Comparison of SEP IRA vs. SIMPLE IRA
Investors in real estate and other alternative investments need to realize that they are eligible to take full advantage of small business retirement plans created by the federal government. These plans include The Simplified Employee Pension Plan (SEP) and The Savings Incentive Match Plan for Employees (SIMPLE), which are available for self-employed individuals and small business owners, in addition to their Traditional or Roth Plan .
In this section, we will compare the SEP and SIMPLE IRA plans. For another small business retirement plan option, please see Individual(k) plan .
SEP and SIMPLE plans are as easy to create as Traditional or Roth IRAs. Once established, these plans become similar to Traditional and Roth IRAs, yet they allow individuals to contribute considerably more than the $4,000 limit (in 2007) for those plans.
People often assume that the term " SIMPLE IRA" refers to a "Traditional IRA" , but this could not be further from the truth. The Traditional IRA and the SIMPLE IRA are not the same. The SIMPLE IRA (Savings Incentive Match Plan for Employees) is a small business retirement plan, not to be confused with the Traditional IRA, which is for individuals.
Real estate investors often wear two hats - employer and employee
In many instances, real estate investors will wear two hats, as it pertains to SEP, SIMPLE and Individual(k) retirement plans: that of employee and employer. In this case, both contributions (employer & employee) go directly to the investor's IRA! Also keep in mind that, in addition to these plans, real estate investors can have an Individual IRA (Traditional or Roth).
No matter what hat you wear - be it a sole proprietor, partner, owner of an incorporated or unincorporated business, consultant or independent contractor - you are eligible for either a SEP or a SIMPLE (or an Individual(k) Plan). The only question is, which plan is right for you?
Which small business retirement plan is right for you?
Now that we have established even a single real estate investor qualifies for one of these plans, let's discuss the basic characteristics of the SEP and SIMPLE, so that you can evaluate which one is right for you. Please note that annual compensation refers to salary/wages for employees or earned income for those self-employed. If you receive only rental income (passive income), you will need to pay yourself a salary for managing your properties (earned income) to be eligible for an IRA.
The SEP IRA (Simplified Employee Pension Plan)
The Simplified Employee Pension Plan (SEP) enables business owners to make IRA contributions of up to $44,000 in 2007 (increasing to $45,000 in 2008 and then subject to annual cost-of-living adjustments for later years) toward their own and their employees' retirement, without getting involved or setting up a more complex qualified, such as the 401(k) plan.
With a SEP, contributions are made to an Equity Trust IRA set up by, or for, each eligible employee. SEP IRAs are owned and controlled by the employee. The employer makes contributions to his own SEP IRA, as well as the SEP IRA of any employees, and must contribute the same percentage for all eligible employees, unless the SEP IRA has adopted the permitted disparity rules. However, an employer may choose each year whether to contribute to this plan and is under no obligation to offer it each year.
- Business Eligibility - Any employer, whether a corporation, partnership, or self-employed individual, may establish the plan, even if there is only one employee.
- Employee Eligibility - Employees must be at least 21 years of age, have worked for the business during any three of the past five years, and earned the annual minimum required compensation of $500 (increasing to (varibale) in (next year)).
- Spousal Eligibility - Your spouse and children may also participate in the plan and open their own SEP IRAs - as long as they are employees of the company and meet the income requirements.
- Employer Contribution - An employer may contribute up to 25% of each eligible employee's annual compensation up to a maximum of $44,000 in 2007 (increasing to $45,000 in 2008). The employer is allowed to make contributions annually, but is not required to make any contribution for any particular year.
- Deductions - Employers may deduct every qualified dollar they contribute from their taxable income.
As with Traditional and Roth IRAs, clients can use funds from their SEP IRA to invest in any of the various investment vehicles offered by Equity Trust Company (see Self Directed IRA Investment Opportunities at Equity Trust).
The SIMPLE IRA (Savings Incentive Match Plan for Employees)
We often recommend that investors who receive less than $50,000 in annual compensation should choose the SIMPLE. This will allow them to contribute the maximum amount to their IRA. Another favorable point about this plan is that, if you have employees other than your family, as the employer you are only responsible to match if the employee contributes funds first. In addition to these benefits, after two years you may be able to convert your SIMPLE IRA to a Roth!
With a SIMPLE plan, employees can choose to make salary reduction/deferral contributions directly into an Equity Trust SIMPLE IRA, rather than receiving these amounts as part of their regular salary. There is a maximum employee contribution of $10,500 for 2007if you are under age 50, and $13,000 if age 50.
In addition, the employer contributes matching funds (up to 3%) into their employee's SIMPLE IRA at Equity Trust.
- Business Eligibility - Generally, small businesses (which include self employed individuals, including sole proprietors, partnerships and corporations) that employ 100 or fewer employees are eligible.
- Employee Eligibility - The employee must have earned at least $5,000 in the preceding year and reasonably expect to earn at least $5,000 for the current year. These requirements are the maximum and can be reduced by the employer.
- Spousal Eligibility - Your spouse and children may also participate in the plan and open their own SIMPLE IRAs - as long as they are employees of the company and meet the income requirements.
- Employee Contributions - Employees can contribute 100% of their annual compensation up to $10,500 ($13,000 if age 50+) for 2007.
- Employer Contributions - Employers match dollar-for-dollar up to 3% of the employee's annual compensation (max. $10,500 for 2007). The employer is only required to match for employees who have contributed to their own SIMPLE Plan.
- Deductions - Employees may deduct their contributions from personal taxable income, while the employer may deduct the matching amount from the business' taxable income. If you are self-employed, you receive both of these deductions!
As with Traditional and Roth IRAs, clients can use funds from their SIMPLE IRA to invest in any of the various investment vehicles offered at Equity Trust Company (see Self Directed IRA Investment Opportunities at Equity Trust).
How These Plans Can Work for a Real Estate Investor - A SEP example
In 2007, Mrs. Jones owns her own mortgage company and earns $100,000 per year in W-2 income. She is the only eligible employee. While she agrees with Mr. and Mrs. Smith that she is paying excessive amounts in tax each year, and has heard from the Smiths how good a SIMPLE plan at Equity Trust is, she realizes that the SEP plan would be even better for her.
As the employer, Mrs. Jones chooses to contribute 15% of her salary to her SEP. Along with her $4,000 contributed to her Equity Trust Roth IRA, she is now able to contribute $19,000 to her IRAs and reduce her company's taxable income by $15,000.
As with the SIMPLE plan, it should be noted that if Mrs. Jones has a husband and children, they may also participate in the SEP plan and enjoy all the benefits she will - as long as they are employees of the company.
Once the plans have been established, a SEP and SIMPLE IRA follow the same guidelines as a Roth IRA or Traditional IRA. The only exception is that a SIMPLE IRA must stay as a SIMPLE for two years before it can be converted to a Roth IRA.
At Equity Trust , clients have the option of using funds from their SEP, SIMPLE or Individual(k) plan to invest in all forms of real estate, as well as any other IRS-permitted investments. All of these small business retirement plans allow investors to enjoy the benefits of tax-deferred, compounded growth while choosing real estate or other alternative investments in which they have knowledge and expertise.
How These Plans Can Work for a Real Estate Investor - A SIMPLE example
In 2007, John Smith and his wife each earn $50,000 a year from their real estate business, in which they are the only employees. The Smiths believe they pay too much in taxes, and they would like to reduce their taxable income as well as contribute the maximum to an IRA. They plan to make real estate investments similar to those in their business, while compounding their profits, tax-deferred. In order to optimize their IRA contributions, they both decide to open a Roth IRA and SIMPLE IRA.
The Smiths are able to each contribute $4,000 to their Roth IRAs, as well as another $10,500 to their SIMPLE IRAs as employees of their real estate company. Finally, as employers, they have also decided that they will match 3% of each employee’s annual compensation. ($50,000 x 3% = $1,500 each)
In this instance, the Smiths are able to wear two hats, one as employees and the other as an employer. Because of their participation in these two IRAs, the Smiths have been able to:
- Contribute $31,000 ($8,000 + $21,000 + $3,000) to their IRAs this year, which can be used to invest in real estate.
- Lower their taxable income from $100,000 to $76,000 with their $24,000 in SIMPLE IRA contributions (Roth IRA contributions are not tax-deductible).
Once the plans have been established, a SIMPLE and SEP IRA follow the same guidelines as a Roth IRA or Traditional IRA. The only exception is that a SIMPLE IRA must stay as a SIMPLE for two years before it can be converted to a Roth IRA.
At Equity Trust Company, clients have the option of using funds from their SIMPLE, SEP or Individual(k) plan to invest in all forms of real estate, as well as any other IRS-permitted investments. (Please see Self-Directed IRA Investment Opportunities at Equity Trust.) All of these small business retirement plans allow investors to enjoy the benefits of tax-deferred, compounded growth while choosing real estate or other alternative investments in which they have knowledge and expertise.
| - | SEP - IRA | SIMPLE - IRA |
|---|---|---|
| Description | Specifically designed for self-employed people and small business owners who typically employ less than 25 employees. | Designed for small businesses with 100 or fewer employees. The plan is funded by employer contributions and can also be funded by elective employee salary deferral. |
| Employer Contributions | Required uniform % of each employee's pay (0-25%) | Employer is required to make either an annual matching contribution between 1 and 3% or an annual non-elective contribution of 2% of compensation. |
| Minimum Coverage Requirements | Plan must cover all employees who earn at least $500, are at least 21 and have worked for employer in 3 of the last 5 years. | Plan must cover all employees who earn at least $5,000 in the current year and have received at least $5,000 during any 2 preceding years |
| Employee Contributions | Not Permitted | Up to $10,500 in 2007. (If age 50+, $12,000.) |
| Maximum Total Annual Contributions | 25%, up to a maximum of $44,000 for 2007 ($45,000 for 2008 | Maximum employee contribution of $10,500 in 2007 (If age 50+, $13,000.) Employer matches up to 3% of salary. |
| Maximum Deductions | 25% of participant's total compensation, excluding SEP contributions | Same as maximum contribution |
| Vesting Schedule for Employer Contributions | All contributions 100% vested | All contributions 100% vested |
| Withdrawals / Distributions (Follows traditional IRA Regulations) | Permitted subject to tax and, if under 59 1/2, potential 10% penalty. | Permitted, however, if under age 59 1/2, potential 10% penalty. (25% penalty if account is less than 2 years old.) |
| Deadline for Establishment of Plan | Any time up to date of employer's return (including extensions). | Any time between 1/1 and 10/1 of the calendar year. For a new employer coming in to existence after 10/1, as soon as administratively feasible. Entries established during the year have until 12/31 |
| Deadline for Contribution | Due date of employer's return (including extensions). | Employee contributions: 30 days following the end of the month with respect to which the contributions are made. Employer matching contributions or non-elective contributions: Due date of employer's return (including extensions). |
Compare for Yourself
See how much you can contribute using the small business retirement plan calculator.