Simplified Employee Pension (SEP) vs SIMPLE IRA

Simplified Employee Pension (SEP) and SIMPLE IRA are both retirement plans that allow you to contribute money into an account on behalf of the employee. However, both plans have different eligibility requirements and tax implications. Knowing each retirement plan is important because they can help you decide which is the best option for you, or which plan is best to offer to your employees.

What Is Simplified Employee Pension (SEP)?

Simplified Employee Pension (SEP) are retirement plans that can be established by employers who have less than 100 employees. The account is set up by the employer and then funded on behalf of each employee. The contributions can be made as a percent of income or a flat amount, whichever the employer decides upon. It is important for you as an employee to understand how much you will be contributing as a part of your total compensation package. For 2021, the contribution limit is the lesser of 25 percent of compensation or $58,000. If you are 50 years old or older, you can put in an additional $6,000 catch-up contribution.

What Is a SIMPLE IRA?

SIMPLE IRA stands for Simplified Employee Pension Individual Retirement Account. It is a defined contribution plan with special tax benefits available to all types of businesses. Business owners can use these plans to save for retirement or other needs, minimize paperwork and recordkeeping requirements, and offer their employees an opportunity to save for their own futures. This type of IRA allows you to contribute up to $13,500 in 2021. If you are 50 years of age or older, you can make an additional $3,000 catch-up contribution. To set up a SIMPLE IRA Account, one must fill out Form 5305 and be signed by both the employer and the employee. The account also requires Form 5304 to be filed by the employer with the IRS.

Key Differences Between SEP and SIMPLE IRA

There are key differences between SEP and SIMPLE IRA: Comparison of SEP and SIMPLE IRA

Eligibility

Simplified Employee Pension and SIMPLE IRA both have eligibility requirements, but these vary depending on the type of plan. SEP eligibility is based on employee deferrals and employer contributions. For example, employers must have less than 100 employees contributing if they are to have this account. SIMPLE IRA on the other hand is available to any employer with an average of one employee per year over a two-year period prior to opening the account.

Tax Status

SEP is a tax-deferred plan, meaning that contributions are not taxed until you withdraw them from the account. In contrast, SIMPLE IRA accounts are exempt from tax as long as the funds remain in the account. However, any income earned on those funds would be taxable.

Contribution Limits

The contribution limit for SEP is higher than that of a SIMPLE IRA. For example, the maximum amount you can contribute to a Simplified Employee Pension is 25 percent of compensation or $58,000 per year in 2021. In contrast, SIMPLE IRA has a lower contribution limit of $13,500 which increases to $16,500 for those over 50 years old.

Contributor

Both Simplified Employee Pension and Simplified Employee Pension offer employer-only contributions to employees. When it comes to SEP, the employer is responsible for all contribution decisions while SIMPLE IRA allows both the employer and employee to contribute a percentage of their income.

Penalty for Withdrawal

Withdrawing money from SEP before you reach 59 ½ can result in a 10 percent penalty on the withdrawn amount. In contrast, SIMPLE IRA does not have a penalty for early withdrawal as long as contributions remain in an individual’s account for at least five years from the date of their first contribution.

Benefits of Simplified Employee Pension

There are many benefits to Simplified Employee Pension when compared to SIMPLE IRA: – less restrictive – tax-deferred account – offers employer matching contribution on employees’ deferrals – employers can use Simplified Employee Pension account to fund the cost of acquiring another company Cash Balance Plan is an option that can be added on top of Simplified Employee Pension

Benefits of SIMPLE IRA

The SIMPLE IRA account is beneficial to both employers and employees because the account offers the following benefits: – easy to set up and operate – contributing to SIMPLE IRA reduces taxable income – no vesting requirements – employers can get a tax credit of up to $500 for contributions made

Final Thoughts

Simplified Employee Pension and SIMPLE IRA are both great retirement plans, but have some key differences. It is important for an employer to do research on the different benefits offered by each plan so they can make a well-informed decision when choosing a plan for their employees. Before you sign up for any retirement plans, it is best to speak with a financial advisor for additional insight.

A Simplified Employee Pension Plan (SEP) is a self-employed retirement plan available to small businesses that have no more than 100 employees.
SIMPLE IRA plan is an alternative to SEP. In this plan, employees may be able to contribute a portion of their income into their account and enjoy the benefits of tax-deferred growth.
Under SEP, an employer can contribute up to 25% of earned income or $58,000 in 2021 per employee. This amount will increase every year in line with inflation.
In a SIMPLE IRA plan, both employees and employers can contribute to the account. The maximum amount an employee can contribute in 2021 is $13,500 which goes up to $16,500 for those age 50 or older.
Both plans are great options for retirement, but they do have some key differences. Simplified Employee Pension is more employer-oriented while Simple IRA gives employees the opportunity to contribute as well. SEP also allows you to use a cash balance plan on top of it and offers a higher contribution limit compared to Simple IRA.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.