In connection with a merger, acquisition, or other corporate (M&A) transaction, buyers often face the dilemma of how to handle the seller’s existing retirement plans covering the continuing employees. Terminating a seller’s existing retirement plan can be complicated if the seller maintains a Savings Incentive Match Plan for Employees (SIMPLE) IRA plan because the “exclusive plan rule” under Section 408(p)(2)(D) of the Internal Revenue Code (Code) provides that a SIMPLE IRA plan may not be maintained for a calendar year if the employer maintains a qualified plan for that calendar year.
Due to this statutory requirement, buyers that assume employees and a SIMPLE IRA plan in connection with an M&A transaction generally will need to determine how to handle the SIMPLE IRA plan and take any appropriate or required steps prior to signing and closing the M&A transaction.
Although Code Section 408(p)(10) does provide transition relief (if certain requirements are met) for the failure to satisfy the exclusive plan rule because of an M&A transaction, terminating a seller’s SIMPLE IRA plan was previously further complicated by the fact that, prior to 2024, the Internal Revenue Service (IRS) took the position that a mid-year termination of a SIMPLE IRA plan was not permitted. However, effective for plan years beginning after December 31, 2023, the SECURE 2.0 Act of 2022 (SECURE 2.0) permits a SIMPLE IRA plan to be terminated mid-year if it is replaced with a safe harbor 401(k) plan.
The new SECURE 2.0 mid-year termination rules for SIMPLE IRA plans provide greater flexibility to buyers and sellers seeking to terminate a SIMPLE IRA plan mid-year in connection with a corporate transaction, and those rules may prove useful for fully integrating continuing employees onto the buyer’s benefits platform immediately or soon after the closing of the M&A transaction. We discussed the termination rules relating to 401(k) plans in the context of M&A transactions in a prior blog post.
Background
SIMPLE IRA plans are a type of defined contribution retirement plan that may be maintained by small employers with no more than 100 employees earning $5,000 or more in compensation for the prior calendar year and that do not maintain a qualified retirement plan, such as a 401(k) plan. Employees are permitted to make elective deferrals each year up to certain maximum limits (which are lower than those applicable to 401(k) plans).
In addition, employers must either make a 3% matching contribution or a 2% nonelective contribution each year. However, SIMPLE IRA plans generally tend to have lower administrative costs than qualified plan arrangements (like 401(k) plans) because they are deemed to be nondiscriminatory, are not subject to coverage testing, and are not required to file the annual Form 5500.
Further, all contributions are made into individual IRAs that are managed by each participating employee, so there is no duty of oversight or management of plan investments by the employer as required under a 401(k) plan. As a result, SIMPLE IRA plans are often viewed as an attractive way for small employers to get started with offering retirement plan benefits to their employees before sponsoring a qualified plan.
Pre-SECURE 2.0 SIMPLE IRA Termination Requirements
Before SECURE 2.0, the IRS took the position that terminating SIMPLE IRA plans in the middle of a calendar year was prohibited. Specifically, if the SIMPLE IRA plan is not terminated prior to the preceding year-end (which, under IRS guidance, requires notifying employees by November 2 that the SIMPLE IRA plan will be terminated effective the first day of the next calendar year), it must be maintained for the entire calendar year through the next December 31.
Exclusive Plan Rule
The “exclusive plan rule” discussed above provides that a SIMPLE IRA plan may not be maintained in a calendar year that the employer maintains any other retirement plan in which employees can accrue benefits. This rule applies even if another qualified plan begins or ends in the same year, and there are very few exceptions.
As noted above, however, the Code provides transition relief for the failure to satisfy the exclusive plan rule because of an M&A transaction. For this relief to apply, the coverage of the SIMPLE IRA plan may not significantly change during the transition period (except as directly affected by the M&A transaction) and the SIMPLE IRA plan must satisfy the exclusive plan rule as if the employer that maintained the plan before the M&A transaction continued to be a separate employer.
Assuming the requirements for this transition relief are met, a buyer may maintain a SIMPLE IRA plan acquired in connection with an M&A transaction simultaneously with its otherwise preexisting qualified plan(s) through the end of the second calendar year following the calendar year in which the M&A transaction occurs.
In the past, buyers typically handled SIMPLE IRA plans covering the continuing employees in an M&A transaction by assuming the SIMPLE IRA plan and then terminating it at the end of the calendar year in which the M&A transaction occurred. While this is a commonly employed approach, it nevertheless also requires buyers to maintain two (or more) plans simultaneously and delays the full integration of the continuing employees into the buyer’s benefits platform.
This is especially burdensome where the buyer may not have the resources necessary to administer separate plans. In addition, if the buyer’s plan(s) offer more generous matching or other benefits that the continuing employees were hoping to access, the ongoing—albeit temporary—operation of the SIMPLE IRA plan may pose potential employee relations challenges for the buyer.
SECURE 2.0 Rules for Mid-Year Terminations of SIMPLE IRA Plans
SECURE 2.0 does not eliminate any prior rules or exceptions relating to SIMPLE IRA plan terminations, but Section 332 of SECURE 2.0, and the corresponding guidance subsequently issued by the IRS in Notice 2024-2, provides a new exception to the otherwise applicable prohibition on mid-year terminations of SIMPLE IRA plans. Specifically, SECURE 2.0 amends Code Section 408(p) effective for plan years beginning after December 31, 2023, to permit employers to terminate a SIMPLE IRA plan in the middle of a calendar year. The terminated SIMPLE IRA must be replaced by a safe harbor 401(k) plan (including a SIMPLE 401(k) plan, a traditional safe harbor 401(k) plan, or a QACA safe harbor plan), and the mid-year termination and replacement process is subject to the requirements detailed in Notice 2024-2.
Notice 2024-2 Requirements for Mid-Year Terminations
Notice 2024-2 requires employers to (1) take formal written action to terminate the SIMPLE IRA plan that specifies the exact termination date, (2) notify the SIMPLE IRA’s custodian or trustee and its payroll provider of the termination, and (3) retain all records relating to the termination.
Employees must receive advance written notice of the SIMPLE IRA plan termination at least 30 days prior to the termination date (as opposed to the usual 60-day advance notice requirement), and the written notice must also specify the following:
- No salary reduction contributions will be made to the SIMPLE IRA plan with respect to compensation paid after the termination date.
- Employees will receive matching contributions attributable to salary reduction contributions or nonelective contributions based on the employees’ compensation through the termination date of the SIMPLE IRA plan.
- The increased 25% early withdrawal penalty that otherwise applies to SIMPLE IRA plan withdrawals made within two years of participation is waived if the employee elects to rollover the amounts in their SIMPLE IRA plan to a 401(k) plan or 403(b) plan (and that rollover is subsequently subject to the distribution restrictions that apply to elective deferrals).
Once the SIMPLE IRA plan is terminated, employees may elect to roll over their terminated SIMPLE IRA plan account balances to the replacement safe harbor 401(k) plan but may also elect to roll over their SIMPLE IRA plan account balances to another 401(k) plan or 403(b) plan. The Notice also specifies the methodology for determining the annual combined limit for contributions to the SIMPLE IRA and the replacement safe-harbor plan in the year of the transition for employees who participated in both plans.
Safe Harbor Plan Adoption
SECURE 2.0 requires the employer to establish and maintain a safe harbor plan to replace the terminated SIMPLE IRA plan effective as of the day after the termination date. This can either be a newly established plan or, more commonly, a preexisting safe harbor 401(k) plan covering the buyer’s other employees.
Employees must also receive advance written notice of their eligibility to participate in the replacement plan in accordance with the rules that otherwise apply to notifications made regarding safe harbor plans (generally no less than 30 days in advance of the effective date of their eligibility). The notice must include an explanation of how the contribution limits under the SIMPLE IRA plan and the safe harbor plan are applied during the transition year.
Other than the special rules that apply in the year of transition, all other rules applicable to safe harbor 401(k) plans continue to apply.
Mid-Year SIMPLE IRA Plan Terminations Provide Greater Post-Transaction Flexibility
The new rules under SECURE 2.0 and corresponding guidance under Notice 2024-2 for terminating a SIMPLE IRA plan mid-year and replacing it with a safe harbor 401(k) plan provide greater post-transaction flexibility by permitting buyers to terminate a SIMPLE IRA plan prior to the end of the calendar year and allowing continuing employees who are participating in the seller’s SIMPLE IRA plan at the time of the closing to participate in a replacement safe harbor 401(k) plan maintained by the buyer.
Since SECURE 2.0 and Notice 2024-2 require that the replacement plan be in place for the transferred employees effective the day after the termination date, the SIMPLE IRA plan cannot be terminated by a seller prior to the closing. Instead, the buyer would have to assume the seller’s SIMPLE IRA plan in connection with the M&A transaction, terminate the SIMPLE IRA plan immediately following the closing and immediately replace it with the safe harbor plan.
To facilitate the satisfaction of the 30-day advance notice requirements and ensure the timely adoption and implementation of the replacement safe harbor plan, buyers and sellers would need to coordinate prior to the closing of the M&A transaction to determine whether the seller’s SIMPLE IRA plan will be terminated in accordance with the new rules under SECURE 2.0 and Notice 2024-2, or will continue to be operated by buyer post-closing and terminate at the end of the calendar year pursuant to the pre-SECURE 2.0 rules described above.
Conclusion
SECURE 2.0 and Notice 2024-2 now provide employers the ability to terminate a SIMPLE IRA plan mid-year, which may help to significantly streamline the post-transaction employee benefits transition process. However, because the previous post-transaction options are still available and were not replaced by the new mid-year termination option, employers may wish to discuss the pros and cons of these potential options with counsel in connection with any M&A transaction involving a SIMPLE IRA plan.
Contact the authors of this blog post to discuss any of these options or with other questions about terminating a SIMPLE IRA plan or navigating employee benefit plans in M&A transactions.