9.3 SEP-IRA & SIMPLE IRA

Both SEP-IRAs and SIMPLE IRAs are designed to provide retirement benefits for small businesses without the administrative complexity of traditional qualified plans like 401(k)s. Understanding the distinctions between these plans is essential for EA exam success and for advising clients on the best retirement vehicle for their situation.

---

SEP-IRA (Simplified Employee Pension)

A SEP-IRA is an employer-funded retirement plan that allows businesses to make tax-deductible contributions to individual retirement accounts established for employees. It is particularly popular among sole proprietors and small businesses due to its simplicity and high contribution limits.

2025 Contribution Limits

Critical Point: Only the employer makes contributions to a traditional SEP-IRA. (SECURE 2.0 created an optional Roth SEP where employees may elect Roth treatment for employer contributions, but Roth SEPs are still employer-funded.) Employees cannot make their own elective deferrals.

Self-Employed Contribution Calculation

For self-employed individuals, the contribution calculation is more complex. You cannot simply take 25% of your net self-employment income.

The Self-Employed Formula:

1. Start with net self-employment income (Schedule C profit)
2. Subtract 1/2 of self-employment tax (the "adjustment")
3. Multiply the result by 20% (not 25%)

Why 20% instead of 25%? The contribution itself is a deduction that reduces the compensation base. The math works out to an effective rate of 20% of net earnings after the SE tax adjustment (25% / 125% = 20%).

2025 Example: Sarah has $100,000 net profit from her Schedule C business in 2025. Her self-employment tax is approximately $14,130 (12.4% Social Security up to the $176,100 wage base + 2.9% Medicare on full earnings, applied to 92.35% of profit). Her SEP contribution is approximately:

• Net profit: $100,000
• Less 1/2 SE tax: $100,000 − $7,065 = $92,935
• SEP contribution: $92,935 × 20% = $18,587

Employee Eligibility Requirements

Employers must include all employees who meet all three of these conditions:

Important: Employers can use less restrictive requirements (e.g., include employees immediately) but cannot be more restrictive than the IRS minimums.

Deadline to Establish and Fund

One of the most attractive features of SEP-IRAs is the generous deadline:

• Deadline: Tax filing deadline plus extensions for the business
• For 2025 contributions, a sole proprietor filing an extension has until October 15, 2026 to both establish and fund the SEP-IRA.

SEP-IRA Advantages and Disadvantages

---

SIMPLE IRA (Savings Incentive Match Plan for Employees)

A SIMPLE IRA is a retirement plan for small employers (100 or fewer employees) that allows both employee salary deferrals and employer contributions. It is "simpler" than a 401(k) but has lower contribution limits.

2025 Contribution Limits

SECURE 2.0 Enhancement for Small Employers: Employers with 25 or fewer employees (or those with 26-100 who elect to provide higher contributions) may offer increased limits 10% higher than the standard ($18,150 deferral / $3,850 catch-up for 2025), though most standard plans use the base limits.

Employer Contribution Requirements

Employers must choose one of these two options each year:

Option 1: Matching Contribution

• Match employee contributions dollar-for-dollar up to 3% of compensation
• Can reduce to 2% match for 2 of any 5-year period

Option 2: Non-Elective Contribution

• Contribute 2% of compensation for ALL eligible employees
• Must contribute regardless of whether employee defers
• Based on compensation up to the $350,000 cap (2025)

Example (Matching, 2025): Employee earns $60,000 and defers 5% ($3,000). Employer matches dollar-for-dollar up to 3% = $1,800 (3% of $60,000). Total contribution: $4,800.

Example (Non-Elective): Same employee, employer chooses 2% non-elective. Employer contributes $1,200 (2% of $60,000) even if the employee defers nothing.

Employer Eligibility Requirements

The "100 Employee" Rule: If employer exceeds 100 employees, may continue SIMPLE for 2 additional years as long as contributions continue.

The 25% Early Withdrawal Penalty

This is a critical EA exam topic. SIMPLE IRAs have a special penalty rule:

The 2-year period starts on the date of the employee's first contribution to the SIMPLE IRA (which could be employer or employee contributions).

Warning: During the 2-year period, transfers to another retirement plan type (Traditional IRA, 401(k), SEP) are treated as distributions and may trigger the 25% penalty. Only SIMPLE-to-SIMPLE transfers are penalty-free during this period.

SIMPLE IRA Advantages and Disadvantages

---

Comprehensive Comparison: SEP vs. SIMPLE vs. Solo 401(k) (2025)

---

Which Plan Should Your Client Choose?

SEP-IRA is Best For:

• Self-employed individuals with high income wanting maximum contributions ($70,000 in 2025)
• Employers who want to contribute for employees but don't want employee deferrals
• Those who need flexibility in contribution amounts year-to-year
• Business owners who want to wait until after year-end to decide on contributions

SIMPLE IRA is Best For:

• Small employers (100 or fewer) who want employees to contribute
• Businesses wanting lower administrative costs than 401(k)
• Employers who prefer predictable matching obligations
• Companies where employees are motivated by the ability to defer their own salary

Solo 401(k) is Best For:

• Self-employed with no employees (except spouse)
• Those wanting highest contribution limits with catch-up (and super catch-up)
• Business owners wanting a Roth option
• Those who may need to borrow from retirement funds

---

EA Exam Tips: SEP & SIMPLE IRAs

High-Frequency Test Topics:

1. SEP contribution calculation for self-employed: Remember the 20% effective rate after SE tax adjustment.
2. SIMPLE 25% penalty: Within first 2 years, penalty is 25%, not 10%.
3. Employer contribution requirements: SEP is employer-only; SIMPLE requires match OR 2% non-elective.
4. 2025 dollar limits: SEP $70,000; SIMPLE deferral $16,500; SIMPLE catch-up $3,500 (or $5,250 ages 60-63); comp cap $350,000.
5. Eligibility: SEP requires 3-of-5 years and $750 compensation; SIMPLE requires $5,000 prior year earnings.

Common Exam Traps:

• Don't confuse SEP's 25% of compensation with the 20% self-employed calculation.
• SIMPLE's catch-up is $3,500 ($5,250 ages 60-63), not $7,500 (which is 401(k)).
• SEP has NO catch-up contributions regardless of age.
• The 2-year SIMPLE penalty clock starts with first contribution, not plan establishment.

Memory Devices:

• SEP = Simple Employer-only Plan (employer funds it)
• SIMPLE = Small employer, Immediate Participation, Lower limits, Employee deferrals allowed