SEP IRA Vs. Simple IRA: How to Decide for Your Business

Small business owners play many roles: boss, accountant, payroll processor, human resources professional and more. Name the job and you’ve likely done it. One position that's vital is retirement plan sponsor. Fulfilling that role with a SEP or SIMPLE IRA may give your business and employees tax-saving benefits today while helping save for the future.

While there are several retirement plan options available for businesses, two popular plans are: SEP IRAs and SIMPLE IRAs. Both can help build up savings for the future. They are also designed to offer tax advantages for you, your employees and your business.

What Is a SEP IRA?

A Simplified Employee Pension IRA (SEP IRA) can be used with a business of any size, including a sole proprietorship. The 2023 contribution limit is 25% of the employee’s salary or $66,000 ($69,000 for 2024), whichever amount is less.

The employer funds all contributions but isn’t required to every year. Employees do not contribute to the plan but are always 100% vested in plan contributions. That means the money belongs to them immediately as each contribution is made.

What Is a SIMPLE IRA?

A Savings Incentive Match Plan for Employees IRA (SIMPLE IRA) can be used for a smaller company with up to 100 employees. Though the 2023 contribution limit of $15,500 ($16,000 for 2024) is much less than a SEP IRA, it’s still more than double the limit allowed for a traditional or Roth IRAs.

With a SIMPLE IRA, employees can elect to defer some of their earned compensation into the SIMPLE IRA established for them. The employer must match each employee’s contributions dollar-for-dollar up to 3% of the employee’s compensation. Or the employer must provide a flat 2% contribution to each employee (whether they contribute or not).

Employees are always immediately 100% vested in both their own and the employer’s plan contributions. Also, SIMPLEs allow additional “catch-up” contributions of up to $3,500 for employees aged 50 and above. The catch-up amount is the same for both 2023 and 2024.

SEP IRAs vs. SIMPLE IRAs: A Comparative Analysis

A breakdown of the differences between SEP IRAs and SIMPLE IRAs (shown here) can help you decide which one may be right for your business.

Why Choose a SEP IRA?

Flexibility is one key attraction of a SEP IRA. If your business experiences lean profits one year, you can waive a SEP IRA contribution. As an employer, you decide which years to contribute and which ones to skip. However, that also means you won't get the business tax deduction in the years you don't contribute.

In addition, SEP IRAs are low cost, easy to set up and maintain, and offer higher contribution limits than some other retirement plans. You also don't have to file additional paperwork with the IRS to maintain your plan.

Why Choose a SIMPLE IRA?

It's in the name. SIMPLE IRAs are, frankly, one of the simplest plans to manage. In many ways, they act like a 401(k) with employee salary deferrals and potential employer matching—but with less effort and usually less expense.

There is no annual IRS filing, no compliance testing and no need for a costly third party to help administer the plan. However, employers must notify eligible employees about the plan by November 1 of each year.

Employers can also decide whether they want to match employee contributions or contribute a flat percentage rate each year. But you must do one or the other; you cannot opt out like you can with a SEP.

Tax Implications and Benefits

Both SEP and SIMPLE IRAs offer tax advantages. For you and your employees, retirement savings grow tax-deferred, meaning each participant pays no taxes on the contributions or earnings until the money is withdrawn, as long as all requirements are met.*

For your business, contributions are generally tax-deductible business expenses. In addition, the SEP and SIMPLE IRA plans may satisfy an employer’s responsibility to offer a plan if they operate in a state with a retirement plan mandate.

Strategic Considerations for Small Business Owners

If you’re trying to decide between a SEP IRA versus a SIMPLE IRA, consider the size of your company, your financial capacity and long-term business goals.

A SEP IRA can work for employers of any size and gives you the flexibility not to contribute every year. Many self-employed or gig workers may want to consider a SEP IRA due to this flexibility.

On the other hand, employers with fewer than 100 employees may want to consider a SIMPLE IRA. It’s easy to manage and allows the employer to match contributions—a highly sought after benefit for potential employees.

Both plans offer tax advantages and a valuable perk for employees. As many Americans struggle to achieve comfortable retirement savings, an employer-based retirement plan can be an important tool for employee retention and satisfaction.

Legal and Compliance Aspects

Small businesses are attracted to SEP IRAs and SIMPLE IRAs partly because these plans require so little compliance work. Typically, there’s no need to file annual financial reports with the federal government. However, the employer must complete and distribute copies of IRS Form 5305-SEP  or IRS Form 5305-SIMPLE  to notify eligible employees about what the plan will offer each year. You will also want to keep a copy of each year’s form, and proof that you provided it to your employees, within your business records.

Aside from the minimal tax filings associated with these plans, employers must ensure that they qualify for the plans based on number of employees and that they adhere to the contribution limits set annually by the IRS.

Investing in a SEP or SIMPLE IRA

Like any retirement plan and depending on the investment firm managing the plan, SEP IRA and SIMPLE IRAs can have a variety of products available to invest in. However, the investments you choose don’t have to be set in stone. It’s important to regularly review and potentially adjust retirement plan investments in response to future changes in regulations, business dynamics or personal circumstances.

SEP and SIMPLE IRA Plan Deadlines

Like just about everything related to taxes and your business, there are deadlines for opening a SEP IRA or SIMPLE IRA. A SEP IRA must be established by the employer's tax deadline plus any extensions. A SIMPLE IRA must be established by October 1 of the year the plan becomes effective.

Make Consistent Contributions

Once you establish your business retirement plan, you should consider regular contributions for your own retirement. Contributions you make for employees to a SIMPLE IRA are mandatory, so that will automatically be a habit.

For SEP IRAs, even though contribution flexibility is allowed, you might want to take advantage of the benefits of regular investing for yourself and any employees, as well as the tax savings from contributing every year, if you can.

Many business owners wait until their tax day (plus extensions) to contribute. But making smaller contributions throughout the year may be easier to manage than coming up with one larger sum at tax time. Whichever strategy you choose, your future self and your employees will be grateful.