Considering SIMPLE IRAs, SIMPLE 401(k) plans, or SEPs? What to know
One of your small business owner clients asks you for help setting up a retirement plan. There are plenty of options available, so you need to identify plan types that align with their goals and objectives. We’ll help you weigh the pros and cons of a few plan types designed for small businesses, including those with only one employee.
Advantages and disadvantages of SIMPLE IRAs, SIMPLE 401(k)s, and SEPs
Savings Incentive Match Plan for Employees (SIMPLE) IRAs, SIMPLE 401(k) plans, and simplified employee pension (SEP) plans are all designed with the small employer in mind. There’s some overlap among them, but, ultimately, each is quite different and helps plan sponsors address varying priorities.
SIMPLE IRA |
SIMPLE 401(k) |
SEP |
|
Employers that are candidates |
Employers with 100 or fewer employees who made at least $5,000 in the prior year, and don't offer another retirement plan |
Employers with 100 or fewer employees who made at least $5,000 in the prior year, and don't offer another retirement plan |
All employers, including self-employed individuals |
Maximum eligibility requirements |
|
|
May require:
|
Can the employer offer other plans? |
Generally, no. Certain employers may be able to offer a 457 plan and SIMPLE IRA. |
Generally, no. Certain employers may be able to offer a 457 plan and SIMPLE IRA. |
Yes |
Employee contributions¹ |
Up to $15,500, plus $3,500 for individuals age 50 or older |
Up to $15,500, plus $3,500 for individuals age 50 or older |
N/A—all plan contributions are made by the employer |
Employer contributions |
|
|
Discretionary, limited to the lesser of:
|
Elective match compensation limit |
Not restricted to annual compensation limit |
Subject to annual compensation limit |
Subject to annual compensation limit |
Vesting |
All employee and employer contributions are immediately vested |
All employee and employer contributions are immediately vested |
All contributions are immediately vested |
Loans |
Not allowed |
Allowed |
Not allowed |
In-service withdrawals |
Allowed, subject to a 10% penalty tax if withdrawn before age 59½, unless an exception applies; 10% increased to 25% if withdrawn within two years of participation in the SIMPLE IRA |
Allowed, subject to a 10% penalty tax if withdrawn before age 59½, unless an exception applies |
Allowed, subject to a 10% penalty tax if withdrawn before age 59½, unless an exception applies |
Form 5500 |
Not required |
Required |
Not required |
Testing exemptions |
Exempt from all nondiscrimination testing |
Exempt from annual nondiscrimination testing and top-heavy rules that apply to traditional 401(k) plans |
Exempt from all nondiscrimination testing |
These aren’t the only retirement plan options available to small business owners. Depending on your client’s business, other plans such as 401(k)s, 403(b)s, or 457s may be a good fit. A 401(k) plan includes a solo 401(k), or one-participant 401(k) plan.
SEPs vs. SIMPLE IRAs—what are the differences?
SEPs and SIMPLE IRAs have a lot in common:
- Participants in both plan types have IRAs set up for them, making their accounts easy to transport if changing employers.
- All contributions are immediately vested.
- Participants, not employers, make investment decisions.
- Form 5500s aren’t required, and both plan types are exempt from all nondiscrimination testing, making administration relatively simple for both plans.
- Loans aren’t allowed.
The differences start with the type of employer eligible to offer the plan. Any company can offer a SEP plan, but only businesses with 100 or fewer employees making at least $5,000 can offer SIMPLE IRAs. There’s a handful of other notable differences:
- Eligibility—SIMPLE IRAs can’t implement age or service requirements but can require an eligible employee to have $5,000 of income in two previous years and expected in the current year. SEPs can require eligible employees to have attained age 21, have been employed with the employer for at least three of the past five years, and have compensation of at least $750 for 2023.
- Multiple plans—Companies can offer other retirement plans alongside a SEP if they choose. That’s generally not the case if they offer a SIMPLE IRA.
- Employee deferrals—SIMPLE IRAs allow participants to save up to $15,500 per year, plus another $3,500 for participants age 50 and older. Employee deferrals aren’t permitted in SEPs—they’re 100% employer funded.
- Employer contributions—Employers have the discretion to contribute to a SEP each year. SIMPLE IRAs require either a company matching or nonelective contribution every year.
- In-service withdrawals—Participants can take distributions from a SIMPLE IRA or SEP at any time; however, if the participant hasn’t attained age 59½, the distribution may be subject to a 10% early withdrawal penalty, unless an exception applies. The early withdrawal penalty is increased to 25% if a participant who’s under age 59½ takes an in-service withdrawal from a SIMPLE IRA within two years of joining the SIMPLE IRA.
Small businesses have several retirement plan options
Fortunately, there are many plan types available for your small business clients. But that also means you need to be sure you know the differences, so you can weigh the pros and cons for each of your clients. These options were designed for small employers, including self-employed individuals. They’re generally easier to administer with fewer testing requirements, but simplicity can come at the cost of potentially lower savings rates and less plan design flexibility. Companies may outgrow these plan types in favor of a traditional 401(k), for example, which enables higher contribution rates, employer contribution flexibility, custom plan designs, and more. Show your value by guiding your clients to the right plan for their needs.
1 The amounts shown are for the 2023 calendar year, and subject to an annual review and potential update by the IRS.
Important disclosures
This content is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made.
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