One of the most common retirement plans is an IRA, or individual retirement account. IRAs are used by both individuals and businesses to contribute money that grows over time as it is invested in assets. This money can then be withdrawn during retirement to cover living expenses.
There are several different types of IRAs. Two of the most popular types are the Roth IRA and the Traditional IRA.
Perhaps less well-known are the SEP IRA and the Simple IRA. Both qualified plans are popular for business owners because they are easy to set up and manage and have lower fees than other types of accounts. They also don’t require complicated tax filings with the IRS.
Both the SEP and the Simple IRA offer retirement plans suited for small businesses and sole proprietors or self-employed individuals. According to an April 2019 report by SCORE, a network of business mentors that help get small businesses off the ground, only 28% of companies with fewer than 10 employees offer a retirement plan. This is partly because 401(K) plans are a lot of work and plan managers don’t always want to work with small businesses.
There are a number of similarities and differences between the SEP IRA vs. Simple IRA. Exploring the attributes of each retirement account and looking at a side-by-side comparison of the plans can help both self-employed people and small business owners make an informed decision about their retirement savings.
What is a SEP IRA?
An SEP IRA, or Simplified Employee Pension IRA, is a retirement plan set up by employers, including those who are self-employed. Although SEP IRAs can be used by any size business, they are geared towards sole proprietors and small business owners. SEP IRAs are very easy to set up and have lower management fees than other types of retirement accounts.
Not only are SEP IRAs set up by employers, but they also make the contributions to the plan. This can be beneficial for businesses with fluctuating income, because the employer can decide when and how much to contribute to the account.
Employers can contribute up to 25% of an employee’s annual salary or $61,000, whichever is less. They aren’t required to contribute every year, but the business owner and all employees must receive the same rate of contribution.
One main benefit of the SEP IRA for individuals is that funds don’t come out of employee paychecks, the money is immediately 100% vested, and each employee manages their own assets and investments.
There are also tax-related benefits for both employers and employees. Employers can deduct contributions to the account from their taxes, but employees don’t have to count the contributions in their gross income. The money in the account is tax-deferred, so employees don’t pay taxes on the money until it gets withdrawn.
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SIMPLE IRA Definition
SIMPLE IRAs, or Savings Incentive Match Plan for Employees Individual Retirement Accounts, like the SEP IRA, are set up for business owners and their employees. Unlike the SEP IRA, both the employer and the employees can contribute to them, making them better for larger businesses with 100 employees or less.
Any employee who earns more than $5,000 per year is eligible to participate in a SIMPLE IRA plan, and those who are eligible are required to participate. Employees contribute pre-tax dollars to their plan—though they can also choose not to contribute.
Employers are required to contribute to employee SIMPLE IRAs in one of two ways. They can either match employee contributions up to 3% of their annual salary, or they can contribute money whether the employee contributes or not. If they choose the second option, they must contribute a flat rate of 2% of the employee’s salary up to a limit of $305,000.
As with a SEP IRA, both employer contributions and employee salary deferral contributions are tax-deductible.
As of 2022, the annual contribution limit to SIMPLE IRAs is $14,000. Workers over age 50 can contribute up to $17,000.
Worth noting: The SIMPLE IRA doesn’t allow contributions to another employer-sponsored retirement plan, so it’s not possible to have both a SIMPLE IRA and a SEP IRA.
Side-by-Side Comparison of SEP IRA vs. SIMPLE IRA
While there are many similarities between SEP IRA and SIMPLE IRA accounts, there are key differences that both employers and employees should be aware of.
| SEP IRA | SIMPLE IRA | |
|---|---|---|
| Who it’s for | Small business owners and employees
Self-employed people Businesses with fluctuating income |
Any business with 100 or fewer employees
Businesses with steady profits |
| Requirements to open an account | Must be a business owner, sole proprietor, in a partnership, or earn self-employment income | Must be a business owner, sole proprietor, in a partnership, or earn self-employment income
Business must have fewer than 100 employees Can’t take part in another employer-sponsored retirement plan |
| Account holder eligibility | Must be over age 21
Have $600 or more in annual income Have been employed three out of the last five years |
Employee must earn $5,000 or more per year |
| Easy set up | Yes | Yes |
| Who can contribute | Employers | Employers and employees |
| Lower fees than other retirement accounts | Yes | Yes |
| Limited financial responsibility | Yes | Yes |
| Tax-deferred | Yes | Yes |
| Tax deductions | Yes | Yes |
| Penalties and Restrictions | 10% fee if money is withdrawn before age 59 ½
Distributions must start by age 72 |
10% fee if money is withdrawn before age 59 ½ (25% if account has been open for less than 2 years) |
| Contribution limits | Employers can contribute up to 25% of an employee’s annual salary or $61,000, whichever is less
No catch-up plan |
$14,000 per year
$17,000 per year for those over age 50 |
The Takeaway
Both the SEP IRA and the Simple IRA were created to help small business owners and their employees save for retirement. Each account can benefit employers and employees in different ways.
With the SEP IRA, the employer (including a self-employed person) contributes to the plan. With the SIMPLE IRA, the employer is required to contribute, and the employee may contribute but can choose not to.
For investors looking to open an individual retirement account for themselves, SoFi Invest® makes it easy to get started. The app lets you open a SEP, traditional or Roth IRA in just a few steps and easily manage the account from your phone. Members can choose between active and automated investing. With active investing you can pick and choose exactly how you want your money to be invested; with automated investing, you can choose from pre-selected groups of assets.
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