Simple IRA vs. SEP-IRA

Most people have heard of traditional IRAs and Roth IRAs. Both are vehicles for saving money for your retirement, separated only by their tax treatment. There are two other types of individual retirement accounts, though, that aren’t as common: the SIMPLE IRA and the SEP-IRA.  Knowing what each of these accounts offers can help you decide which is right for you, or which to offer your employees if you’re a small business owner. A financial advisor can help you create a financial plan to reach your retirement goals.

What Is a SIMPLE IRA?

SIMPLE IRA stands for Savings Incentive Match Plan for Employees Individual Retirement Account. A SIMPLE IRA functions fairly similarly to a traditional IRA, but it has a higher contribution limit and is typically for anyone who is self-employed with less than 100 employees.

How a SIMPLE IRA Works

Eligible employees can choose to make elective deferrals. This works just like a 401(k) plan, where employees defer a certain amount of their pre-tax income into the plan. The employer can also make contributions to employee accounts, either by matching employee contributions or as a non-elective contribution. In a non-elective contribution, the employer decides to put money in the employee’s account regardless of whether the employee participated in the plan that year.

Unlike some other types of retirement plans, you cannot opt out of participating in a SIMPLE IRA if you are eligible. You can choose not to put money in your account, but you must receive non-elective company contributions if for some reason you’re opposed to getting free money.

Who Can Open a SIMPLE IRA? 

Anyone – often someone without access to a workplace savings plan like a 401(k) – can set up a traditional IRA. A small business owner or a business sole proprietor can set up a SIMPLE IRA, both for themselves and for their employees. Any employee who has earned at least $5,000 in compensation from the company during any two years before the current year and who expects to make at least that much in the current calendar year, is eligible to participate in the plan.

What Is a SEP-IRA?

The “SEP” part of SEP-IRA stands for “simplified employee pension.” While how simple it seems probably depends on your level of confidence with financial matters, a SEP-IRA does seek to streamline the tax-deferred savings process for self-employed and small business owners. It also helps provide savings vehicles to employees of small businesses.

How a SEP-IRA Works

Unlike other workplace retirement plans, any employee enrolled in a SEP-IRA does not make contributions themselves. Instead, the employer makes contributions for them directly. For 2023, the employer can contribute up to 25% of an employee’s salary or $66,000, whichever is less.

Employers choose when to make contributions, and they don’t have to do it each year. All employees and the owner of the business must receive contributions at the same percentage of salary.

Who Can Open a SEP-IRA? 

Anyone who is a business owner with one or more employees can open a SEP-IRA. Additionally, these financial accounts are available to those who have freelance income as well. All contributions are tax-deductible for your business or for yourself if you’re opening one with your freelance income. Keep in mind that employees of the business can’t contribute to these accounts, only the business.

SIMPLE IRAs vs. SEP-IRAs

If you are the sole proprietor of a small business, you can choose between using a SIMPLE IRA or a SEP-IRA for yourself and your employees. The two types of plans have many similarities, but there are differences to consider as well.

A SIMPLE IRA allows both the employee and the small business owner or sole proprietor to make contributions. A SEP-IRA, meanwhile, only allows business owners to make contributions for both themselves and their employees. The contribution limits of a SIMPLE IRA vs. SEP-IRA are different too. The SEP-IRA limit in 2023 is 25% of an employee’s salary or up to $66,000, whichever is less. The SIMPLE IRA contribution limit is $15,500 for 2023, with a catch-up contribution limit of $3,500. Workers over 50 can contribute up to $19,000.

Generally, a SEP-IRA is good for businesses with less than 100 employees because it allows employers to adjust contributions based on cash flow. SIMPLE IRAs can be used by businesses of any size. The charts below highlight some of the differences between the two retirement plans and the contribution limits for both the 2023 and 2024 tax years.

Comparison of Plans for 2023

There aren’t many changes to the 2024 tax year, with only the contribution limit increasing by a total of $500.

Comparison of Plans for 2024

Bottom Line

If you own a small business and want to help both yourself and your employees save for retirement, you may have to consider the question of SIMPLE IRA vs. SEP-IRA. Both plans help with retirement savings, but there are some key differences. These mostly pertain to how the accounts are funded. Each type of IRA also has different limits for how much money one person can deposit into their account in a given year.

Retirement Tips

• If all of this seems like a lot to you, don’t sweat it. A financial advisor can help you understand retirement and all of its moving parts. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• If you want to set up and plan your retirement goals, SmartAsset’s retirement calculator can help you figure out how much you will need to save to retire comfortably.
• It’s important to have some sort of plan for dealing with emergencies in retirement. You never know when an emergency could derail your retirement, whether it’s a medical incident or a child moving back home.

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