Today I’m going to compare two IRA’s side by side to give you some insight on which is the best for you. The two we are going to look at are the Simple IRA and the SEP IRA. If you wish to know some more in depth information about either of these you can view the IRA section of my website and it will direct you to some articles I wrote on each.
Ok, let’s first determine what is the most suitable IRA for you?
Simple IRA’s are best for…
Savings Incentive Match Plan for Employee IRAs are best for those employers who have 100 or less employees and includes those of you who are self employed who meet the compensation requirements and are not maintaining any other qualified plans.
[message type=”info”]Qualified plans receive favorable tax treatment and are regulated by ERISA.[/message]
SEP IRA’s are best for…
Self employed individuals with no employees or small businesses with employees who meet required compensation and tenure requirements.
[message type=”info”]SEP-IRA’s are better for the self-employed is because annual funding is not required which provides a great amount of flexibility and there is only a 10% penalty for early withdrawals regardless of how long you’ve had the account in place.[/message]
Both the Simple IRA and the SEP-IRA are easy to administer and have relatively low cost. Neither require IRS reporting either which saves on accounting fees. They do however differ in that the Simple IRA is funded mostly via employee contributions with a limited amount required to be contributed by the employer. On the other hand, the SEP-IRA does not require annual funding but if it is funded, the employer must contribute on behalf of each eligible employee.
The sole reason for the IRA’s, tax benefits is to encourage saving. With Simple IRAs, any contributions made by the employer are tax deductible but all employee contributions are made pre-tax and build tax deferred until distributed. The SEP-IRA contributions are mostly 100% tax deductible and made via the employer as they are geared towards very small business and all earnings are tax deferred until distributions.
Early Distribution Penalties
If you have a Simple IRA you’ll be displeased to know that if you find yourself in a bind, you’ll have to pay a 25% penalty on top of additional income tax if you withdraw (distribute) your funds before having the plan in place for 2 years time. Additionally if you aren’t past the age of 59 1/2, you’ll have to pay another 10% penalty.
For the SEP-IRA things are a bit different, and this is why I believe it is best for the self employed (i.e. small business) of the two IRA options. There is no two year rule, meaning you don’t have to worry about getting that huge 25% penalty if you’d only had your IRA for less than 2 years. The 10% penalty sadly does still apply if you decide to take early distributions and of course any additional income taxes.
Contributing to your Simple or SEP IRA
The Simple IRA is a bit more complicated than the SEP-IRA when it comes to contributions. An SEP-IRA contributions are made solely by the employer (another reason its best for the self-employed as you are the employer). A Simple IRA contributions depend on if your the employer or the employee. If your the employer you have two options and they are:
- Match up to 3% of each employee’s compensation or $11,500, whichever is less.
- Contribute 2% of each eligible employee’s compensation up to $4,900 for 2011 and $5,000 for 2012. (The eligible compensation limit determined by the IRS is $245,000 in 2011 and $250,000 in 2012.)
If you are the employee you can contribute $11,500 for the 2011 tax year and $14,000 for the 2012 tax year assuming you have no other qualified investments.