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Our business owner clients may be searching for retirement plan options that benefit their employees and themselves, without incurring burdensome costs or administrative complexity. SEP and SIMPLE IRAs can be great alternatives to 401(k)s, each offering attributes that could be attractive, depending upon your client’s specific circumstances. Comparing these two options can be difficult, as there are multiple factors to weigh.
To help you lead our clients through a SEP vs. SIMPLE IRA analysis, we have created this flowchart. Through a series of decision points, we can collect the information necessary to guide our clients to the best decision. It covers pertinent factors, including:
Business owner goals and preferences
Size of business/employee headcount
Employer and employee ability to contribute
Contribution minimums and limits
As a small business owner, you may be seeking a retirement plan that not only benefits yourself but also your employees, without the burden of high costs or complex administration. In this blog post, we will discuss two popular alternatives to traditional 401(k) plans: SEP and SIMPLE IRAs. These retirement options offer attractive features depending on your business size, employee count, and contribution preferences. By comparing SEP and SIMPLE IRAs, you can make an informed decision that aligns with your specific situation. Let's dive in and explore the key considerations for small business retirement planning.
Understanding SEP IRAs:
A Simplified Employee Pension (SEP) IRA can be a suitable choice for small businesses with a significant number of employees or a growing employee count. Here are some essential points to consider:
Employee Count and Eligibility: If you have over 100 employees who earned more than $5,000 each in the previous year, you are required to establish a SEP IRA. However, SEP IRAs are commonly used by businesses with fewer employees, typically up to 20 individuals.
Employer Contributions Only: SEP IRAs are funded solely by employer contributions. Employees cannot make contributions to their SEP accounts. This feature simplifies administration and ensures that contributions are exclusively employer-funded.
Contribution Limits: SEP IRAs allow employers to contribute up to the lesser of 25% of an employee's salary or $61,000 per year. This high contribution limit makes SEP IRAs attractive for small business owners who want to maximize their retirement savings.
Exploring SIMPLE IRAs:
A Savings Incentive Match Plan for Employees (SIMPLE) IRA is an option that allows both employer and employee contributions. Here's what you need to know about SIMPLE IRAs:
Employee Contributions: If you want to allow employee contributions to their retirement accounts, a SIMPLE IRA might be the right choice. Employees can make deferrals up to the lesser of 100% of their salary or $14,000 per year ($17,000 for those aged 50 or older).
Employer Contributions: Employers are required to contribute either a matching contribution or a non-elective contribution. The matching contribution is up to 3% of the employee's salary, while the non-elective contribution is a flat 2% of the employee's salary.
Eligibility Criteria: A SIMPLE IRA must be offered to employees who earned at least $5,000 in any two prior years and are expected to earn at least $5,000 in the current year. This requirement allows some flexibility in selecting eligible employees.
Factors to Consider:
When choosing between a SEP IRA and a SIMPLE IRA, here are additional factors to evaluate:
Number of Plan Participants: If you want to limit the plan's participation to specific employees, a SIMPLE IRA allows for carve-outs. You can choose to offer the plan only to certain employees based on factors like compensation and length of service.
Early Withdrawal Penalties: Withdrawals from a SIMPLE IRA within the first two years of participation are subject to a 25% penalty, whereas SEP IRAs have a 10% penalty for withdrawals before age 59 ½. Consider the potential need for early withdrawals and the associated penalties.
Loans and Contributions: Neither SEP nor SIMPLE IRAs allow loans. If you anticipate the need for loans within the retirement plan, a 401(k) plan may be a better fit. Additionally, consider how the chosen plan will affect your contribution limits for traditional or Roth IRAs.
Choosing the right retirement plan for your small business is crucial for ensuring financial security for both yourself and your employees. SEP and SIMPLE IRAs offer distinct advantages depending on your business size, employee count, and contribution preferences. By carefully evaluating factors such as eligibility requirements, contribution limits, and employee participation, you can make an informed decision. Remember to consult with a financial advisor or accountant to fully understand the tax implications and optimize your retirement savings strategy. With the right retirement plan in place, you can help your employees retire with dignity and achieve your long-term financial goals.