The Difference Between a SEP IRA & a Simple IRA

by Kay Dean, Demand Media
    Retirement planning is an important part of any sound financial plan.

    Retirement planning is an important part of any sound financial plan.

    Retirement is a major component of any well designed financial plan. Retirement plans can be confusing because they are frequently made up of a number of different components such as Social Security, private savings, company pension plans, 401(k) plans and individual retirement arrangements (IRA). Even among IRAs there are different types, such as SEP IRAs and SIMPLE IRAs, that are available to different segments of the working population.

    Types

    Congress first authorized individual retirement arrangements, sometimes referred to as individual retirement accounts, or IRAs, in 1974 as part of the Employee Retirement Income Security Act. These original IRA programs were only available to working taxpayers whose employer did not offer a qualified retirement program. This tax-advantaged savings program proved so popular that Congress expanded it to cover virtually every taxpayer who had earned income. Eventually new varieties of IRAs were introduced for individual taxpayers, including the Roth IRA. In 1996 Congress authorized tax-advantaged SIMPLE IRA programs for employers with a limited number of employees under the Small Business Job Protection Act. Congress also authorized SEP IRA programs for employers of any size.

    Acronyms

    The federal government is fond of using acronyms as a means of distinguishing similar items, such as IRA, SEP IRA or SIMPLE IRA, but it can be confusing to ordinary taxpayers. An IRA is an individual retirement arrangement. IRA may also refer to an individual retirement account, which is the specific financial account where the taxpayer's retirement funds are held. SEP refers to a Simplified Employee Pension program. SEP IRA is the specific employee retirement account that is funded by the SEP. SIMPLE is short for Savings Incentive Match PLan for Employees.

    SEP

    A Simplified Employee Pension plan can only be set up by the employer. Each eligible employee has their own IRA account associated with the SEP, and each eligible employee must be covered equally by the plan. The employer is the only one who can make contributions into the employee's IRA account, but the employee is 100 percent vested in the account as soon as the contribution is made. This means once the money is in the employee's IRA, the money belongs to the employee. There are certain restrictions that apply, including early withdrawal tax penalties if money is taken out of the account prior to the employee reaching 59 1/2 years of age.

    SIMPLE

    SIMPLE plans are similar to SEP plans in that they are both established by employers for the benefits of their employees, but SIMPLE plans are limited to companies with 100 or fewer eligible employees. Under SIMPLE plans, an IRA is established for each eligible employee, but funding the account may include a combination of employer and employee contributions. SIMPLE plans allow employees to elect to contribute a percentage of their income into their IRA on a pre-tax basis. The employer is required to match the employee's contribution, up to three percent. The employer may also elect to make a non-elective contribution to all eligible employees' accounts rather than making matching contributions. Once SIMPLE IRAs are funded, the account is 100 percent vested to the employee.

    About the Author

    After attending Hardin Simmons University, Kay Dean finished her formal education with the Institute of Children's Literature. Since 1995, Dean has written for such publications as "PB&J," Disney’s "Family Fun," "ParentLife," "Living With Teenagers" and Thomas Nelson’s NY Times bestselling "Resolve." An avid gardener for 25 years, her experience includes organic food gardening, ornamental plants, shrubs and trees, with a special love for roses.

    Photo Credits

    • Making a financial plan image by Allen Stoner from Fotolia.com