One of the most common retirement plans is an IRA, or individual retirement account, which allows individuals to contribute and save money for retirement over time. The money can be withdrawn during retirement to cover living expenses and other costs.
There are several different types of IRAs. Two of the most popular types are the Roth IRA and the Traditional IRA.
Perhaps less well-known are the SEP IRA and the SIMPLE IRA. These IRAs are designed for business owners, sole proprietors, and the self-employed.
For small business owners who would like to offer their employees — and themselves — a retirement savings plan, a SEP IRA and a Simple IRA can be options to explore. According to a 2023 study by Fidelity, only 34% of small business owners offer their employees a retirement plan. This is because they believe they can’t afford to do so (48%), are too busy running their company to do it (22%), or don’t know how to start (21%). SEP or Simple IRAs are generally easy to set up and manage and have lower fees than other types of accounts.
There are a number of similarities and differences between the SEP IRA vs. the SIMPLE IRA. Exploring the pros and cons of each and comparing the two plans can help self-employed people, small business owners, and also employees make informed decisions about retirement savings.
How SEP IRAs Work
A SEP IRA, or Simplified Employee Pension IRA, is a retirement plan set up by employers, sole proprietors, and the self-employed. Although SEP IRAs can be used by any size business, they are geared towards sole proprietors and small business owners. SEP IRAs are typically easy to set up and have lower management fees than other types of retirement accounts.
Employers make contributions to the plan for their employees. They are not required to contribute to a SEP every year. This flexibility can be beneficial for businesses with fluctuating income because the employer can decide when and how much to contribute to the account.
Employers can contribute up to 25% of an employee’s annual salary or $69,000 in 2024, whichever is less. The employer and all employees must receive the same rate of contribution.
Employees cannot make contributions to their SEP accounts.
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SEP IRA Pros and Cons
There are advantages to a SEP IRA, but there are disadvantages as well. Here are some of the main benefits and drawbacks to be aware of.
Pros
The pros of a SEP IRA include:
• A SEP IRA is an easy way for a small business owner or self-employed individual to set up a retirement plan.
• The contribution limit is higher than that for a SIMPLE IRA. In 2024, the contribution limit is $69,000 to a SEP IRA.
• Employers can deduct contributions to the account from their taxes up to certain amounts, and employees don’t have to include the contributions in their gross income. The money in the account is tax-deferred, and employees don’t pay taxes on the money until it gets withdrawn.
• For self-employed individuals, a SEP IRA may help reduce certain taxes, such as self-employment tax.
• An employer isn’t required to make contributions to a SEP IRA every year. This can be helpful if their business has a bad year, for example.
• For employees, the money in a SEP is immediately 100% vested, and each employee manages their own assets and investments.
• Having a SEP IRA does not restrict an individual from having other types of IRAs.
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Cons
There are some drawbacks to a SEP IRA for employees and employers. These include:
• Employees are not able to make contributions to their own SEP accounts.
• Individuals cannot choose to pay taxes on the contributions in their SEP now, even if they’d like to.
• Employers must contribute the same percentage to all employees’ SEP accounts that they contribute to their own account.
• There are no catch-up contributions for those 50 and older.
How SIMPLE IRAs Work
SIMPLE IRAs, or Savings Incentive Match Plan for Employees Individual Retirement Accounts, are set up for businesses with 100 or fewer employees. Unlike the SEP IRA, both the employer and the employees can contribute to a SIMPLE IRA.
Any employee who earns more than $5,000 per year (and has done so for any two- year period prior to the current year) is eligible to participate in a SIMPLE IRA plan. Employees contribute pre-tax dollars to their plan — and they may have the funds automatically deducted from their paychecks.
Employers are required to contribute to employee SIMPLE IRAs, and they may do so in one of two ways. They can either match employee contributions up to 3% of the employee’s annual salary, or they can make non-elective contributions whether the employee contributes or not. If they choose the second option, the employer must contribute a flat rate of 2% of the employee’s salary up to a limit of $345,000 in 2024.
Both employer contributions and employee salary deferral contributions are tax-deductible.
As of 2024, the annual contribution limit to SIMPLE IRAs is $16,000. Workers age 50 and up can contribute an additional $3,500.
SIMPLE IRA Pros and Cons
There are benefits and drawbacks to a SIMPLE IRA.
Pros
These are some of the pros of a SIMPLE IRA:
• A SIMPLE IRA is a way to save for retirement for yourself and your employees. And the plan is typically easy to set up.
• Both employees and employers can make contributions.
• Money contributed to a SIMPLE IRA may grow tax-deferred until an individual withdraws it in retirement.
• For employees, SIMPLE IRA contributions can be deducted directly from their paychecks.
• Employers can choose one of two ways to contribute to employees’ plans — by either matching employee contributions up to 3% of the employee’s annual salary, or making non-elective contributions of 2% of the employee’s salary up to an annual compensation limit.
• Employees are immediately 100% vested in the SIMPLE IRA plan.
• A SIMPLE IRA has higher contribution limits compared to a traditional or Roth IRA.
• Catch-up contributions are allowed for those 50 and up.
Cons
SIMPLE IRAs also have some drawbacks, including:
• A SIMPLE IRA is only for companies with 100 employees or fewer.
• mployers are required to fund employees’ accounts.
• The SIMPLE IRA contribution limit ($16,000 in 2024) is much lower than the SEP IRA contribution limit ($69,000 in 2024).
Main Differences Between SEP and Simple IRAs
While SEP IRAs and SIMPLE IRAs share many similarities, there are some important differences between them that both employers and employees should be aware of.
Eligibility
On the employer side, a business of any size is eligible for a SEP IRA. However, SIMPLE IRAs are for businesses with no more than 100 employees.
For employees to be eligible to participate in a SIMPLE IRA, they must earn $5,000 or more annually and have done so for at least two years previously. To be eligible for a SEP IRA, an employee must have worked for the employer for at least three of the last five years and earned at least $750.
Who Can Contribute
Only employers may contribute to a SEP IRA. Employees cannot contribute to this plan.
Both employers and employees can contribute to a SIMPLE IRA. Employers are required to contribute to their employees’ plans.
Contribution limits
Employers are required to contribute to employee SIMPLE IRAs either by matching employee contributions up to 3% of the employee’s annual salary, or making non-elective contributions of 2% of the employee’s salary up to a limit of $345,000 in 2024.
With a SEP IRA, employers can contribute up to 25% of an employee’s annual salary or $69,000 in 2024, whichever is less. A business owner and all employees must receive the same rate of contribution. Employers are not required to contribute to A SEP plan every year.
Taxes
For both SEP IRAS and SIMPLE IRAs, contributions are tax deductible. Individuals typically pay taxes on the money when they withdraw it from the plan.
Vesting
All participants in SIMPLE IRAs and SEP IRAS are immediately 100% vested in the plan.
Paycheck Deductions
Employees contributing to a SIMPLE IRA can have their contributions automatically deducted from their paychecks.
Employees cannot contribute to a SEP IRA, thus there are no paycheck deductions.
Withdrawals
For both SEP IRAs and SIMPLE IRAS, participants may withdraw the money penalty-free at age 59 ½ . Withdrawals are taxable in the year they are taken.
If an individual makes an early withdrawal from a SEP IRA or a SIMPLE IRA, they will generally be subject to a 10% penalty. For a SIMPLE IRA, if the withdrawal is taken within the first two years of participation in the plan, the penalty is raised to 25%.
SEP IRAs may be rolled over into other IRAs or certain other retirement plans without penalty. SIMPLE IRAs are eligible for rollovers into other IRAs without penalty after two years of participation in the plan. Before then, they may only be rolled over into another SIMPLE IRA.
Here’s an at-a-glance comparison of a SEP IRA vs. SIMPLE IRA:
| SEP IRA | SIMPLE IRA | |
|---|---|---|
| Eligibility | Businesses of any size
Employee must have worked for the employer for at least three of the last five years and earn at least $750 annually |
Business must have no more than than 100 employees
Employees must earn $5,000 or more per year and have done so for two years prior to the current year |
| Who can contribute | Employers only | Employers and employees (employers are required to contribute to their employees’ plans) |
| Contribution limits | Employers can contribute up to 25% of an employee’s annual salary or $69,000 in 2024, whichever is less
No catch-up contributions |
$16,000 per year in 2024
Catch-up contributions of $3,500 for those 50 and up |
| Taxes | Contributions are tax deductible. Taxes are paid when the money is withdrawn | Contributions are tax deductible. Taxes are paid when the money is withdrawn |
| Vesting | 100% immediate vesting | 100% immediate vesting |
| Paycheck deductions | No (employees cannot contribute to the plan) | Yes |
| Withdrawals | Money can be withdrawn without penalty at age 59 ½. There is generally a 10% penalty if money is withdrawn early, before age 59 ½ | Money can be withdrawn without penalty at age 59 ½. There is generally a 10% penalty if money is withdrawn early, before age 59 ½ (or 25% if the account has been open for less than 2 years) |
The Takeaway
Both the SEP IRA and the SIMPLE IRA were created to help small business owners and their employees save for retirement. Each account may benefit employers and employees in different ways.
With the SEP IRA, the employer (including a self-employed person) contributes to the plan. They are not required to contribute every year. With the SIMPLE IRA, the employer is required to contribute, and the employee may contribute but can choose not to.
In addition to these plans, there are other ways to save for retirement. For instance, individuals can contribute to their own personal retirement plans, such as a traditional or Roth IRA, to help save money for their golden years. Just be sure to be aware of the contribution limits.
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