We are independent & ad-supported. We may earn a commission for purchases made through our links.
Advertiser Disclosure
Our website is an independent, advertising-supported platform. We provide our content free of charge to our readers, and to keep it that way, we rely on revenue generated through advertisements and affiliate partnerships. This means that when you click on certain links on our site and make a purchase, we may earn a commission. Learn more.
How We Make Money
We sustain our operations through affiliate commissions and advertising. If you click on an affiliate link and make a purchase, we may receive a commission from the merchant at no additional cost to you. We also display advertisements on our website, which help generate revenue to support our work and keep our content free for readers. Our editorial team operates independently of our advertising and affiliate partnerships to ensure that our content remains unbiased and focused on providing you with the best information and recommendations based on thorough research and honest evaluations. To remain transparent, we’ve provided a list of our current affiliate partners here.
Taxation

Our Promise to you

Founded in 2002, our company has been a trusted resource for readers seeking informative and engaging content. Our dedication to quality remains unwavering—and will never change. We follow a strict editorial policy, ensuring that our content is authored by highly qualified professionals and edited by subject matter experts. This guarantees that everything we publish is objective, accurate, and trustworthy.

Over the years, we've refined our approach to cover a wide range of topics, providing readers with reliable and practical advice to enhance their knowledge and skills. That's why millions of readers turn to us each year. Join us in celebrating the joy of learning, guided by standards you can trust.

How do I Choose Between a SIMPLE and a SEP IRA?

By Amanda Lacasse
Updated: May 16, 2024
Views: 6,623
Share

A business owner trying to make a choice between a SIMPLE and a SEP IRA needs to know a bit about these two plans and how they differ. Making the best choice between these two types of IRAs, or individual retirement accounts, may depend on several variants, such as whether the business has employees and how much net income the business makes per year. Other considerations may include any contribution limits, tax ramifications or early withdrawal penalties attached to particular IRAs.

SIMPLE IRAs, or Savings Incentive Match Plan for Employees IRAs, were created so small business owners could set up retirement accounts for their employees and themselves without complicated rules and reams of paperwork. These plans usually cover businesses with fewer than 100 employees when no other retirement plan exists. The employer can elect to either match employee contributions to the account up to 3 percent of salary or contribute 2 percent of salary to each employee account, regardless of employee contribution. Individual owners could contribute up to $11,500 of net income — up to $14,000 if they are over age 50 — for 2010.

SEP, or Simplified Employee Pension, IRAs are more commonly used by high-earning entrepreneurs who have no employees. These plans allow the owner to contribute 25 percent of net earnings, up to $49,000 in 2010, into the account. The term "net earnings" means gross income minus expenses, the deduction for half of paid self-employment tax, as well as the amount of the SEP IRA contribution for that year. The latter amount can be quantified because the account may be set up the year after the contribution year, as long as it is in place by 15 April or, if an extension is filed, 15 October.

There are several differences between a SIMPLE and a SEP IRA. While both will incur a penalty if a withdrawal from the account occurs within the first two years of its existence, the penalty is higher — 25 percent — for a SIMPLE IRA than it is for a SEP IRA, which incurs a 10 percent withdrawal penalty. Also, even though SIMPLE IRA plans may be funded as late as 15 October of the next tax year as well, the law says the plan must have been established by 1 October of the tax year in question.

The biggest difference between a SIMPLE and a SEP IRA is the amount the business owner can contribute to these tax-deferred accounts, which is entirely dependent on income. For the entrepreneur with a net income of less than $46,000, the $11,500 or $14,000 yearly SIMPLE IRA contribution may be doubled, because the owner can contribute as an individual and, as the business owner, match that amount. A SEP IRA would allow a contribution of only $11,500 at the same income level. The most important difference between a SIMPLE and a SEP IRA becomes apparent when net income is quite high: a net income of $196,000 will provide the $49,000 maximum contribution under SEP rules while, with a SIMPLE IRA plan, the contribution level would not change. Participants in either plan may contribute to traditional or Roth IRAs, as well.

Share
SmartCapitalMind is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
Discussion Comments
Share
https://www.smartcapitalmind.com/how-do-i-choose-between-a-simple-and-a-sep-ira.htm
Copy this link
SmartCapitalMind, in your inbox

Our latest articles, guides, and more, delivered daily.

SmartCapitalMind, in your inbox

Our latest articles, guides, and more, delivered daily.