What’s the difference between
a SIMPLE and a SEP?
You work hard for your money and therefore deserve to reap all the benefits you can from it, even after you stop working. While on the surface, retirement plans look like a string of acronyms, over the long haul, they can really have a huge financial impact on your future. That’s why it’s important to weigh the pros and cons and choose the one that is the most lucrative in the long run.
In general, retirement plans are designed to be a safeguard from bankruptcy, provide substantial tax benefits and are set in motion to clear a path for financial security. However, depending on the situation, some plans are more efficient than others. Differences begin to emerge when it comes down to the contribution limits, both from employee and employer, establishment deadlines, eligibility and distributions. As a rule of thumb, SIMPLE IRAs are designed for any size business while SEP IRAs are common for small businesses with less than 100 employees.
SEP and SIMPLE Contribution limits differ with both the employer and employee. With the SEP or Simplified Employee Pension Plan, contributions are up to the employer’s discretion as long as it doesn’t exceed 25% of the employee’s income and comes with a maximum cap of $56,000. This flexibility allows employers to adjust how much is invested based on their current cash flow. Contributions may extend beyond 70.5 years of age but compensation must not exceed $280,000. In addition to the contribution from the employer, employees can add up to $6,000 to their SEP IRA. For employees over the age of 50, a catch-up contribution of $1,000 is also an option. For the SIMPLE IRA or the Savings Incentive Match Plan For Employees, the employer can match up to 3% of the employee’s annual income or the employer can set up a 2% contribution of the employee’s compensation. This 2% is considered a non-elective contribution. In this scenario, compensation has a cap of $280,000. Employees can defer up to $13,000 a year or 100% income based on whichever is less. For those who are 50 or older, an additional $3,000 can be deferred.
Establishment deadlines also differ. The establishment deadline for the SEP IRA is based on the employer’s tax filing deadline, which includes extensions. With the SIMPLE IRA, the establishment deadline is October 1, or after, if the business is established after the first.
Eligibility requirements differ for the two plans as well. The SEP IRA cannot exclude anyone who exceeds the age of 21, those employed three of the last five years or those who have an annual income of $600. This requires 100% of participation from eligible employees. Those eligible for the SIMPLE IRA are employees who receive an income of $5,000 in two preceding years and who will receive $5,000 during the current year. It turns out that the SIMPLE IRA is not as restrictive as the SEP IRA.
They also differ when it comes to distributions. In both cases, a 10% premature distribution penalty may apply but with the SIMPLE IRA, the penalty is increased to 25% in the first two years. The distributions for both must begin at the age of 70.5 and in-service distributions are allowed.
It might be too late but it’s never too soon to plan for your future.