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

Simplified employee pensions (SEP) and SIMPLE IRAs are both types of retirement accounts designed to help small business owners offer retirement benefits to employees (as well as to provide for themselves). Contributions to both types of accounts are (within limits) tax deductible by the employer and earnings accumulate on a tax-deferred basis, but permitted contribution levels vary based on the type of account chosen (see below). Penalties on early withdrawals also vary as discussed below.

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).