SEP and SIMPLE IRAs appear so similar that it is often difficult and confusing for people to choose which one to set up when planning for retirement. Both IRAs are low-cost and allow employers to make contributions to their employee’s plan without IRS reporting.
However, each type of IRA has its own distinct features geared towards different individuals’ employment situations. Below are key features of the SEP IRA and Simple IRA important to choosing which plan best suits your life:
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Simplified Employee Pension Plan (SEP) IRA
The SEP IRA is a plan that enables employers to set up and make contributions to traditional plans for their employees. The SEP IRA is most beneficial to employers, as all contributions that go toward the employer and employee’s IRA are tax-free and do not require annual funding. Most business owners, including sole proprietors, small businesses, corporations, and self-employed individuals are eligible to set up an SEP IRA.
Once an employer contributes to their own SEP IRA and those of their eligible employees, the investment earnings that increase overtime are tax deferred. Additionally, employers have discretion to decide the amount and frequency of contributions into SEP IRAs as long as they do not exceed 25 percent of their compensation. There is only a 10 percent penalty (plus normal income taxes) for withdrawal of funds from the plan prior to age 59 and a half.
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Savings Incentive Match PLan for Employees (SIMPLE IRA)
The SIMPLE IRA is a low-cost plan that is predominantly funded by the employee, though employers also make limited contributions (only 1-3 percent of employees’ pay for two years). The plan is well-suited for small businesses that do not offer another retirement plan. The plan covers employees who have earned at least $5,000 in their place of work in the past two years and who intend to earn a minimum of $5,000 in the following year. Employers also have the option of making this eligibility requirement less restrictive.
There is a 25 percent penalty tax (plus normal income taxes) for withdrawals before the age of 59 and a half during the first two years of a SIMPLE IRA. After the first two years that the plan is set up, there is only a 10 percent penalty.
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