SEP IRA vs. SIMPLE IRA [How To Choose What Works For YOU]

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You’ve likely heard of the traditional and Roth IRA – most people are aware of the two retirement options that either tax your money during retirement or now. But did you know there are a couple of other great options?

Sole proprietors and self-employed business owners have two additional retirement options: the SEP IRA and the SIMPLE IRA.

While these accounts aren’t as standard, they have their benefits and are especially helpful for those without access to an employer-sponsored 401K.

Why would you want a SEP IRA or SIMPLE IRA?

If you don’t have an employer-sponsored 401K, you may wonder why setting up an IRA or two is important. It seems like a lot of decision-making and administrative work.

While you can save however you want, no other accounts offer the same tax benefits as IRAs and 401Ks. Retirement accounts offer tax savings either now when you contribute or during retirement, depending on the type of account you choose. Tax savings are a formidable force when combined with the power of compounding.

This is key to being able to get through retirement with enough money. If you don’t work for an employer, either a SEP IRA or a SIMPLE IRA may be a good option.

Ever wonder if 401ks are still worth it anymore? Check it out!

What does SEP IRA stand for?

SEP IRA stands for Simplified Employee Pension Individual Retirement Account.

What is a SEP IRA?

A SEP IRA is a retirement plan for the self-employed. It doesn’t matter if you have any additional employees other than yourself. However, it’s best for those without employees (sole proprietors or single-member LLCs) since the plan doesn’t allow employees to make elective contributions.

The contributions can only come from the employer. As the employer, you are 100% in charge of how much you contribute to your employees.

But, with a SEP IRA, there is a very important catch. Any amount you contribute to your own retirement plan, you must also contribute to your employees’ plans. This means if you contribute 20% of your income to your retirement plan, you must contribute 20% of each of your employee’s income to their retirement plan.

The benefit is that you are in control of what percentage to contribute, and when you want to contribute. You aren’t obligated to contribute to the SEP IRA every year if you don’t want to.

Employers may contribute a maximum of $58,000 a year or 25% of employee salary, whichever is less. This plan may get expensive if you have numerous employees.

Employees cannot contribute to a SEP IRA on their own. They can only make standard IRA contributions and take the deduction when they file their taxes.

How does a SEP IRA distribution work?

Any SEP-IRA distribution and earnings are taxed only when the owner withdraws funds from the account. It works just like a traditional IRA. If you wait until you’re at least 59 ½ years old, you pay taxes only on the amount you withdraw and at your current year’s tax rate.

If you or your employee withdraw funds early, you’ll have to pay a 10% penalty plus taxes at the current year’s rate.

Who can qualify for a SEP IRA?

You can use the SEP IRA as long as you are self-employed, with or without employees.

For your employees to be eligible, they must be at least 21 years old, earn at least $600 for the year, and have worked for the same employer for three of the last five years at a minimum.

Pros and cons of a SEP IRA: The pros


  • The contribution limits are much higher than a traditional IRA, which is great for the self-employed without an employer-sponsored 401K
  • Money grows tax-deferred until you withdraw it during retirement.
  • You control how much you contribute to your employees’ plans.
  • You don’t have to contribute every year.

Pros and cons of a SEP IRA: The cons


  • If you have employees, you contribute the same percentage of salary to them as for yourself
  • Employees can’t make deductible contributions for themselves
  • Employees are immediately 100% vested (they take the account if they leave unexpectedly)

What does SIMPLE IRA stand for?

SIMPLE IRA stands for Savings Incentive Match Plan for Employees Individual Retirement Account.

What is a SIMPLE IRA?

A SIMPLE IRA works much like a traditional IRA, but you can contribute much more to it. Your business must comprise of 100 or fewer employees.

If you’re a sole proprietor or small business owner, you can contribute to a SIMPLE IRA. You can set it up for yourself and your employees, but employees can make their own elective contributions, unlike the SEP-IRA.

If employees choose to defer some of their income to contribute, they lower their tax liability for the year since the withdrawals are pre-tax. Employers must contribute to their employees’ accounts but have a couple of options to do so:

  • Match contributions – Like a 401K, employers can match an employee’s elective contribution. You must match 3% with this option.
  • Non-elective contributions – Employers contribute to an employee’s SIMPLE IRA without any employee contribution. You would be contributing 2% using this option.

If you set up a SIMPLE IRA, all employees must join. However, employees aren’t required to contribute their own money. They’ll still receive non-elective contributions, but they don’t have to defer their income if they choose not to.

In 2021, you may contribute up to $13,500 per year. If you’re over 50 years old, you can contribute up to $3,000 on top of that.

Withdrawals work the same as a traditional IRA, and your money grows tax-deferred if you wait to withdraw funds until age 59 ½ or later. You’ll pay taxes at your current tax rate when you withdraw funds. If you withdraw funds early, you’ll pay a 10% penalty plus the current tax rate.

Who can qualify for a SIMPLE IRA as an employee?

To be eligible, employees must work for the same employer for two of the last five years at a minimum. In that time, they must earn at least $5,000 each year, and they must also expect to make as much money in the year they contribute.

Contribution Limits for SEP vs. SIMPLE IRA

PlanContribution (2022)Contribution (2023)
SEP IRA$61,000$66,000
SIMPLE IRA$14,000 (plus $3,000 for 50+)$15,500 (plus $3,000 for 50+)

Pros and cons of a SIMPLE IRA: The pros


  • Simple to set up if you have fewer than 100 employees
  • Much less administrative work compared to a 401K
  • Employers get tax advantages for contributing to their employees’ plans

Pros and cons of a SIMPLE IRA: The cons


  • Employers must contribute to all employees’ plans every year
  • The contribution limits are much lower than the SEP-IRA if you’re trying to max out your own accounts
  • Employees are immediately 100% vested

Is a SIMPLE IRA the same as a traditional IRA?

No, a SIMPLE IRA is not the same as a traditional IRA.

What is the difference between a SIMPLE IRA and a traditional IRA?

In a traditional IRA, an individual sets up the IRA for themselves. In a SIMPLE IRA, the business owner sets up the IRA for themselves and their employees.

Is a SIMPLE IRA the same as a Roth IRA?

No, a SIMPLE IRA is not the same as a Roth IRA.

What is the difference between a SIMPLE IRA vs a Roth IRA?

In a Roth IRA, an individual sets up the IRA for themselves, whereas in a SIMPLE IRA, the business owner sets up the IRA for themselves and their employees as previously mentioned.

What is the difference between a traditional and a Roth IRA?

The difference is that in a traditional IRA, you contribute pre-tax dollars to your account and it gets taxed when you take it out during retirement, whereas in a Roth IRA, you contribute after-tax dollars and it doesn’t get taxed when you take it out during retirement.

How to choose between a SEP IRA vs. a SIMPLE IRA as a self-employed business owner?

To choose between the SEP IRA and SIMPLE IRA, consider the following:

If you want your employees to be able to make tax-deferred contributions?

Go with a SIMPLE IRA. The SEP-IRA only allows employer contributions, not employee contributions.

If you want your employees to have control of how much they contribute to their own retirement?

Go with a SIMPLE IRA. It allows employees to make contributions how they want. This puts employees in control and acts like a traditional 401K. The SEP-IRA works more like an ‘old school’ pension.

If you want to be able to contribute a considerable amount to your own retirement?

Go with a SEP-IRA. It allows much higher contribution limits than a SIMPLE IRA. The SIMPLE IRA allows up to $13,500 per year, whereas the SEP-IRA allows $58,000 per year.

If you have a volatile business year-to-year?

Go with a SEP-IRA. It allows employers to adjust the amount of their contributions each year. For example, if you’re having a challenging year, you aren’t obligated to make contributions but can pick them up again the following year. The SIMPLE IRA doesn’t allow this break.

Can you have both a SIMPLE IRA and SEP IRA?

No, you must choose one or the other. The IRS doesn’t allow the self-employed to have both types of accounts.

For more types of IRAs, check out Roth Contributory IRA.

Are SEP IRA contributions tax-deductible?

Yes, in addition to the tax benefits you get for the contributions to your account, you also get a tax break for any contributions made to your employees’ accounts.

Can employees opt out of a SEP IRA or SIMPLE IRA?

Since the SEP-IRA isn’t an optional plan for employees, they can’t opt out. Employees don’t make contributions to their SEP IRA – all money comes from the employer. For a SIMPLE IRA, all employees must join as well. Most employees don’t mind the account since it’s a part of the benefits of working for you.

Can a sole proprietor qualify for a SEP IRA or a SIMPLE IRA?

Yes, you don’t need to have employees to have a SEP IRA or SIMPLE IRA. Sole proprietors can have either account and realize the tax advantages of saving for retirement.

What are some small business owner retirement options other than SEP and SIMPLE IRA?

  • Solo 401(k): This plan is designed for self-employed individuals or small business owners without any employees. Contributions can be made as both an employer and an employee, and the maximum contribution limit is higher than that of a traditional IRA.
  • Defined Benefit Plan: This plan allows for a larger contribution limit and is best suited for high-income earners with no or few employees. The plan is based on a formula that determines the amount of retirement benefits an employee will receive.
  • Profit-Sharing Plan: This plan allows for discretionary contributions to be made to employee accounts based on the profits of the business. The employer decides how much to contribute, and the plan is subject to annual contribution limits.
  • Cash Balance Plan: This plan is similar to a defined benefit plan, but it is easier to understand and manage. Contributions are made based on a formula, and the employee receives a benefit based on the account balance at retirement.
  • Individual Retirement Account (IRA): An IRA is a retirement account that individuals can set up and contribute to themselves. Traditional IRAs offer tax-deferred savings, while Roth IRAs offer tax-free growth and withdrawals.

In conclusion

If you own a business, you owe it to yourself to save for retirement. Not saving for retirement early on can be financially devasting as you near retirement age.

Fortunately, there are many ways for sole proprietors and business owners to open a retirement account for themselves and their employees. Offering a retirement plan to your employees can be a great way to bring in top talent since most people consider a retirement plan a crucial part of their benefits.

Do you have a SEP IRA or SIMPLE IRA? If so, how are you liking it? Let us know, we’d love to hear from you!

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