SEP vs. SIMPLE IRAs: Which is Right for Your Business?

For anyone out there who’s self-employed and/or runs a small business, you can rest easy knowing a few retirement plan options exist for both you and your employees—including those that are easy to set up, fairly simple to maintain, and don’t require annual IRS reporting. Two such options? Simplified Employee Pension (SEP) and Savings Incentive Match Plan for Employees (SIMPLE) individual retirement accounts (IRAs).

What are SEP & SIMPLE IRAs?

Both SEP and SIMPLE IRA accounts are tax-deferred retirement savings plans used to provide retirement benefits for business owners and employees. The term “tax-deferred” means the account is funded with pre-tax dollars and pay taxes on any withdrawals.

Who can establish a SEP or SIMPLE IRA?

Any employer, including self-employed individuals, can establish a SEP; but small business owners with few or no employees (more on this later) typically rely on this option more so than others.

No matter who you are, the same rules apply when opening a SIMPLE IRA account; you must have 100 or fewer employees and cannot maintain any other employer-sponsored retirement plan—such as a 401(k), profit-sharing plan, or pension plan—during the same calendar year.

Who is eligible to participate in a SEP or SIMPLE IRA plan?

While exceptions do exist, SEP IRA eligibility typically extends to employees who are aged 21+, have worked for that employer in at least three out of the last five years, and have earned at least $750 in annual income from that employer during the current year.

SIMPLE plan participation, meanwhile, requires employees to have earned at least $5,000 in any two preceding years and expect to earn $5,000+ in the year they are eligible. However, employers can set less restrictive requirements such as a lower minimum compensation threshold or the ability to participate immediately upon hire.

SEP and SIMPLE IRA contribution details

SEP IRAs are funded entirely by the employer, who has the flexibility to determine when to make contributions and how much to contribute as requirements don’t exist in this regard. That said, when employers do decide to jump in, they can contribute up to 25% of the employee’s/owner’s compensation or up to $69,000 (as of 2024), whichever is less. Unlike SIMPLE IRAs, SEP IRAs have no catch-up contributions (additional contributions you can make to your 401(k) and IRA accounts above standard limits).

Employers who contribute to their own SEP IRAs must also do so for eligible employee accounts. Furthermore, contributions must reflect the same percentage of salary (e.g., if you contribute 20% of your salary (up to $69,000) to your SEP IRA, you must also contribute 20% of employees’ salaries to their SEP IRAs).

Small businesses with few or no employees often utilize SEP IRAs due to these key characteristics.

With SIMPLE IRAs, meanwhile, contributions are mandatory for employers but optional for employees—who can defer up to $16,000 or 100% of compensation, whichever is less. Those aged 50+ can defer an additional $3,500 (referred to as the “catch-up limit”).

Employers are required to make contributions to employee accounts in one of two ways: via dollar-for-dollar matching contributions up to 3% of each employee’s compensation or by making non-elective contributions for all employees (equating to 2% of each employee’s compensation) regardless of their contributions. The figure of 2% is based on a maximum salary of $345,000 for 2024, meaning employers would contribute at most $6,900 to an individual account.

Other SIMPLE and SEP IRA considerations

If you’re considering a SIMPLE IRA, think about just how much you want your company to grow both now and in the foreseeable future—because if you expand beyond 100 employees, you’ll need to transition to a different type of retirement account such as a 401(k) plan.

As with traditional IRAs, borrowing money against a SIMPLE IRA is prohibited (and a 10% penalty may apply for withdrawals taken before age 59½). A “2-year rule” also applies to SIMPLE IRA withdrawals, meaning that if you take money out before a two-year period beginning on the first day your employer deposits contributions (regardless of your age), your early withdrawal fee may increase from 10% to 25%—and that doesn’t even include taxes on your withdrawal!

Regarding SEP IRAs, know that borrowing money against the account is prohibited and a 10% penalty may apply to withdrawals taken before age 59½.

How to choose between a SIMPLE and SEP IRA plan

SIMPLE IRAs are best designed for larger businesses with up to 100 employees, as they allow both employers and employees to contribute and fund the plan. On the other hand, only employers are permitted to contribute and fund SEP IRA plans: making them ideal for self-employed individuals or small business owners with no or few employees.

A SIMPLE IRA is also perhaps best suited for businesses with steady profits that want to allow pre-tax employee contributions—akin to 401(k) plans. For businesses with fluctuating income and/or those seeking additional flexibility, meanwhile, a SEP IRA is sometimes preferred as it gives employers the authority to determine when and how much to contribute.

How to establish a SIMPLE or SEP IRA

Setting up either account is thankfully fairly simple—especially compared to other types of retirement plans! In this case, those interested need only contact a retirement plan or investment professional to establish the plan and draft all related details, share a copy of plan documents with employees, and finally set up the account.

While SIMPLE IRAs must be established by October 1st if doing so for the current tax year, SEP IRAs must be set up and funded by the tax filing deadline or extension.

In sum: SIMPLE vs SEP IRAs

Choosing which plan to go with is thankfully pretty straightforward depending on your own unique circumstances. Generally speaking, SEP IRAs are often preferred among those who are self-employed and small businesses with no or few employees who want the flexibility to choose when and how much to contribute—especially seasonal businesses and those with fluctuating income. Larger businesses (up to 100 employees), meanwhile, will likely consider SIMPLE IRAs a better option as employees bear much of the funding burden in this case.

Want to know whether a SIMPLE or SEP IRA is better for you? Schedule a FREE Discovery call with one of our CFP® professionals.

FAQs

• When is the SEP or SIMPLE IRA contribution deadline?

  Contributions for either account must be made by April 15 of the following year for the previous year's contributions (e.g., the 2024 deadline is April 15, 2025).

• When do employees become vested in a SEP or SIMPLE IRA plan?

  For both SEP and SIMPLE IRAs, employees are immediately 100% vested and must begin taking required minimum distributions at age 73 (with this stipulation climbing to age 75 in 2033).

• Can I roll over my SEP IRA into a traditional or Roth IRA?

  cause SEP IRAs and traditional IRAs are the same type of retirement savings account, you can do so in this case without any tax consequences. You can also convert your SEP IRA into a Roth IRA via a Roth IRA conversion, keeping in mind you’ll owe taxes on the amount converted.

• Can I roll over my SIMPLE IRA into a traditional or Roth IRA?

  While the same rules apply as with a SEP IRA (see above), going this route with a SIMPLE IRA dictates a two-year waiting period for conversions (with a failure to do so triggering a 25% penalty).

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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:
This document is a summary only and not intended to provide specific advice or recommendations for any individual or business.