OK, you are late according to the IRS website, but where is that in the laws. What is the penalty? 

There is a $50 a day penalty under IRC 6693(c)(1) for every day you are late providing a notice, but it is the notice regarding making contributions that is referenced. And even that can be eliminated with "reasonable cause" (but first you have to get caught - how does the IRS ever know about it?). But there is no reference to this "termination notice" except on the IRS website; it is not in the code, and the penalties don't apply to it.

So, in our situation above, there is no penalty on the 2018 year (all is ok) and there are no contributions in 2019 to be penalized ("lose tax benefits"). Is the new 401(k) plan "in trouble". Nope. Does anyone think they can find an actual penalty for providing the termination notice late?    I suggest it is really a penalty without a penalty!  Which means, maybe you do have until 12/31 to "terminate" the SIMPLE!

[Sully]

Thank you!