Choosing Between a SEP and Simple IRA

When entering the world of entrepreneurs, there are important decisions to be made when talking about the steps to prepare for retirement, and what benefit plans for your employees are the most manageable and are the most effective in terms of cost. Large companies can offer plans where savings are encouraged, mostly seen in 401k plans. Companies can also stay competitive in the market by matching some contributions. However, if you work in a business where you are self-employed, a different strategy is needed in order to take full advantage of the compensation benefits. Small business owners can form two types of plans: SEP IRAs or A SIMPLE IRA.

Many similarities can be seen between both types of plans, but there are important differences that need to be recognized when making a decision about which one can benefit your company more. Both plans can be easy to establish, and both plans can be easy to keep in-tact, which is perfect for those owners of a small-business and might not have payroll or a department that can help look over employee packages that seem complicated.

A SIMPLE IRA gets most funding from contributions made by employees, but there is a contribution that is required to be made by employers. Some companies do not offer other qualified plans, in which the company would have eligibility to get this plan. For some companies, participation in this kind of plan would be the most beneficial, because then there is not one burden on one person. The employees get to decide what contribution is made. Even though employer’s are required to make a contribution, there can still be a choice made to cover the employer’s part, and there are two options. The employer can either fully match the first 3% of the compensation or make a contribution of 2% of every the employee’s compensation who is eligible.

Employers fund SEP IRAs. No funding requirements are required annually, which means that if the businesses has expenses that could be considered fluctuating, expenses have the option of being prioritized by the owner. A SEP IRA is available to a business with one or more employees. If you are more interested in making a greater amount of contributions to your retirement retirement, a SEP IRA plan is probably the best plan for you. You also have the option to make an IRA that is personal to you, while still having the SEP IRA. A person is given the ability to make contributions that are able to be fully deducted to the plan of the employee, which can be of benefit to the worker.

Regardless of the type of business you own, there can be benefits shown from both SIMPLE IRAs or SEP IRAs. Expenses will not only be deductible and can have the potential to lower the self-employment tax, but there will also be opportunity for a benefit of value to be provided, so that you have the chance to save up and contribute to your personal retirement.

Four Differences Between SEP and SIMPLE IRAs

Just because you own a small business doesn’t mean you aren’t qualified to offer retirement plans to your employees. Because Americans like options, there’s not just one option for you to utilize, there are two—the Simplified Employee Pension (SEP) IRA and the Savings Incentive Match Plan for Employees (SIMPLE) IRA. While each are designed to help small businesses with retirement plan options, there are differences between the two in their set-up, flexibility, and employee participation rules. Explained below are four key differences between SEP IRA and SIMPLE IRA retirement plans to help you better decide which would work best for you and your company.

  1. Eligibility and Participation. Only employers with fewer than 25 employees can participate in a SEP IRA plan. This plan is more flexible for the business as they allow employers to adjust annual contribution limits and frequency. Individual employees are not allowed to contribute to their plans however.

SIMPLE IRAs can only be utilized by companies who have 100 employees or less. For an employee to participate in this plan, they must prove an income of at least $5,000 for the previous two years as well as be expected to earn at least that much in the current year. They must also prove they have no participation in any other qualified retirement plan concurrently. Employees can contribute to their accounts, but are only guaranteed an employer contribution regardless of their own contribution under a non-elective 2% plan.

  1. Contribution limits. For a SEP IRA, only the employee’s first $270,000 of income is eligible for up to 25% contribution, creating a total of $54,000 annually that can be applied to their account.

For a SIMPLE IRA plan, employers can either choose to match an employee’s contribution up to 3% of the employee’s salary or offer a non-elective guaranteed 2% contribution regardless of employee contribution. In each case, the employee contribution amount cannot exceed $12,500 per year, or $15,500 if older than 50. An employer can offer 2% of the employee’s income in the non-elective plan only up to an income amount of $270,000. If an employer chooses the 2% plan, they must contribute to all eligible employee plans in this way.

    1. Taxes. Contributions for both plans, as well as matches for SIMPLE IRAs, are tax deductible for the employer only, even for their individual plan. Contributions and earnings grow tax deferred, but the employee must pay an income tax on all amounts withdrawn.
  1. Early Withdrawals. Funds removed before the account holder reaches 59 ½ may be subject to a 10% early withdrawal penalty for either type of account, on top of the income tax required for the amount. SIMPLE IRA early withdrawals within the first two years of participation in the plan will incur a hefty 25% fee.

Each plan holds unique costs and benefits for both employer and employee, and only you will know which is right for your personal business. Before choosing a plan, be sure to talk with your financial advisor for additional information and counsel.