SEP and SIMPLE Plans: Retirement Savings Opportunities for Small Businesses

retirement saving

If you’re considering setting up a retirement plan for yourself and your employees, you may be worried about the administrative burdens and financial commitment required by providing a traditional pension plan. If so, you might want to consider a “simplified employee pension” (SEP) or “savings incentive match plan for employees” (SIMPLE).

SEPs are particularly appealing because of the relative ease of administration and the discretion they allow the employer in deciding whether or not to make annual contributions. They’re intended to serve as an alternative to “qualified” retirement plans, especially for small businesses.

Simplified employee pensions (SEPs)

Setting up an SEP is simple: so long as you don’t already have a qualified retirement plan, you can simply use the IRS model SEP, Form 5305-SEP. The form doesn’t need to be filed with the IRS, and you’ll satisfy SEP requirements just by adopting and implementing this model SEP. 

Employers will receive current income tax deduction for contributions they make on behalf of their employees—and employees aren’t taxed until later when distributions are made, usually at retirement. An individually-designed SEP, rather than the model SEP, might be appropriate for you depending on your situation.

Once an SEP is established for you and your employees, deductible contributions will be made to each employee’s IRA, called an SEP-IRA—and these deductions must be IRS-approved. 

In 2021, the maximum amount of deductible contributions that can be made to an employee’s SEP-IRA and excluded from their income is the lesser of: 

  • 25% of compensation 
  • $58,000 

The deduction ceiling applicable to an individual’s own contribution to a regular IRA doesn’t limit the deduction for your contributions to your employees’ SEP-IRAs. Employees have control of their own individual IRAs and IRA investments, and the earnings on these IRAs and IRA investments are tax-free.

In order to be eligible to set up a SEP, you’ll also need to meet certain other requirements. Contributions can’t discriminate in favor of more highly compensated employees, and all regular employees must elect to participate in the program. However, when compared with the bookkeeping and administrative burdens associated with traditional profit-sharing and qualified pension plans, these requirements are relatively minor.

SEPs don’t require the detailed records that traditional plans are required to maintain in order to comply with complex nondiscrimination regulations. In addition, they don’t require employers to file annual reports with the IRS, which could require the services of an actuary (as in the case of pension plans). All of the necessary recordkeeping can be completed by a trustee of the SEP-IRAs, typically a bank or mutual fund. 

Savings incentive match plans for employees (SIMPLE)

Smaller businesses with 100 or fewer employees can also choose to establish a “savings incentive match plan for employees” (SIMPLE). These plans establish a “SIMPLE IRA”  for all eligible employees. Participating employees then elect contributions under a qualified salary reduction arrangement and the employer makes matching contributions. Like SEPs, SIMPLE plans are subject to less stringent requirements compared to traditional qualified retirement plans. 

Employers can also adopt “simple” 401(k) plans, which have similar features to SIMPLE plans and allow for automatic passage of the nondiscrimination test for 401(k) plans, an otherwise complex procedure.

Up to $13,500 plus an additional $3,000 in catch-up contributions for employees age 50 and older can be deferred under SIMPLE plans for 2021.

If you need more information, or would like to discuss any other aspect of retirement planning, contact us today.