SIMPLE vs. SEP IRA

Most small business owners want to offer some sort of retirement plan to their employees as a work benefit. And the most cost effective options are the SEP IRA (Simplified Employee Pension) and the SIMPLE IRA (Savings Incentive Match Plan for Employees). We’ll compare the two plans below but I want you to keep in mind the reason for this plan in the first place. It is to increase your tax savings and provide a work benefit to retain talent. If there’s another option that solves these problems such as a nicer office, using Traditional IRA/Roth IRA, covering a gym membership, or paying out a bonus at year end then that could be a great decision as well.

Deductibility

Contributions into the SEP and SIMPLE IRA are always deductible if within the annual contribution limits. Neither the SEP IRA or SIMPLE IRA have a Roth option which may be a negative for younger lower income employees.

SEP IRA Positives

SEP IRA’s have contribution limits of 20% of the employers income and 25% of employees income.
- If the employer receives $100k in income then their contribution limit will be $20k. If an employee receives $100k in income then their contribution limit will be $25k.
Maximum annual contribution of $69,000 in 2024

SEP IRA Negatives

All contributions are made by the employer. Meaning this plan doesn’t work like the SIMPLE or 401k where there’s an employee contribution and a company match. All contributions into the owner and employee pension plan accounts are employer contributions.
SEP IRA’s do not offer catch up contributions for participants over age 50

Withdrawals before age 59.5 will receive a 10% penalty on top of their taxation.

SEP IRA Participation

Employees must be allowed to join the plan if older than 21, earned at least $600 this year, and employed with the company for 3 of the past 5 years. The age limit can be adjusted downward to age 18 if employer desires.

SEP IRA Creation Deadline

SEP plans have the same contribution and creation deadline of the company’s tax filing deadline.

SIMPLE IRA Positives

Employee contribution limits in 2024 are $16,000 or $19,500 if over age 50.
Employer’s can offer a contribution of 2% of employee income up until income reaches $275,000 regardless of employee contribution. Or the employer can provide a 3% match dependent on employees contributing to receive this match. Lastly, Employer’s can lower match to 1% 2 out of 5 years if the business is struggling.
Employees being able to contribute in the SIMPLE IRA is a positive for most employers vs. having to make all the contributions like within a SEP IRA.

SIMPLE IRA Negatives

Withdrawals from a SIMPLE IRA plan before age 59.5 are subject to income taxes and if done within the first 2-years of opening the account you will face a steep 25% penalty. This 25% penalty also stands for rollovers. So if you open a SIMPLE IRA be sure to leave it be for at least 2-years.
When income levels break $100,000 you can likely contribute more into a SEP IRA as opposed to a SIMPLE IRA.
Must have fewer than 100 employees

SIMPLE IRA Creation Deadline

SIMPLE IRA’s must be established by October 1 in the year you want to contribute. If you had a SIMPLE in a previous year then you must set it up by Jan 1 of the contribution year.

SIMPLE IRA Participation

No age restriction and employee must earn $5,000 during any two prior years and be expected to earn $5,000 in the current year.

Contributing to 401k and SIMPLE or SEP IRA in the same year.

If you had two jobs and one offered a 401k and the other offered a SIMPLE IRA or SEP IRA you could contribute to both. The main rule you want to be aware of is not contributing more than the employee limit of $23,000 in 2024 or the overall limit of $69,000 plus catch up contribution of $7,500 if using your 401k. You will still need to follow the individual plan limits, however, combined you will be penalized if you break the $23k (employee) or overall $69k ($76.5k over 50) limit.

Overcontribution Penalty

Any excess contribution or earnings tied to that contribution will have a 6% penalty for each year they remain in a retirement account. If you find yourself in this position you should notify your employer and plan administrator immediately and withdraw the excess contributions and related earnings or apply it to a future years contribution. Your w-2 form will also need to be amended. The difficulty with combining plans is you are responsible for these limits. The 401k custodian doesn’t know what you’re contributing to your other jobs SIMPLE or SEP IRA and therefore it is very easy to overcontribute.

Where To Open A SIMPLE IRA or SEP IRA

You can open these plans at most custodians such as Altruist, Vanguard, Schwab, and Fidelity. It is possible to self manage these plans but I recommend talking it over with a financial advisor who has managed these plans before to ensure there is direction with investing employee accounts, employee reporting, and having the correct forms on file to pass compliance tests.

Conclusion

I believe if you are the only employee in your company and plan to keep it that way then the SEP IRA or Solo 401k provide the highest contribution limits and may be best for tax deductions. I am slightly in favor of the solo 401k due to it’s Roth option and higher contribution limits at lower income levels. However, if I had any employees I would lean towards the SIMPLE IRA because I wouldn’t want to be responsible for all of their retirement account contributions and 401k’s are around $5k/year to manage on the low end and SIMPLE’s may only cost $1k-$2k/year. However, these are complex topics and I recommend discussing this with your financial advisor before making a decision.