SIMPLE IRA vs. SEP IRA

By: Josh Slocum, McClellan Wealth Management

You, as an employer, may plan on retiring at some age, but may not be thinking about actually saving money for retirement. Luckily, there are different investment plans that could contribute to retirement — IRA plans. IRA stands for an individual retirement account. 

There are many types of IRA plans, but two types of IRA accounts that are set up by employers for employees that we will focus on here are SIMPLE IRA and SEP IRA. These are IRA business plans and not individual plans so an employer would set up these plans for employees of their business and themselves. Both plans offer benefits to the employee, but also have their disadvantages. Both also differ greatly. 

SIMPLE IRA Plans

The word simple here does not mean basic or easy. SIMPLE stands for Savings Incentive Match Plan for Employees. This type of plan is set up by an employer and allows employee contributions. With a SIMPLE IRA plan, employees may choose to make salary reduction contributions with the employer making matching or non-elective contributions. 

These IRA plans are generally limited to smaller businesses with fewer than 100 employees so growing businesses will need to track employee numbers and possibly change plans if the threshold is met. 

Employees eligible under the SIMPLE IRA plan have to have made at least $5000 in the last two years and expect to make at least $5000 in the current year. 

Pros and Cons of a SIMPLE IRA

Just like any financial plan or business benefit, there are pros and cons to SIMPLE IRAs.

1. Pro: provides a way for business owners and employees to save for retirement
2. Pro: Deductions can be taken directly from a paycheck
3. Pro: Catch-up contributions up to $3,000 a year can be saved by those 50 or older
4. Pro: Employee contributions are not reported as income

This plan might not be best for your business, though. Let’s review a few cons. 

1. Con: generally limited to smaller companies of less than 100 employees
2. Con: Employers must fund the employee’s accounts yearly
3. Con: There is no Roth option so employees will not be able to save after-tax money and get tax-free withdrawals
4. Con: There are penalties for early withdrawal before the age of 59 ½ in the form of taxes and up to a 10% bonus penalty 

SEP IRA Plans

A Simplified Employee Pension plan, or SEP, is set up by an employer who directly contributes to each employee’s IRA. Employers can contribute up to 25% of an employee’s annual income. Employers must also contribute an equal amount for each employee. This plan is available to any size employer and does not allow for employee contributions. Employers are also required to notify every eligible employee that a SEP IRA plan has been established. 

Eligible employees include those at least 21 years of age, have worked with the company for three of the last five years, and have made at least $600 in compensation during the year.

Pros and Cons of a SEP IRA

SEP IRA plans might be beneficial, and they come with some advantages and disadvantages.

1. Pro: provides a way for business owners and employees to save for retirement
2. Pro: Employee contributions are made pre-tax
3. Pro: A SEP IRA plan is easy to set up by a business
4. Pro: Flexibility of contributions means business owners and employees don’t have to make a contribution each year

This plan might not be best for your business, though. Let’s review a few cons. 

1. Con: Employers and employees are treated equally in terms of contributions
2. Con: Employees and employers over the age of 50 can’t contribute more to catch up to a certain monetary amount 
3. Con: While a SEP IRA will grow tax-free, taxes are due when money is withdrawn
4. Con: There are penalties for early withdrawal before the age of 59 ½ in the form of taxes and up to a 10% bonus penalty

Selecting The Right IRA Plan

The primary benefits of contributing to an IRA are the tax deductions, tax-deferred or tax-free growth on earnings, and overall tax deductions. Getting started with a retirement plan for a business can feel overwhelming.

SIMPLE IRA and SEP IRA plans offer different benefits to employees and have different requirements for employers. It is important to select the right plan based on your business size and employee demographics. 

Getting Started With Mclellan Wealth Management

The professionals at Mclellan Wealth Management would love to sit down with you and go over your current SIMPLE IRA or SEP IRA plan or help you develop one and decide on which plan best fits your needs.

We also offer additional services including wealth management, financial planning, investment management, and estate and trust planning. Give us a call today at 205-208-9868 or contact us online.

This material is provided as a courtesy and for educational purposes only.  Please consult your investment professional, legal, or tax advisor for specific information pertaining to your situation.  Investing involves risk including loss of principal. Advisory services are offered through McClellan Wealth Management, a Member of Advisory Services Network, LLC.