3711 / What are the differences between a simplified employee pension (SEP) and a SIMPLE IRA?

Both SEP IRAs and SIMPLE IRAs must meet certain vesting, participation, nondiscrimination and other administrative requirements (see Q 3701 and Q 3706).

Generally, a SEP IRA is a traditional individual retirement account or individual retirement annuity that is adopted by a business to provide retirement benefits for the business owners and employees and may accept a higher rate of contributions than traditional IRAs.¹ The SEP IRA is owned by the employee. The SEP rules permit an employer to contribute a limited amount of money each year on behalf of its employees. A self-employed individual may contribute to his or her own SEP. All contributions must be in the form of money; property cannot be contributed. Although contributions are not required every year, any contributions made by an employer in a given year must be based on a written formula and must not discriminate in favor of highly-compensated employees.

A SIMPLE (which stands for Savings Incentive Match Plan for Employees) IRA plan is a simplified, tax-favored retirement plan offered by small employers that provides employees with a simplified method to contribute toward their retirement savings. Employees may choose to make salary reduction contributions (aka elective deferrals) and the employer is required to make either matching or nonelective contributions.² A SIMPLE IRA plan may permit contributions only under a qualified salary reduction arrangement (see Q 3706).

Both SEP IRAs and SIMPLE IRAs are attractive retirement savings vehicles for small businesses, but SIMPLE IRA sponsors should keep in mind that the accounts must be funded each year (i.e., a contribution must always be made for employees who earn $5,000 or more per year, see Q 3708). SIMPLE IRAs have lower contribution limits than SEP IRAs, as discussed below.

SEP IRAs tend to be more popular among self-employed individuals because there is no annual funding requirement. However, if a SEP IRA is funded in any year, contributions must be made to the accounts of certain employees (i.e., those who are 21, have at least $650 in compensation and performed services for the employer during the year in question, see Q 3701).

Contributions

SEPs are treated as defined contribution plans for purposes of the overall limits on employer contributions (see Q 3868).³ For plan years beginning in 2025, the annual additions limit for defined contribution plans as a whole is the lesser of $70,000 ($69,000 for 2024, $66,000 for 2023, $61,000 for 2022, $58,000 for 2021, $57,000 for 2020)⁴ or 100 percent of compensation.⁵ Any contribution by an employer to a SEP must be aggregated with all other employer contributions by that employer to defined contribution plans for purposes of the Section 415(c) limit on annual additions. Catch-up contributions to a SEP IRA are only permitted in grandfathered plans established prior to 1997.

Contributions to a SIMPLE IRA cannot exceed $16,500 per year in 2025 ($16,000 in 2024, $15,500 in 2023, $14,000 in 2022, $13,500 in 2020-2021), but may provide for catch-up contributions in the amount of $3,500 per year (as indexed for 2025) for participants who have reached age 50 by the end of the plan year.⁶ Elective contribution amounts made under a SIMPLE IRA plan are counted in the overall limit ($23,500 in 2025) on elective deferrals by any individual.⁷

Early Withdrawals

Early withdrawals (prior to age 59½) from a SEP IRA may subject the participant to an additional 10 percent penalty tax (plus ordinary income tax). Participants in a SIMPLE IRA will be subject to a 25 percent tax on early withdrawals if the withdrawal is made within two years of participating in a SIMPLE IRA. After the two-year period has expired, a 10 percent additional penalty tax will apply to early withdrawals.⁸