Understanding Retirement Options for Your Small Business: SEP IRA vs. SIMPLE IRA

As your small business grows, it’s time to start thinking about the kinds of financial benefits you’d like to offer your employees. While you want to offer your employees the safety and security of a retirement plan, it can be difficult to understand what you can afford and what options require the least amount of work, maintenance, and expense.

SEP IRA vs. Simple IRA

We broke down the two main plans, SEP and SIMPLE IRAs, to explain the advantages, who qualifies, and provide examples. Some of the main differences to consider when choosing a plan are how many people your company employs, contribution limits and whether employees contribute (SEP IRA plans only allow the employer to make contributions to the account whereas a SIMPLE IRA allows more employee control).

[Related post: Differences between a Roth and Traditional IRA]

SEP – Simplified Employee Pension

Summary: A Simplified Employee Pension (SEP or SEP IRA) is designed for self-employed individuals or small businesses with fewer than 25 employees. If you earn a self-employment income, you are allowed to save more for retirement using a SEP plan than a traditional IRA or Roth allows.

Who is a SEP good for?

Self-employed people or small businesses with fewer than 25 employees. The SEP allows for pre-tax contributions toward retirement without getting involved in a more complex qualified plan such as a 401(k). Contributions to a SEP are tax-deductible and compound tax-deferred until withdrawn, pending that the distribution is taken after the account holder reaches 59 1/2 years of age. Additional information related to SEP accounts can be found on the IRS website.

Advantages:

• Less complex and costly than a 401(k)
• Allows individuals to contribute larger amounts than a traditional or Roth IRA
• May qualify for larger tax deductions

Who can and cannot participate in a SEP

The IRS tells us who can participate in a SEP. The employee:

• Has reached age 21
• Has worked for the employer in at least three of the last five years
• Received at least $750 in compensation from the employer during the year (for 2023 and 2024)

An employer can use less-restrictive participation requirements than those listed, but not more restrictive ones.

Who can’t participate in a SEP:

• Employees covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees’ union and the employer.
• Nonresident alien employees who do not have U.S. wages, salaries or other personal services compensation from the employer.

SEP contribution limits

The IRS states that employers’ contributions cannot exceed the lesser of:

• 25% of the employee’s compensation, or
• $69,000 for 2024

Compare 2024 contribution limits for various IRA options.

Examples

Here are examples from the IRS to help demonstrate when a SEP is a good choice:

Example 1: Employer X maintains a calendar year SEP. The eligibility requirements under the SEP are: An employee must perform service in at least three of the immediately preceding five years, reach age 21 and earn the minimum amount of compensation during the current year.

Bob worked for Employer X during his summer breaks from school in 2016, 2017 and 2018, but never more than 34 days in any year. In July 2019, Bob turned 21. In August 2019, Bob began working for Employer X on a full-time basis, earning $30,000 in 2019. Bob is an eligible employee in 2019 because he has met the minimum age requirement, has worked for Employer X in three of the five preceding years and has met the minimum compensation requirement for 2019.

Example 2: Employer Y writes its SEP plan to provide for immediate participation regardless of age, service or compensation. John is age 18 and began working part-time for Employer Y in 2019. John is an eligible employee for 2019.

SIMPLE IRA plan

Summary: Savings Incentive Match Plan for Employees allows employees and employers to contribute to traditional IRAs set up for employees.

Who is a SIMPLE plan good for?

It is ideally suited as a start-up retirement savings plan for small employers (100 or fewer employees) not currently sponsoring a retirement plan. With a SIMPLE plan, contributions are tax-deductible, and earnings within the account are tax-free until withdrawn. Employees are also 100-percent vested, which means they are able to take all funds, including employer contributions, with them if they leave.

Advantages:

• Flexibility for employers to choose to match employee contributions or the employer can contribute a fixed percentage of eligible employees’ pay
• Ease for the employer: A SIMPLE IRA is simple to set up and maintenance is typically more affordable than other options and there are generally no filing requirements with the IRS
• Tax-deductible contributions as well as tax benefits when employees withdraw from the account in retirement