Can We Convert A SEP-IRA To A 401(k) Plan?

Got a SEP-IRA? Wondering how to convert it to a 401(k)? The short answer is: you can't. However, you can discontinue the SEP IRA and start a new 401(k) plan and we'll tell you how to do it! But first, a few words on SEP IRAs vs 401(k) plans:


Employers offering SEP IRAs for their employees realize the value of saving for retirement. A SEP IRA is easy to establish with a minimal amount of administrative work. For these reasons it can be an attractive option for jump starting retirement savings.

The downside of offering a SEP-IRA is there is very little room for customization.

Establishing A SEP-IRA

  • Who May Establish?
    • Any US business may establish a SEP, regardless of size
  • How To Establish?
    • The easiest way to establish a SEP is by adopting the IRS Form 5305-SEP
      • Generally if you adopt a SEP by way of Form 5305-SEP, you cannot sponsor any other retirement plan in this or any other company you own within a controlled or affiliated service group, or other such arrangement such as management organization

SEP-IRA Contributions

Within a SEP-IRA only Employer contributions are permitted. In addition, the rules governing those contributions are not as flexible as they would be in a 401(k) Plan.

  • Types of Contributions
    • Employer contributions only, no employee contributions are permitted
  • Contribution Rate (formula)
    • Uniform; the same percentage of compensation for every employee must be used
  • Vesting Schedule 
    • 100% vested immediately; no other schedule is permitted

SEP-IRA Distributions

A SEP-IRA has specific options for participant distributions. 

  • Rollovers
    • Participants may rollover their SEP IRA to most IRAs or qualified plans (like a 401(k) or 403(b))
  • Loans
    • Not permitted
  • Withdrawals
    • Contributions and earnings can be withdrawn at any time, subject to the general limitations imposed on traditional IRAs


401(k) Plan

Employers looking for a more flexible custom option for their retirement goals should consider establishing a 401(k) plan. 

Establishing A 401(k) Plan

  • Who May Establish?
    • Any US business, regardless of size or parent company location
  • How To Establish?
    • You'll need to design the provisions of your specific plan and adopt a plan document - we can help with this!

401(k) Plan Contributions

You'll have much more flexibility with contributions in a 401(k) over a SEP-IRA. To start, employees are permitted to contribute. Here are a few highlights around contributions and their options within a 401(k) plan:

(Note: these are just a few of many options, connect with us for more insight!) 

  • Types of Contributions
    • Employer - discretionary or required (depending upon design, such as a Safe Harbor Plan)
    • Employee - pre-tax elective deferrals and Roth (after-tax) contributions are permissible

  • Employer Contribution Formula
    • Pro Rata (same % to all)
    • Integrated with Social Security-based - sometimes referred to as Permitted Disparity
    • Age-Weighted, or
    • Class-Based (also called Cross-Tested or New Comparability, a favorite of ours!)
  • Vesting Schedule 
    • Employee and Rollover contributions are always 100% vested immediately.
    • Employer Contributions
      • Employer Discretionary Contributions - Typical Schedules
        • 6-Year Graded: Year 1: 0%; Year 2: 20%; Year 3: 40%; Year 4: 60%; Year 5: 80%; Year 6: 100%
        • 5-Year Graded: Year 1: 20%; Year 2: 40%; Year 3: 60%; Year 4: 80%; Year 5: 100%
        • 3-Year Cliff: Year 1: 0%; Year 2: 0%; Year 3: 100%
        • 25% per year: Year 1: 25%; Year 2: 50%; Year 3: 75%; Year 4: 100%
      • Employer Safe Harbor Contributions
        • 100% immediate, or
        • 100% vested in Year 2 when paired with a Qualified Automatic Contribution Arrangement (QACA)

401(k) Plan Distributions

Beyond the standard distributable events (termination, retirement, death, and disability), you may permit other types of distributions in your retirement plan:

  • Rollovers
    • Participants may rollover their entire account balances from prior-employer retirement plans
    • Participants may rollover their entire account upon severance of employment
    • Participants may make a withdrawal of all or part of their rollover source at any time, if permitted by the plan
  • Loans
    • Loans are allowable in qualified 401(k) plans, but are not required should the employer not wish to offer this option
  • Additional Withdrawal Options
    • Hardships are permitted, but again, not required
    • In-Service withdrawals may also be permitted, but are not required


Close Your SEP IRA and Start a 401(k) Plan

We've got good news all around! First, if you haven't contributed to the SEP for this calendar/tax year, you could establish a 401(k) now for 2021. Second, if you're working with a financial advisor let them know you'd like to explore options for a 401(k) plan this year. 

Once you've decided that your business has outgrown the limitations of a SEP, contact the financial institution to inform them that you will no longer be contributing to the SEP and you want to terminate the contract/agreement. Also, consider notifying employees that you have discontinued the plan.

Starting a 401(k) is easier than you think, but a lot of time and care should go into the establishment - after all, this is not only your future but the future of your employees.