Contents
An Overview of Retirement Plans
Retirement Plan Terminology
401(k) Retirement Plans
403(b) Retirement Plans
457(b) Retirement Plans
Traditional IRAs
Roth IRAs
SEP IRA and SIMPLE IRA Plans
Rollover IRAs
How to Manage Your Retirement Plan
How to Consolidate Different Retirement Plans
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SEP IRA and SIMPLE IRA Plans
SEP IRAs and SIMPLE IRAs are two types of IRAs that
employers can establish on behalf of their employees.
SEP IRAs
Simplified Employee Pension Individual Retirement Accounts, known as SEP IRAs, are IRAs that business owners can set up and fund on behalf of employees and/or themselves. SEP IRAs are most often used by:
- Self-employed sole proprietors who don’t otherwise have access to employer-sponsored plans, such as 401(k)s, for their own retirement investing purposes
- Small-business owners who want to offer a basic retirement plan to employees without the complexity and expense of setting up a 401(k) plan
How SEP IRAs Work
SEP IRAs for self-employed sole proprietors work a bit differently from SEP IRAs for employers.
- If you’re a self-employed sole proprietor: You set up an account with a financial services firm and make contributions up to certain annual limits, just as you would with a Roth or Traditional IRA.
- If you’re an employer: You set up SEP IRA accounts with a financial services firm for yourself and your employees. Employees do not set up or administer their own accounts. By law, as an employer you’re required to contribute the same percentage of income into your employees’ accounts as they contribute into their own accounts each year. Employees cannot make contributions on their own but can roll over their accounts into Rollover IRAs if or when they leave the company (see Rollover IRAs).
Regardless of whether you’re a sole proprietor or an
employer, SEP IRA contributions are usually tax deductible and grow tax deferred until withdrawal.
The Advantages of SEP IRAs
SEP IRAs have three main advantages:
- High contributions: If you’re an employer, SEP IRAs let you contribute up to 25% of your eligible annual income (and that of your employees), up to $45,000 per year. These limits vastly exceed those of IRAs and allow self-employed people to contribute as much as the maximum annual 401(k) contribution ($45,000, including employee and employer contributions). SEPs don’t allow catch-up contributions, however.
- High deductions: SEP IRA contributions are usually 100% tax deductible, which means you can take up to a $45,000 tax deduction annually—much more than the $4,000 deduction for Traditional IRAs.
- Multiple plans: You can create SEP IRAs even if you also have another IRA. Likewise, you can set up a SEP even if you already have an employer-sponsored plan, such as a 401(k), as long as the income you use to contribute to the SEP IRA comes from a separate source. SEP IRAs are a great option if you have an employer-sponsored plan but also earn income on the side by running your own business.
SIMPLE IRA Plans
SIMPLE IRAs—“SIMPLE” stands for Savings Incentive Match Plan for Employees—are employer-sponsored
retirement plans that give employers a basic alternative to traditional 401(k)s, which are more expensive and complicated to set up than SIMPLE IRAs. The simplicity and relative affordability of SIMPLE IRA plans make them very popular with small businesses and partnerships. In fact, they’re available only to companies with 100 or fewer employees. As companies grow, they typically shift from offering SIMPLE IRA plans to 401(k)s, which feature much larger contribution limits and usually more investment options.
How SIMPLE IRAs Work
- For employees: SIMPLE IRAs work like 401(k) plans: you set up an account with a financial services firm through your workplace and contribute to the account with pre-tax dollars, which are deposited into the account at each pay period. Your contributions are not limited to a percentage of your annual salary, but they’re capped at $10,500 per year.
- For employers: SIMPLE IRAs are the only type of retirement plan that requires employers to make employer matching contributions. SIMPLE IRA employer matching contributions must equal 3% of the employee’s annual salary (though a few exceptions apply).
The Advantages of SIMPLE IRAs
Although annual employee contribution limits for SIMPLE plans are lower than those of other employer-sponsored plans, SIMPLE IRAs do offer two significant advantages over SEP IRAs and other small-business retirement plans:
- Catch-up contributions: Employees age 50 and up can make extra “catch-up” contributions up to $2,500 per year beyond the ordinary contribution limits.
- Higher contributions for some employees: Since employee contributions aren’t limited to a percentage of salary, employees at certain income levels can potentially contribute more annually to a SIMPLE IRA than to SEP IRAs. For example, if you’re age 50 or older and earn $25,000 (after deductions), you could contribute at most $6,250 to a SEP IRA but up to $12,500 to a SIMPLE IRA (including a $2,500 catch-up contribution).
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