SEP and SIMPLE IRAs

Two small-business plans with different contribution designs

A Simplified Employee Pension (SEP) is an employer-sponsored retirement arrangement funded through individual SEP IRAs. A Savings Incentive Match Plan for Employees (SIMPLE IRA) is a salary-reduction plan that combines employee deferrals with employer contributions. Both are designed to be easier to administer than many qualified plans, but their funding rules are not interchangeable. SEP plans generally rely on employer contributions, while SIMPLE IRA participants can defer salary and receive an employer match or nonelective contribution.

The employer’s workforce is central to the comparison. A business adopting a SEP generally must cover eligible employees under the plan’s rules and provide the same contribution percentage to each eligible person. A SIMPLE IRA has its own eligibility and required employer-contribution provisions. The owner should compare the likely contribution cost for employees, not only the amount that might be contributed to the owner’s account. A structure that appears inexpensive when staffing is small may cost more when the business grows.

SEP contributions and an example

For 2026, an employer’s SEP contribution for an employee generally cannot exceed the lesser of 25% of compensation or $72,000, subject to the tax-year rules and compensation cap. A SEP does not permit ordinary employee elective salary deferrals or catch-up contributions. A grandfathered SARSEP established before 1997 is a narrow exception with special salary-reduction rules. For a self-employed person, the contribution calculation uses net earnings and the special IRS worksheet rather than multiplying gross business revenue by 25%.

Suppose a small employer uses a 10% SEP contribution rate and has two eligible employees with compensation of $60,000 and $90,000. The employer’s illustrative contributions would be $6,000 and $9,000, assuming the plan terms, compensation definition, and annual limits allow those amounts. The owner cannot choose a 20% rate for the owner and 5% for staff under a plan requiring the same percentage. A separate eligible employee with $30,000 of compensation would receive $3,000 at the same 10% rate.

A self-employed consultant with net profit should not use the same arithmetic without adjustment. The IRS treats the proprietor as both employer and employee for certain calculations, and the contribution base is adjusted. Publication 560 provides a worksheet and rate table. The consultant should also check whether other defined contribution plans sponsored by the business share the applicable overall limit. Contribution capacity is tied to eligible compensation, not the owner’s household cash balance.

SIMPLE IRA contributions and required employer amounts

A SIMPLE IRA permits employee salary-reduction contributions and requires an employer contribution under the adopted design. The employer generally chooses either a matching contribution formula, commonly matching employee deferrals up to a specified percentage, or a nonelective contribution for eligible employees even if they do not defer. The plan document and current rules determine the exact requirement. Employees who do not make a deferral can still receive an employer contribution under the nonelective approach.

For 2026, IRS guidance lists a standard SIMPLE IRA elective-deferral limit of $17,000. Catch-up limits depend on age, plan type, and employer eligibility; some qualifying plans have different limits. The overall employee deferral limit may coordinate with deferrals to other workplace plans. An employee should not assume that a SIMPLE IRA’s salary reduction limit can be added without qualification to a 401(k) or 403(b) deferral. Check the IRS aggregation rules for the tax year.

Consider an employee who earns $50,000 and defers 4% into a SIMPLE IRA. The employee contributes $2,000. If the employer’s matching formula is 100% of deferrals up to 3% of compensation, the match is $1,500: three percentage points of $50,000. Deferring 4% rather than 3% does not increase the match under this example, though it increases the employee’s own savings. A nonelective formula would calculate the employer amount differently and may apply even when the employee defers nothing.

Compare SIMPLE and SEP with a decision table

Eligibility and employee coverage

A SIMPLE IRA is generally available to employers with 100 or fewer employees who received at least $5,000 in compensation in the preceding year, subject to statutory exceptions and plan rules. The employer generally must not maintain another retirement plan for the same employees during the year, subject to exceptions. A SEP has different employer-eligibility and employee-coverage rules. Plan adoption deadlines and notice requirements also differ. These are operational conditions, not merely labels on an investment account.

When a business hires its first worker, it should check eligibility before adopting a plan and repeat the review each year. The relevant employee population and prior-service requirements matter. A worker’s eligibility can create an employer contribution duty even if that worker does not personally make a salary deferral. The owner should keep compensation records, notices, election forms, and contribution calculations. A missed employee contribution or late notice may require a correction.

Plan access, investing, and tax treatment

SEP and SIMPLE balances are generally held in individual IRA accounts for participants. Participants can have investment choices under their custodial or brokerage account arrangements, but investment availability and expenses differ by provider. A familiar IRA wrapper does not make early access unrestricted. Distributions may be taxable, and additional taxes can apply depending on age, timing, plan type, and applicable exceptions. SIMPLE IRA distributions taken during the initial two-year period can face a different additional-tax rule than other IRAs.

Employer contributions to a SEP or SIMPLE IRA are generally tax-deferred until distribution under applicable rules. SIMPLE salary reductions are normally excluded from current income for federal income-tax purposes, while designated Roth SIMPLE contributions are available only under current rules and plan implementation. The tax result depends on contribution type and year. A client should distinguish a pretax salary deferral from a Roth contribution and should not infer current deductibility from the account’s name alone.

A second worked comparison

Assume a firm has 12 eligible employees and wants to contribute 8% of compensation to each worker’s retirement account. A SEP may allow an employer contribution calculated using the common percentage, within statutory limits. If total eligible compensation is $720,000, an 8% contribution would be $57,600 in aggregate, distributed according to each worker’s compensation. The employer must verify the calculation against the plan and each employee’s eligibility; the total alone does not confirm compliance.

If the same firm instead adopts a SIMPLE IRA, employees may defer part of their pay and the employer must make the required matching or nonelective contribution under the chosen design. Suppose payroll deferrals total $40,000 and the employer uses a 3% match. The employer contribution is based on each eligible participant’s deferral and compensation formula, not simply an 8% allocation of total payroll. The two arrangements may lead to different employer costs and participant savings even when both use IRA accounts.

A business owner with variable income might value the ability to choose a SEP contribution each year, while a business seeking employee salary deferrals may prefer the SIMPLE structure. A higher owner contribution could be possible under another plan, but employee coverage, administrative expense, and business cash flow matter. Compare actual contribution schedules under a low-profit year and a strong year before selecting a plan.

Common mistakes and a short checklist

A common error is describing a SEP as an employee salary-deferral plan. Another is treating a SIMPLE employer match as optional when the adopted structure requires it. A third is applying a contribution percentage only to the owner while ignoring eligible employees. Errors also arise from using a prior year’s dollar limit or treating the general 25% SEP rule as the self-employed owner’s effective rate. Current IRS worksheets and plan documents resolve these details.

Before recommending or administering either plan, identify eligible employees, confirm the plan’s adoption and notice deadlines, choose the contribution method, and calculate the employer cost for everyone who qualifies. Check current-year limits and whether the sponsor maintains another plan. Then compare investment expenses, participant access, and recordkeeping burden. The right plan is the one that fits the workforce and can be operated correctly over time, not simply the one with the highest advertised contribution ceiling.

A business owner models the staff cost

Consider a sole proprietor whose business has $140,000 of net earnings and one eligible employee earning $50,000. The proprietor cannot choose a SEP percentage for the owner without considering the percentage applied to the eligible employee under the plan. The owner’s own contribution calculation also uses adjusted net earnings and a worksheet. If the owner’s goal is to contribute a high percentage only for personal savings, a SEP may not match that goal because staff coverage and the common contribution approach constrain the design.

A SIMPLE IRA gives employees the chance to defer their own pay. If the employee opts out or contributes a small percentage, the employer still follows the adopted matching or nonelective formula. That feature can make a SIMPLE plan more predictable as a payroll benefit but requires notices, salary elections, and timely deposits. The employer should compare the expected match cost under different participation rates and whether all employee contributions can be deposited promptly.

Check the two-year SIMPLE distribution rule

SIMPLE IRA distributions have a special rule during the first two years of participation. A distribution during that period may be subject to a 25% additional tax rather than the 10% rate that generally applies to certain early distributions from other retirement arrangements, unless an exception applies. The two-year period begins under the relevant participation rule, not necessarily on the date the account first appears in a statement. A participant considering a transfer or withdrawal should check the plan’s start date and current IRS guidance.

The 25% additional tax is separate from ordinary income tax on taxable amounts. It is also not a reason to assume a SIMPLE IRA is unsuitable; it is a liquidity constraint to include in planning. An employee who may need near-term access to savings should understand the plan’s distribution and rollover provisions before making a salary election.

Use year-specific limits carefully

A limit quoted for one year should never be carried forward by habit. For 2026, IRS sources list the standard SIMPLE deferral limit as $17,000 and the SEP employer cap as $72,000, with additional compensation-based limits and special plan exceptions. Catch-up amounts differ by plan and age. A comparison should say “for 2026” beside the amount, identify the participant category, and direct the reader to the latest IRS page for another contribution year.

Eligibility and compensation records should be reviewed annually. A corrected employee census can change both the plan’s cost and the required notice or contribution, even when the owner’s own income has not changed.