There are a variety of options available to business owners and self-employed individuals seeking to establish a retirement plan for themselves and their staff.
The SEP IRA and the SIMPLE IRA are two of the most common options since they share many of the same tax benefits as a traditional IRA. On the other hand, business owners can save time and effort by using these programs rather than setting up a traditional retirement program like a 401(k) (k).
While the SEP IRA and SIMPLE IRA share the IRA nomenclature with their more well-known relatives, they are intended for enterprises, rather than sole owners. (If you are a person considering opening an Individual Retirement Account (IRA) or Roth IRA, you should consider the advantages of each.)
We’ve laid out the fundamental differences between the SEP IRA and the SIMPLE IRA so you can make an informed choice.
What Is a SIMPLE IRA?
SIMPLE IRA stands for Savings Incentive Match Plan for Employees Individual Retirement Account. The primary difference between a regular IRA and a SIMPLE IRA is that the former allows for greater contributions than the latter.
Anyone who meets the eligibility requirements can open a SIMPLE IRA.
A traditional IRA can be opened by anyone, including those who do not have access to an employment savings plan such as a 401(k). A SIMPLE IRA can be established for both the business owner and their employees by a solo proprietor or small business owner. Participation in the plan is open to all employees who have made at least $5,000 in remuneration from the company in either of the two years before to the current year and who anticipate making at least $5,000 in compensation in the current calendar year.
How a SIMPLE IRA Functions
Elective deferrals are available to eligible employees. Like a 401(k) plan, this allows workers to set down a portion of their salary before taxes. Employer contributions may take the form of a matching employee contribution or a non-elective contribution to the employee’s account. Non-elective contributions are those sent to an employee’s account at the discretion of the employer, regardless of whether the employee chose to participate in the plan during the year in question.
If you are eligible for a SIMPLE IRA, you are required to participate in the plan regardless of whether or not you want to. In other words, you can opt out of making voluntary donations to your account, but you’ll still get the company’s mandatory contributions even if you don’t like free money.
What Is a SEP-IRA?
The “SEP” part of SEP-IRA stands for “simplified employee pension.” To what extent a SEP-IRA succeeds in making tax-deferred savings easier for the self-employed and small business owners is, of course, a matter of opinion. In addition, it facilitates the provision of savings vehicles to the staff of small firms.
Who Is Eligible to Open a SEP-IRA?
A SEP-IRA can be established by any employer with one or more eligible workers. Those who earn money through freelancing can also open one of these accounts. If you’re starting a business with your freelancing income, whatever money you put into it is tax deductible, both for your business and for yourself. Remember that only the firm itself can make contributions to these accounts, not the employees.
How Does a SEP-IRA Work?
A SEP-IRA differs from other corporate retirement plans in that employees who participate in it do not have to make their own contributions. To replace it, we have direct donations from the employer. The maximum employer contribution for 2022 is the lesser of 25% of the employee’s salary or $61,000.
A company’s contributions can be made at any time, and not just once a year. Contributions must be made at the same percentage of salary for all employees and the business owner.
SIMPLE IRAs vs. SEP-IRAs
If you run a small business as a sole proprietor, you and your employees can set up retirement accounts through either a SIMPLE IRA or a SEP-IRA. Although the two strategies share many similarities, they also have important distinctions.
A Simplified Employee Pension (SIMPLE) IRA enables the firm or sole proprietor and the employee to make contributions. While a SEP-IRA permits employers to contribute on behalf of their workers, SEP-IRAs are limited to the contributions of the business owner. SIMPLE IRAs and SEP-IRAs have varying contribution limits. In 2022, an individual can contribute up to 25% of their salary to a SEP-IRA, or $61,000. For 2022, the maximum contributions to a SIMPLE IRA are $14,000, with a $3,000 catch-up limit for those over the age of 50. Participants over the age of 50 can put in up to $17,000.
Due to the flexibility it provides, a SEP-IRA is ideal for companies with less than 100 employees. The size of the firm does not matter when it comes to using a SIMPLE IRA.
The following comparison table outlines key distinctions between the two pension options.
Comparison of Plans for 2022
Small business owners who want to contribute to their employees’ retirement funds may need to decide between the Simple IRA and the SEP-IRA. While both plans can help you save for retirement, they do it in different ways. Almost all of them have to do with the monetary input into the accounts. The maximum annual contribution that a person can make to an IRA varies by account type.
Contact Credo for more information about Simple IRA and SEP-IRA.
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