SEP vs SIMPLE IRA: Differences Explained

There are many differences between the SEP vs. Simple IRA, but most are not obvious at first glance. Both plans are designed for the small business owner. They are easy to administer, require no annual IRS reporting, are cost-effective, and are limited to those individuals with less than 101 employees. The companies offering these options must not have another retirement plan in place. While these elements are common to both plans, there are far more differences than similarities between the two.

SEP IRA Basics

When an employer sets up an SEP (Simplified Employee Pension) IRA, there is no annual funding directive. An employer can choose to fund the account or not to fund it, depending on the business cycle that year. However, if an employer does fund the account, even for himself or herself, all employees must also have their accounts funded. This holds for any employee making more than $500 at the company that year. For this reason, SEP IRAs are often best for very small family businesses or those with no employees.

With an SEP IRA, the employer is doing all of the funding, and the employer is the one who receives the tax break. One hundred percent of funds deposited are tax deductible. Like all retirement accounts, there are limitations as to when the funds can be pulled from the account and how much can be deposited annually. Generally speaking, withdrawals cannot be taken until the individual account holder has reached minimum retirement age. The annual maximum deposit is: either 25 percent of an annual income up to $45,000; or 20 percent of the net earnings of the company if the employer is the owner. 


A simple IRA is also set up by an employer. An employee is primarily responsible for contributions, all of which can be withheld from paychecks and directly deposited. An employer may also be held responsible for funding the accounts to a very small degree. The employer's contribution is less important with a SIMPLE IRA. Therefore, it is best for employers with 20-100 employees, each of who may want to fund their accounts to a different degree. 

With a SIMPLE IRA, the employee is doing nearly all of the funding, and the employee is the one who gets the big tax break. An employee can only contribute up to $11,500 annually as of 2011. The limit goes up if the individual is over the age of 50; then, the limit extends to $14,500. An employer can only contribute a small amount relative to the employee's income, either 3 percent or $11,500, whichever is lower. In a second option, an employer can contribute 2 percent up to $4,900. Based on these figures, it is obvious the contribution limits for the SIMPLE IRA are much lower than those for the SEP IRA. This will be best for individuals and employers who have fewer needs from the funds or less means to fully fund a large number of IRAs.

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