United States
Hong KongSEP and SIMPLE plans: the small employer routes
A SEP is funded entirely by the employer at a uniform percentage of compensation, up to 25 per cent and the annual additions limit. A SIMPLE allows employee deferrals with a mandatory employer match or non-elective contribution.
Two plans built for small employers who do not want the cost of a 401(k), and the exam asks which suits a described business.
The SEP
- Employer contributions only - no employee deferrals.
- Up to 25 per cent of compensation, capped at the annual additions limit.
- The same percentage for every eligible employee, including the owner.
- Discretionary - the employer can contribute nothing in a bad year.
- Immediately vested.
- Minimal administration, and can be established up to the tax filing deadline.
The uniform percentage rule is the constraint. An owner wanting to contribute 25 per cent for themselves must contribute 25 per cent for every eligible employee.
For a sole proprietor with no employees, that constraint costs nothing, which is why the SEP is the default answer for a one-person business wanting simplicity.
The SIMPLE
- Employee deferrals up to USD 17,000 in 2026, with a USD 4,000 catch-up from 50.
- A mandatory employer contribution: either a match up to 3 per cent of compensation, or 2 per cent non-elective for all eligible employees.
- Available to employers with 100 or fewer employees.
- The employer may not maintain another qualified plan.
- Immediately vested.
- A higher early-withdrawal penalty in the first two years of participation.
That last point is examinable: withdrawals within two years of first participation face a 25 per cent penalty rather than 10 per cent.
Choosing between them
| Situation | Plan |
|---|---|
| Sole proprietor, no employees, wants simplicity | SEP |
| Wants employees to fund their own savings | SIMPLE |
| Variable profits, wants discretion | SEP |
| Wants the largest possible owner contribution alone | Solo 401(k), not either of these |
| Several employees and a limited budget | SIMPLE, with the 3 per cent match |
| Older high-earning owner wanting a very large deduction | Defined benefit or cash balance |
It allows an employee deferral and an employer contribution, so a sole proprietor can reach the annual additions limit at a much lower income than a SEP requires. Where a question describes one person wanting the maximum, that is the answer.
The self-employment adjustment
For an unincorporated business owner, the contribution is calculated on net earnings from self-employment after the deduction for half of self-employment tax and after the contribution itself - which reduces the effective rate below the headline percentage.
Knowing the adjustment exists is generally enough for the exam. Knowing that it makes the true percentage lower than 25 avoids a confidently wrong calculation.
Contribution and benefit limits are indexed annually and several were changed by recent legislation. Confirm the current figure against the IRS before relying on it.
Common questions
What is a SEP IRA?
An employer-funded plan contributing up to 25 per cent of compensation, capped at the annual additions limit, at the same percentage for every eligible employee. Contributions are discretionary and immediately vested.
What is a SIMPLE IRA?
A plan for employers with 100 or fewer employees allowing employee deferrals up to USD 17,000 in 2026, with a mandatory employer match of up to 3 per cent or a 2 per cent non-elective contribution.
What is the SIMPLE two-year rule?
Withdrawals within two years of first participation face a 25 per cent early-withdrawal penalty rather than the usual 10 per cent.
Which plan suits a sole proprietor wanting the maximum?
A solo 401(k), not a SEP or SIMPLE. It allows both an employee deferral and an employer contribution, reaching the annual additions limit at a much lower income.
Why is the SEP percentage effectively lower for the self-employed?
The contribution is calculated on net earnings after the deduction for half of self-employment tax and after the contribution itself, which brings the effective rate below the headline 25 per cent.