A SEP IRA allows employers a simplified method to contribute toward employees' and their own retirement. A SIMPLE IRA helps small businesses create streamlined retirement accounts for their employees and themselves. Neither option requires annual IRS reporting, and both are designed to be cost-effective and easily set up. Although these systems seem similar, distinct differences set them apart from one another.
According to the IRS, a SEP IRA is common for small businesses with less than 100 employees, while a SIMPLE IRA is designed for any size business. Moreover, only employers can contribute to a SEP IRA. A SEP IRA allows employers to adjust how much money is invested depending on the company's cash flow, making it a smart choice for businesses that have fluctuating seasons of good and bad income streams. Employers can invest up to 25% of the employee's salary.
Example: Joe works at Taylor's Body Shop, a company that offers a SEP IRA. Taylor's Body Shop can make large or small contributions to Joe's retirement depending on its current financial status. Every employee receives the same percentage of contribution. Joe cannot invest his own income into the SEP.
A SIMPLE IRA has two contribution formulas that can be used. An employer can match up to 3% of the employees annual contribution, or an employer can set up a non-elective 2% contribution of each employee's salaries without requiring employee contribution.
Example: Mary works at Micro Tech, a small business that provides SIMPLE IRAs to its employees. Micro Tech matches 3% of Mary's annual contribution. This year she did not contribute to her retirement, thus Micro Tech did not contribute to her SIMPLE IRA.
Example: Janet works for LoveScope Investing. The company participates in a SIMPLE IRA and contributes a non-elective 2% to Janet's SIMPLE IRA annually. Janet did not contribute any of her $24,000 salary, but LoveScope Investing still had to invest $480 to the SIMPLE IRA.
Thus, a SEP IRA is more flexible than a SIMPLE IRA with respect to annual contributions.