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Two of the most popular ways for business owners and the self-employed to set up a retirement account for themselves and their employees are the SEP IRA and the SIMPLE IRA. Both accounts offer many of the significant tax advantages of a regular IRA and the benefit of saving money above and beyond the amount in their own personal IRA, with the added benefit of offering business owners a way to avoid the administrative hassle of typical retirement plans such as the 401(k)1. First, we’ll look at each option and then compare the two types of accounts.
SEP stands for Simplified Employee Pension. With this plan, employers, including the self-employed, can avoid the complex reporting requirements that the government usually mandates for retirement plans.
With a SEP IRA, only the employer makes contributions to the account. Employers may contribute up to 25% of an employee’s pay annually to the account, up to a total contribution of $61,000 for 2022 and $66,000 for 2023. The employer must contribute an equal percentage for all employees, though it may exclude some who have retirement plans through a union agreement.2
The employee Is Immediately 100% vested in all SEP IRA contributions and has complete control of the money. With a SEP IRA, employees can enjoy tax-deferred growth until retirement on any deposits.3
Regarding distributions, a SEP IRA functions like a traditional IRA, and money is taxed only when withdrawn. If money is withdrawn from the account before age 59 ½, a penalty of 10% will typically be assessed. Required minimum distributions on the account must start by at least age 73 according to the rules laid out by the IRS.
SIMPLE stands for Savings Incentive Match Plan for Employees, and it’s available for employers (including the self-employed) with no more than 100 employees earning more than $5,000 in the preceding year. It is ideally suited as a start-up retirement savings plan for small employers not currently sponsoring a retirement plan. SIMPLE IRA plans do not have the start-up and operating costs of a conventional retirement plan. However, unlike a SEP IRA, the employer can hire a financial institution to administer the SIMPLE IRA program.
With a SIMPLE IRA, employees can have contributions deducted from their paychecks and deposited into their accounts, where they can grow tax-deferred until retirement. The plan allows employees to contribute up to $14,000 for 2022 and $15,500 in 2023, while those age 50 and over can add $3,000 (in 2022) or $3,500 (in 2023). These elective deferrals count toward the annual maximum on elective deferrals for this and other retirement programs4.
Employers must contribute to their employees’ SIMPLE IRA, and they have two options5:
Regarding distributions, a SIMPLE IRA works like a traditional IRA. Money is taxed only when it’s withdrawn. For funds withdrawn before age 59 ½ or under some special exceptions, the IRS may assess a 10% penalty and a 25% levy in certain circumstances. Required minimum distributions must start at age 73 under IRS rules.
While the SEP IRA and SIMPLE IRA look a lot like traditional 401(k) programs, they differ in important respects from those programs and each other. Employers set up both programs on behalf of their employees and have similar distribution rules as a traditional IRA. Key differences between the two programs include the following:
Plan Contribution limit (2022) Contribution limit (2023)
SEP IRA $61,000* $66,000*
SIMPLE IRA $14,000** $15,500**
*or up to 25% of an employee’s salary, whichever is less
**plus $3,000 (2022)and $3,500 (2023) for those over age 50
The SEP IRA and SIMPLE IRA were created to help smaller employers, including the self-employed, have a more robust vehicle to help employees save for retirement. The plans boast significant maximum contributions and offer varying benefits, but it’s up to employers to decide which plan works best for them and their financial situation. Looking for more information on retirement account options? Find information about the differences between traditional and Roth IRAs on our blog. If you’d like to find out what retirement account option suits your situation, give us a call. We’re happy to chat.
Sources:
Garrison Point Advisors, LLC doing business as “Treehouse Wealth Advisors” (“TWA”) is an investment advisor in Walnut Creek, CA registered with the Securities and Exchange Commission (“SEC”). Registration of an investment advisor does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. TWA only transacts business in states in which it is properly registered or is excluded or exempted from registration. A copy of TWA’s current written disclosure brochures, Form ADV Part 1 and Part 2A, filed with the SEC which discusses among other things, TWA’s business practices, services, and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov.
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