Case of the Week: Terminating a Simple IRA Plan Mid-year

The ERISA consultants at the Columbia Management Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call with a financial advisor in California is representative of a common inquiry involving savings incentive match plans for employees (SIMPLE) IRA plans. The advisor asked:

“I have a client who maintains a SIMPLE IRA plan, but is thinking of changing to a 401(k) plan. Could he terminate the SIMPLE IRA plan mid-year and start a 401(k) plan?”

Highlights of Discussion

  • No, he would not be able to terminate the SIMPLE IRA plan mid-year. The IRS’ rules state that businesses that sponsor SIMPLE IRA plans must maintain their SIMPLE IRA plans on a whole calendar-year basis (except for the initial year of establishment, which may be a shortened plan year). See IRS Notice 98-4 for detailed rules.
  • Once started, a sponsor must continue his or her SIMPLE IRA plan for the entire calendar year, funding all contributions as promised in the employee notice.
  • A sponsor may terminate his or her SIMPLE IRA plan prospectively, beginning with the next calendar year, but only after informing participants within a reasonable time before the election period that there
    will be no SIMPLE IRA plan for the upcoming year.

  • The IRS has defined “a reasonable time before the election period” as at least one day before (i.e., by November 1 for the 60-day election period that begins November 2).
  • Your client need not give any notice to the IRS regarding the termination of the business’s SIMPLE IRA
    plan.

    Example

    In 2013 Sam’s Small Company decides to terminate its SIMPLE IRA plan as soon as possible. Sam must
    inform its employees by November 1, 2013, that there will be no SIMPLE IRA plan for 2014. For 2014,
    Sam is free to establish and maintain another kind of qualified plan for the company’s employees.

    Conculsion

    While a SIMPLE IRA plan sponsor has the ability to terminate the plan, the termination must occur on a
    prospective basis. Financial advisors who are aware of the rules for plan termination for all plan types
    are better positioned to support their clients.

    The Columbia Management Retirement Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC, a third-party industry consultant that is not affiliated with Columbia Management. For informational purposes only. Please consult a tax advisor or attorney for specific tax or legal needs. © 2013 Columbia Management Investment Advisers, LLC. Used with permission.

  • Add Your Comments

    8 Comments

    1. Sarah Gronvold
      Posted July 24, 2013 at 1:00 pm | Permalink

      Hold on a minute! There is also a provision that a SIMPLE must be the only Plan maintained by a Sponsor. If a Sponsor adopts a 401(k) Plan, the SIMPLE is automatically voided. We have terminated many SIMPLES this way, redirecting the SIMPLE contributions to the 40(k) Plan, so there is no elimination of the SIMPLE obligation. IRS has commented publicly (but not by Regulation) at ASPPA Conferences.

    2. James Nolan
      Posted July 25, 2013 at 9:22 am | Permalink

      Sarah is correct, and John has simply gotten this answer wrong. You absolutely CAN terminate a SIMPLE during the year, because that is what happens AUTOMATICALLY if you adopt another plan during that year. As soon as you adopt the new plan (like a 401(k)) your SIMPLE becomes what we like to refer to as a “COMPLEX”; actually, you now have some corrective work to do on the SIMPLE contributions made during that year, since they now will potentially be excess contributions to an IRA in relation to the employees, and that needs to be corrected as any excess IRA contribution needs to be corrected. I’m not going to go into all the details here (I’m on vacation in ALASKA and a really nice description of the process, but it’s at home and I’m not really going to try to recreate it from memory without being able to check my resources).

      But bottom line: this answer is just plain wrong.

      Oh, and Sarah’s reference to the ASPPA Conferences most likely is referring to the Q&A sessions that I used to chair and where this question is one I reviewed and discussed with our IRS friends, and they agreed with our analysis.

      Larry.

    3. Lawrence Starr
      Posted July 25, 2013 at 9:26 am | Permalink

      My apologies: Jim Nolan had pointed out the incorrect response in an email to me an somehow when I clicked on it I ended up being logged in as Jim. The above response is from me; please don’t blame Jim if you don’t agree with it! If you do agree with it, didn’t Jim do a great job???? 🙂

      Larry.
      ___________________________

      Sarah is correct, and John has simply gotten this answer wrong. You absolutely CAN terminate a SIMPLE during the year, because that is what happens AUTOMATICALLY if you adopt another plan during that year. As soon as you adopt the new plan (like a 401(k)) your SIMPLE becomes what we like to refer to as a “COMPLEX”; actually, you now have some corrective work to do on the SIMPLE contributions made during that year, since they now will potentially be excess contributions to an IRA in relation to the employees, and that needs to be corrected as any excess IRA contribution needs to be corrected. I’m not going to go into all the details here (I’m on vacation in ALASKA and a really nice description of the process, but it’s at home and I’m not really going to try to recreate it from memory without being able to check my resources).

      But bottom line: this answer is just plain wrong.

      Oh, and Sarah’s reference to the ASPPA Conferences most likely is referring to the Q&A sessions that I used to chair and where this question is one I reviewed and discussed with our IRS friends, and they agreed with our analysis.

      Larry.

    4. url url'>John Carl
      Posted July 29, 2013 at 12:27 pm | Permalink

      While it is true that a plan sponsor may “invalidate” its SIMPLE IRA plan by contributing to another plan in the same year, I maintain there is a distinct difference between legitimately terminating a SIMPLE IRA plan, as I described in the Case of the Week, and illegitimately invaliding a SIMPLE IRA plan by intentionally creating a plan compliance error, for which the IRS will expect the plan sponsor to take corrective steps.

      According to the guidance in IRS Revenue Procedure 2013-12 http://www.irs.gov/pub/irs-drop/rp-13-12.pdf which encompasses the IRS’ Employee Plans Compliance Resolution System, the IRS views an invalid SIMPLE IRA plan as a plan compliance error for which the sponsor is expected to file with the IRS under the Voluntary Correction Program(VCP) with Service Approval—it is an error that the plan sponsor cannot self-correct with full confidence. Consideration must be given to the cost of the preparing and filing the VCP submission, the time and effort needed to properly notify the SIMPLE IRA participants of the excess contributions in each of their SIMPLE IRAs (if amounts were contributed), how to effect correction of these excess amounts, and payment of any associated penalties. It comes down to a business decision on the part of the plan sponsor as to whether it is more important to have the 401(k) immediately and create a compliance issue with the SIMPLE IRA plan, or wait until the beginning of the next year and follow the SIMPLE IRA plan termination steps.

    5. Michael Preston
      Posted December 16, 2015 at 4:58 am | Permalink

      Larry, John,

      My reading of RP 2013-12 is much closer to John’s original article. While the $250 VCP filing fee is attractive, note that 12.07 calls for a negotiated percentage of the Maximum Payment Amount in the event of an intentional failure. The informed client (which is by definition all of ours, right?) is less well positioned if the IRS raises the issue.

      I’m not saying I have ever heard of the IRS going down this path, but if they do it most assuredly would be better if the client had been warned of the possibility.

      mike

    6. Larry Starr
      Posted December 16, 2015 at 10:49 am | Permalink

      We’d all like to welcome Mike back from his two and a half year COMA! (This issue was last discussed in July of 2013.)

      But, I still stick with my original comment (and, remember, in private conversations with IRS in prep for annual conference Q&A, they reluctantly agreed that I was right). Actually, John and I agree that the SIMPLE plan is now subject to a compliance problem/error and can be corrected via VCP. HOWEVER, the key here is that we DON’T WANT TO CORRECT. We want to take the penalties. So, what are the penalties? Nothing other than that the contributions to the SIMPLE are no longer SIMPLE contributions. So, they are something else. They are contributions to an IRA, which may or may not be ok. Deal with them as excess contributions to an IRA (if they are same) or ANNUAL contributions to an IRA. The IRS cannot disqualify the IRA; the IRA hasn’t done anything wrong. They can only deal with the contributions, and in my outline for dealing with these broken plans, we don’t neglect that issue.

      Don’t over think it; we don’t have to use VCP or any IRS “fix it” program if, instead, we are willing to accept the penalties that would otherwise apply. In this case, the penalties are not a substantial issue and can be easily dealt with if you know what you are doing.

      Larry.

    7. Sean
      Posted March 8, 2017 at 11:10 am | Permalink

      I know this is an old thread but maybe someone will pick up on it. Different slant on this question: What if you have a SIMPLE in 2016, did not “terminate” it but rather just don’t contribute to it any further, can you start a 401(k) in January 2017? In other words, can you have both plans at the same time as long you don’t fund both in the same year? My option is that you may not want to actually terminate the SIMPLE for various reasons (2 year window), but rather “freeze” it. Thanks.

    8. Clark
      Posted March 13, 2018 at 12:40 pm | Permalink

      What if you have a company with a SIMPLE IRA plan, 80 employees, and they purchase 2 other companies, adding 40 employees, and thus go over the 100 employee limit. The purchased companies had no retirement plan in place. Can they discontinue the SIMPLE immediately and institute the 401k covering all 120 employees?

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