SEP and SIMPLE IRAs: retirement accounts for the self-employed and small businesses

Self-employed people and small employers have access to retirement plans that are simpler to run than a 401(k). Two of the most common are the SEP IRA and the SIMPLE IRA. Both are built on individual retirement arrangements, so each participant owns an IRA, but the contribution rules are quite different. The names are similar enough that the two are often confused.

What the two plans have in common

• Contributions go into an IRA set up for each eligible person, including the owner.
• The employee is always 100% vested, meaning the money belongs to them as soon as it is contributed.
• The employer generally has no annual filing requirement with the IRS.
• Once money is in the account, withdrawals follow IRA rules: they are generally taxable, subject to the additional tax on early distributions before age 59½, and subject to required minimum distributions later in life.

Both plans were originally pre-tax only. IRS Publication 560 notes that, under the SECURE 2.0 Act, a SEP or SIMPLE IRA plan may allow contributions to be made to a Roth IRA for tax years beginning after 2022. Whether that choice is actually available depends on the plan and the financial institution.

How a SEP IRA works

SEP stands for simplified employee pension. The IRS describes it as a plan in which only the employer contributes, and a business of any size, even a self-employed individual, can establish one.

Contribution limit. The IRS says employer contributions to an employee's SEP IRA cannot exceed the lesser of 25% of the employee's compensation or $72,000 for 2026. For 2027, Notice 2026-66 increases the underlying dollar limit for defined contribution plans from $72,000 to $75,000. There are no employee salary deferrals and no catch-up contributions in a SEP.

Self-employed owners. For someone who is self-employed, compensation means net earnings from self-employment, and the calculation has to account for the contribution itself and for part of the self-employment tax. The effect is that the maximum works out to a lower percentage of net profit than the headline 25%. Publication 560 has a rate table and worksheet for this.

Flexibility. The employer decides each year whether to contribute and how much. A business can contribute generously in a strong year and nothing in a weak one.

Uniformity. The contribution rate has to be the same for all eligible employees. An owner who contributes 15% of their own compensation contributes 15% for each eligible employee too. Under the IRS's standard eligibility rules, an eligible employee is one who has reached age 21, has worked for the employer in at least three of the last five years, and has received at least a minimum amount of compensation for the year. An employer can use less restrictive requirements, but not more restrictive ones.

Timing. The IRS says a SEP can be set up for a year as late as the due date, including extensions, of the business's income tax return for that year.

How a SIMPLE IRA works

SIMPLE stands for savings incentive match plan for employees. The IRS says it is available to small businesses, generally those with 100 or fewer employees, and the employer cannot have any other retirement plan.

Employee contributions. Employees can choose to contribute part of their pay. The IRS says the amount an employee contributes from salary cannot exceed $17,000 in 2026, with an additional catch-up contribution of $4,000 for those age 50 or over if the plan permits, and a higher catch-up limit of $5,250 for employees aged 60 through 63. For 2027, the IRS has announced that the general limit increases to $17,500, while the catch-up amounts remain $4,000 and $5,250. SECURE 2.0 also created a somewhat higher contribution limit, with a different catch-up amount, for certain plans, mainly those of employers with 25 or fewer employees; the IRS announcement linked above lists those amounts.

Required employer contributions. Unlike a SEP, the employer must contribute every year, using one of two formulas described by the IRS:

• A dollar-for-dollar match of employee contributions up to 3% of compensation.
• A nonelective contribution of 2% of compensation for every eligible employee, whether or not the employee contributes.

Timing. A new SIMPLE IRA plan generally can be set up effective on any date from January 1 through October 1 of a year.

The two-year rule. The IRS notes that if withdrawals are made within the first two years of participation, the 10% additional tax on early distributions is increased to 25%. Other exceptions to the additional tax are described in early withdrawals and the rule of 55.

Side-by-side comparison

Questions that often guide the choice

• Are there employees besides the owner? A SEP requires the same percentage for everyone eligible, which can be costly with a larger staff. A SIMPLE shifts much of the saving to employees' own deferrals.
• How steady is the business's cash flow? A SEP contribution can be skipped; a SIMPLE employer contribution cannot.
• Do employees want to contribute from their own pay? Only the SIMPLE allows it.

Having a SEP or SIMPLE IRA does not prevent someone from also contributing to a personal traditional or Roth IRA, though participating in an employer's plan can affect the deduction rules described in IRA contribution limits and income rules.