Small business owners have many responsibilities, including what type of retirement vehicle they will use for themselves and their employees. The recent enactment of the SECURE 2.0 Act has introduced Roth versions of SEP and SIMPLE individual retirement accounts (IRAs), changing the landscape of retirement preparation for small business owners.
Simplified Employee Pension (SEP)
A SEP is an IRA designed for self-employed individuals and small business owners. It is an employer-sponsored plan where only the employer can contribute to the SEP. Contributions made by the employer are tax-deductible, and they have the flexibility to decide when to make contributions. SEP IRAs are popular due to easy setup process, cost-effectiveness, eligibility criteria, ability to skip contributions if necessary, immediate vesting of funds, and higher contribution limits compared to traditional IRAs.
Savings Incentive Match Plan for Employees (SIMPLE)
A SIMPLE is another type of IRA available to small businesses. SIMPLE IRAs share many of the same benefits as SEP IRAs, such as cost-efficiency, immediate vesting, and employer tax deductions. However, there are differences. SIMPLE IRAs offer catch-up contributions for employees over age 50, can only be used by businesses with 100 or fewer employees, allow employee contributions, and require employers to match a certain percentage of employee contributions.
What to Consider
Previously, SEP and SIMPLE IRAs were like traditional IRAs with deferred tax treatment. Converting to a Roth IRA was an option later on. However, recent changes allow contributions to be designated as Roth IRA contributions (after-tax dollars) upfront, eliminating the need for conversion. Consequently, small business owners and employees need to conduct further analysis to determine the best approach for their future retirement plans. Although detailed information on these new plans is currently limited, the traditional rules of Roth IRAs will apply, introducing certain differences compared to traditional IRAs.
Roth IRAs are funded with post-tax dollars, which means there is no immediate tax break. However, qualified withdrawals from a Roth IRA are tax-free, including any earnings accumulated in the account. In contrast, traditional IRAs provide a tax break at the time of contribution with tax-deductible contributions in the year they are made. Consequently, distributions from traditional IRAs are subject to ordinary income tax rates in the year in which withdrawals are made. Both types of IRAs impose penalties for early withdrawals before reaching 59 ½ years of age. To summarize, traditional IRAs reduce your adjusted gross income in the current year for tax purposes while Roth IRAs do not. Both have tax-deferred growth, while only Roth IRA distributions are tax-free.
| Features | SEP IRA | SIMPLE IRA |
|---|---|---|
| Contribution Limit | Lesser of 25% of compensation or $66,000 | $15,500 ($3,500 catch-up if 50+) |
| Tax-Deductible at Time of Contribution | Traditional (Yes) Roth (No) |
Traditional (Yes) Roth (No) |
| Retirement Taxation | Traditional (Yes) Roth (No) |
Traditional (Yes) Roth (No) |
| Employee Eligibility | 21 years old, worked for the business in three of the last five years, received $750 of compensation | Employee must have earned $5,000 in compensation during any preceding two years |
| Contributions | Employers only (required for all eligible employees) | Employees with employer match |
| Maximum Employees | None (typically 1–3) | 100 |
Considering the intricacies of these options, consulting a Forvis Mazars Private Client™ professional can provide valuable guidance to help you select a suitable retirement plan for you and your small business. If you have questions or need assistance, please reach out to one of our professionals or use the Contact Us form below.