SEP and SIMPLE IRAs

Small employers and self-employed individuals have their own retirement plan options. SEP and SIMPLE plans are IRA-based: the Internal Revenue Code gives them their own rules rather than the qualified-plan requirements that govern 401(k), 403(b), and 457(b) plans.

That is the point of them. The administration is lighter, and the accounts are individual retirement accounts owned by each employee from day one.

How Does a SIMPLE IRA Work?

• Designed for small employers: the employer must have 100 or fewer employees who received at least $5,000 in compensation in the preceding year
• 2-year grace period: an employer that already maintains a SIMPLE plan and then grows past the 100-employee line stays eligible for the 2 years after the last year it qualified. The grace period does not apply when the growth comes from an acquisition, disposition, or similar transaction
• Employee participation: an eligible employee must have received at least $5,000 in compensation in any 2 preceding years AND be reasonably expected to receive at least $5,000 in compensation during the current year
• Both employer and employee contribute
• Employee deferral limit (2026): $17,000 (under 50); $21,000 (age 50+, with $4,000 catch-up)
• Enhanced deferral limit (2026): $18,100 / $22,100, which is 110% of the standard figures. Who gets it depends on employer size:
  • 25 or fewer employees earning at least $5,000: the enhanced limit applies automatically, with no extra employer cost
  • 26 to 100 employees: the employer may elect the enhanced limit, but only by raising its own contribution to a 4% match or a 3% nonelective contribution
  • An employer that grows past 25 employees keeps the automatic treatment for 2 more years
• Age 60-63 super catch-up (2026): $5,250 for SIMPLE plans, a smaller figure than the $11,250 super catch-up that applies to 401(k)-style plans. Don't carry the 401(k) table's number over to a SIMPLE plan.
• Employer contribution: must provide EITHER:
  • Dollar-for-dollar match up to 3% of employee compensation, OR
  • 2% nonelective contribution for all eligible employees (regardless of whether they contribute)
• Both employer and employee contributions are immediately 100% vested
• 25% early withdrawal penalty if distribution taken within first 2 years of participation (instead of the normal 10%)
• After 2 years, standard 10% early withdrawal penalty applies (if under 59.5)

Exam Tip: Gotchas

• SIMPLE IRAs have a HIGHER early withdrawal penalty (25% instead of 10%) during the first 2 years of participation. This is a unique and heavily tested rule. After 2 years, the standard 10% applies.

How Does a SEP IRA Work?

• Employer-funded IRA for small businesses and self-employed individuals
• Only the employer contributes (employees cannot make elective deferrals)
• Contribution limit (2026): 25% of employee compensation, up to $72,000
• Must cover all eligible employees: age 21+, worked for employer in 3 of last 5 years, earned at least $800 (2026)
• Contributions are immediately 100% vested
• Easy to establish and maintain (minimal paperwork vs. 401(k))
• No annual Form 5500 filing: the employer keeps Form 5305-SEP on file instead, so SEP IRAs stay simple for tiny practices
• Can be established and funded up to the employer's tax-filing deadline (with extensions) for the year, giving high-income professionals flexibility once cash flow is known
• Employer contributions must be a uniform percentage of compensation for all eligible employees

Exam Tip: Gotchas

• SEP IRA = employer-only contributions. No employee deferrals, no catch-up contributions. Often confused with SIMPLE IRA, which allows both.
• A self-employed owner's own contribution is effectively 20%, not 25%. The 25% rate applies to a common-law employee's W-2 compensation.
• Why the rate drops. A self-employed owner has no W-2 wages, so their net self-employment income and their own contribution are circular: the contribution reduces the income it is based on.
• How the IRS resolves it. A reduced rate of 20%, applied to net self-employment income after the self-employment tax deduction, reaches the same result the 25% W-2 formula would. The Solo 401(k) page states the same rule.

How Do Employer Retirement Plans Compare?

What Should You Check on Exam Day?

• A SIMPLE IRA is limited to employers with 100 or fewer employees who received at least $5,000 in compensation in the preceding year; an employee must separately have received at least $5,000 in compensation in any 2 preceding years and be reasonably expected to receive at least $5,000 in the current year to participate
• Standard SIMPLE deferral limit is $17,000 ($21,000 at 50+). The enhanced limit of $18,100 ($22,100 at 50+) is automatic for employers with 25 or fewer employees, and available to employers with 26 to 100 employees only if they elect it and raise their contribution to a 4% match or 3% nonelective
• The SIMPLE age 60-63 super catch-up is $5,250, smaller than the $11,250 super catch-up under 401(k)-style plans; don't carry the 401(k) figure over to a SIMPLE plan
• The employer must choose between a 3% dollar-for-dollar match or a 2% nonelective contribution for all eligible employees. Those rise to 4% and 3% for a 26-to-100-employee employer that elects the enhanced deferral limit
• SIMPLE IRA early withdrawals carry a 25% penalty in the first 2 years of participation, dropping to the standard 10% after that (if under 59.5)
• A SEP IRA is employer-only funded, up to 25% of compensation or $72,000, whichever is less; a self-employed owner's own effective rate is about 20%, not 25%, because of the circular relationship between net self-employment income and the contribution based on it