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.
- 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.
- 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.
- 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 Contributions and earnings grow tax deferred, but the employee must pay an income tax on all amounts withdrawn.
- 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.