SEP IRA vs SIMPLE IRA (For Self Employed)

How do you define a SEP IRA?

A SEP is an individual retirement account (IRA) that a self-employed person or employer can create. With a SEP IRA, only the employer can make contributions to the account. If you’re self-employed or run a small business, you can set up a SEP IRA with pretty much any financial brokerage institution out there. Examples of this are Vanguard, Fidelity, TD Ameritrade, Schwab, E-Trade. SEP stands for Simplified Employee Pension.  Here are five great features of a SEP IRA.

What are the advantages of a SEP IRA?

1)  It’s tax-deductible. If you put $10,000 into a SEP IRA, you can deduct $10,000 from your taxable income on your tax return, which translates to a lower tax bill.

2) Investment Choice. This really is the beauty of a SEP IRA compared to a 401(k). With a 401(k), you generally have to choose from 10 or 15 funds that your employer has selected for you. With a SEP IRA, once it’s set up, you can pretty much invest in any ETF or mutual fund that’s publicly available to retail investors out there. So you can even buy individual stocks like Amazon or Tesla if you wanted to. 

We aren’t suggesting you should use your SEP IRA to purchase individual stocks, but your investment options are much wider with a SEP. By the way, if you’d like some tips on how to pick individual stocks, make sure you check out our video on four smart steps on how to pick stocks.

3) A SEP IRA is tax deferred. This means you don’t have to pay taxes now on any dividends your investments are generating each month or each quarter. Also, let’s say you bought GameStop for $10 a share and you sold it for $200 a share, you don’t have to pay capital gains taxes on the profit you just made because it’s in a tax-advantaged account. You’ll just need to pay taxes when you take it out during retirement.  

4) You don’t need to report anything to the IRS. If you set up a different account, such as a 401(k), you have to do a bunch of paperwork and non-discrimination testing each year. There aren’t the same requirements for a SEP IRA. 

5) A SEP IRA has flexibility in terms of how much you can contribute each year. Let’s say last year you put in $10,000 and then this year, you’re feeling like hey, you know what? I want to go to Finland and check out the Northern Lights and maybe bring along and pay for my sibling’s or my loved one’s costs as well. And maybe I’ll just put $1,000 into my SEP IRA this year. It’s really up to you. It gives you a lot of flexibility. 

How do you create a SEP IRA?

There are two main steps to creating a SEP IRA.

1. First, you simply go to, let’s say Vanguard or Fidelity or another financial institution.

Find where it allows you to open an account. You may have to choose an option to see all account types available to find the SEP IRA. Since not everybody can contribute to one, they may not have it on the main screen of options. Then you just follow the instructions afterward to open the account. 

2. The other important thing that you need to do to create a SEP IRA, which many people forget, is you need to fill up what’s called a Form 5305-SEP .

You’re probably now thinking, I thought there wasn’t going to be any paperwork. What is this form that you’re asking me to fill up? Well, it’s only half a page, and pretty straightforward. Don’t get to intimidated about it. You’ll just need to sign and date it. You don’t even need to send it to the IRS. You just file it for your own paperwork so in case you get audited, you have it. 

Now, if you read the official IRS website, it’s going to tell you that you can contribute up to 25% of your total salary, up to the IRS maximum. In our experience really, it comes down to roughly just about 18% after adjustments. You just need to take note of exactly how much you can contribute if you want to max out your SEP IRA.

Are there any caveats to a SEP IRA?

The main caveat of a SEP IRA is that technically, it’s the employer making contributions. If you’re self-employed, you’re the employee and the employer, so it’s not a problem. But if you have a W2 employee and let’s say you put in 18% of your salary to your SEP IRA. According to the rules, you as the employer will also have to contribute 18% of your W2 employee’s total salary to his or her SEP IRA. For a lot of small business owners, that’s probably too high of an employee benefit. This is where a SIMPLE IRA comes in.

What is a SIMPLE IRA?

The second option for a small business retirement plan is a Savings Incentive Match Plan for Employees (SIMPLE IRA).  Employers (including self-employed), can contribute if they have no more than 100 employees earning more than $5,000 in the preceding year.   Employees can have their contributions deducted from their paycheck and that money will grow tax-differed until retirement. If you’re a small business owner and you have a W2 employee, a SIMPLE IRA might be attractive for you. There are five great features of a SIMPLE IRA, which are very similar to a SEP IRA. 

What are the advantages of a SIMPLE IRA?

1)  A SIMPLE is tax-deductible.

2) A SIMPLE IRA is tax-deferred.

3) It has flexible investment options. If you open it at the right institution, you can purchase any ETF or mutual fund you’d like.

4) The really awesome feature here is being able to offer this as a retirement benefit for your W2 employees. And you might ask, what’s so great about that? Well, there are actually 40 million private-sector employees in this country that do not have access to a retirement plan. So it’s really a big deal setting up a retirement plan that you can contribute to and that you can give the option for your employees to contribute to as well. The cost to you as the employer is really only 2 to 3% of your employee’s salary. You have to provide some type of matching to this SIMPLE IRA. It’s almost like giving your employees a 2 or 3% raise, it’s not that much.

5) With SIMPLE IRAs, you don’t have to have a W2 employee to open a SIMPLE. If you’re the sole employee of your practice, you can also contribute to a SIMPLE IRA. You also need to fill up Form 5305-SIMPLE. Again, it’s a really short form, half a page. You don’t need to file with the IRS, just sign, date, and keep it. For 2022, you can contribute up to $14,000 as an employee, plus the matching from the employer. This is up from $13,500 in 2021. 

What is the difference between a SEP IRA vs SIMPLE IRA?

1. Eligibility

• SEP IRA: Available to all types of businesses, including those who are self-employed. Any employee who is at least 21 years old, has worked for the employer for three of the past five years, and has earned at least $600 in the current year can participate. 
• SIMPLE IRA: Available to businesses with 100 or fewer employees. Employees are eligible to participate if they have earned at least $5,000 in any two previous years and are expected to earn at least $5,000 in the current year.

2. Contributions

• SEP IRA: Contributions are made only by the employer. The contribution limit is the lesser of 25% of the employee’s compensation or
• SIMPLE IRA: Contributions can be made by both the employer and the employee. Employees can contribute up to $15,500 for 2023 (with a catch-up contribution of $3,500 for those aged 50 and over).

3. Administration

• SEP IRA: It’s easy to set up and maintain. There are no annual reporting requirements. 
• SIMPLE IRA: It’s not as easy to set up and maintain. There are annual reporting requirements.

4. Contributor

• SEP IRA: Offer employer-only contributions to employees. The employer is responsible for all of the contribution decisions.
• SIMPLE IRA: Offer employer-only contributions to employees. However, SIMPLE IRAs allow the employer and the employee to contribute a percentage of their income.

5. Deadline for establishing the plan

• SEP IRA: Plan must be established and funded by the employer’s tax-filing deadline.
• SIMPLE IRA: Plans must be established by October 1st of the year they are to take effect.