A SIMPLE IRA and SEP IRA Comparison
The Internal Revenue Service regulates two IRA savings plans designed for small businesses. The Simplified Employee Pension (SEP) IRA allows employers or sole proprietors to make large contributions to a retirement plan. The Simplified Savings Incentive Match Plan for Employees (SIMPLE) IRA offers a more traditional employee-contribution plan with an employer's matching contribution. Before choosing one of these retirement plans, you should compare the features of the SEP and SIMPLE IRAs.
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Eligibility
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SEP IRA and SIMPLE IRA plans allow employers to set limitations on an employee's eligibility to participate in the plan. Employers considering a SEP IRA plan can disqualify employees who have not been employed for at least three out of the past five years, who are under age 21 and who have earned less than $550. Employers who are considering a SIMPLE IRA plan can limit the plan to employees who earned at least $5,000 in the past two years and are expected to earn at least $5,000 in the current year. Both plans allow employers to restrict employees covered by collective bargaining agreements.
SEP IRA
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Employees may not make elective contributions to a SEP IRA. Employers make discretionary contributions based on their cash flow. In any year, employers may contribute up to 25 percent of the employee's net income to a SEP IRA. In 2011, the maximum allowable SEP IRA contribution is $49,000. Employers must contribute a uniform percentage rate to all employee SEP IRA accounts. Employees are considered 100 percent vested for all employer contributions.
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SIMPLE IRA
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SIMPLE IRA contributions include employee elective deferrals combined with mandatory employer matching contributions each year. Although employers must contribute annually, they can set their matching contributions as low as 1 percent in any two years out of five. This flexibility allows employers to adjust for occasional business downturns. Employers can match up to 3 percent of an employee's salary. Employee salary deferrals are capped at $11,500 in 2011. Workers older than age 50 can make catch-up contributions of $2,500 for a total annual deferral limit of $14,000.
Considerations
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SEP IRAs favor employers who want to make potentially large contributions to their retirement accounts. The plan is suitable for businesses with unpredictable revenue streams from year to year. When revenues are down, employers may elect to skip the contribution. If employers do make a contribution, they must contribute to every eligible employee equally. SEP plans generally favor self-employed individuals or employers with few employees. SIMPLE IRAs are designed for businesses with fewer than 100 workers. SIMPLE IRAs are suitable if the employer enjoys a predictable annual income and wants employees to contribute to their own retirement plans. SIMPLE IRA plans avoid the extensive reporting requirements of a 401k plan. Both plans are easy to establish and maintain, and employee accounts are set up individually.
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