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Simple IRA vs. SEP-IRA

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simple ira vs sep ira

Most people have heard of traditional IRAs and Roth IRAs. Both are vehicles for saving money for your retirement, separated only by their tax treatment. There are two other types of individual retirement accounts, though, that aren’t as common: the SIMPLE IRA and the SEP-IRA.

When comparing SIMPLE IRA vs. SEP-IRA, there are both similarities and key differences to keep in mind. Knowing what each of them offers can help you decide which is right for you, or which to offer your employees if you’re a small business owner.

SIMPLE IRA Defined

simple ira vs sep ira

SIMPLE IRA stands for Savings Incentive Match Plan for Employees Individual Retirement Account. A SIMPLE IRA functions fairly similarly to a traditional IRA, but it has a higher contribution limit.

Anyone — often someone without access to a workplace savings plan like a 401(k) — can set up a traditional IRA. A small business owner or a business’ sole proprietor can set up SIMPLE IRA, both for themselves and for their employees. Any employee who has earned at least $5,000 in compensation from the company that’s setting up the plan, and who expects to make at least that much in the current calendar year, is eligible to participate in the plan.

Eligible employees can choose to make elective deferrals. This works just like a 401(k) plan, where employees defer a certain amount of their pre-tax income into the plan. The employer can also make contributions to employee accounts, either by matching employee contributions or as a non-elective contribution. In a non-elective contribution, the employer makes the decision to put money in the employee’s account regardless of whether the employee participated in the plan that year.

Unlike some other types of retirement plans, you cannot opt out of participating in a SIMPLE IRA if you are eligible. You can choose not to put money in your account, but you  must receive non-elective company contributions, if for some reason you’re opposed to getting free money.

The SIMPLE IRA contribution limit is $12,500 in 2018, with a catch-up contribution limit of $3,000. The limit will go up to $13,000 in 2019. This means that workers over 50 can contribute up to $15,500 ($16,000 in 2019).

SEP-IRA Defined

The ‘SEP’ part of SEP-IRA stands for simplified employee pension. While how simple it seems probably depends on your level of confidence with financial matters, a SEP-IRA does seek to streamline the tax-deferred savings process for the self-employed and small business owners. It also helps provide savings vehicles to employees of small businesses.

Unlike other workplace retirement plans, any employee enrolled in a SEP-IRA does not make contributions themselves. Instead, the employer makes contributions for them directly. The employer can contribute up to 25% of an employee’s salary, or up to $55,000, whichever is less. That number increases to $56,000 in 2019. Employers choose when to make contributions, and they don’t have to do it each year. All employees and the owner of the business must receive contributions at the same percentage of salary.

SIMPLE IRA vs. SEP-IRA

simple ira vs sep ira

If you are the sole proprietor of a small business, you can choose between using a SIMPLE IRA or a SEP-IRA for yourself and your employees. The two types of plans have many similarities, but there are differences to consider as well.

A SIMPLE IRA allows both the employee and the small business owner or sole proprietor to make contributions. A SEP-IRA, meanwhile, only allows business owners to make contributions for both themselves and their employees. The contribution limits of a SIMPLE IRA vs. SEP-IRA are different too. The SIMPLE IRA contribution limit is $12,500 ($13,500 in 2019), with a catch-up limit of $3,000. The SEP-IRA limit is up to 25% of an employee’s salary or up to $55,000 ($56,000 in 2019), depending on which is less.

Generally, a SEP-IRA is good for businesses with less than 100 employees because it allows employers to adjust contributions based on cash flow. SIMPLE IRAs can be used by businesses of any size.

The chart below highlights some of the differences between the two retirement plans.

Comparison of Plans SIMPLE IRA SEP-IRA Tax status  Tax-deferred Tax-deferred Contributor  Employees and/or employer  Employer Contribution Limit  $12,500 ($13,500 in 2019); catch-up limit of $3,000  25% of an employee’s salary or up to $55,000 ($56,000 in 2019), whichever is less Good For  Any size business Businesses with less than 100 employees The Bottom Line

If you own a small business and want to help both yourself and your employees save for retirement, you may have to consider the question of SIMPLE IRA vs. SEP-IRA. Both plans help with retirement savings, but there are some key differences. These mostly pertain to how the accounts are funded. Each type of IRA also has different limits for how much money one person can deposit into their account in a given year.

Retirement Tips
  • If all of this seems like a lot to you, don’t sweat it. A financial advisor can help you understand retirement and all of its moving parts. SmartAsset can help you find an advisor with our free financial advisor matching service. You answer a few questions, and we match you with up to three advisors in your area. We fully vet all advisors on our platform to ensure they are free of disclosures. You then interview each match to see who is a good fit for you.
  • It’s important to have some sort of a plan for dealing with emergencies in retirement. You never know when an emergency could derail your retirement, whether it’s a medical incident or a child moving back home.

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