Self-Employed? Simple IRA or SEP IRA


As a self-employed worker, you must independently manage a number of important financial affairs. Along with ongoing responsibilities like quarterly taxes and health insurance, you must also look ahead to the future and consider your options for retirement. Investing in a retirement account can yield enormous benefits once you reach retirement age, and it can take a lot of the confusion and frustration out of the savings process. As a self-employed worker, you can select from among two main types of individual retirement accounts (IRAs). Understanding the differences between a Simple IRA and an SEP IRA can help you to decide on the best types of contributions for your own retirement.

What Does SIMPLE IRA Stand For?

A Simple IRA doesn’t just mean “simple” as in easy, but it actually stands for “Savings Incentive Match Plan for Employees.” As a self-employed worker, you are effectively your own boss, which affords you the dual role of employer and employee. This type of plan is similar to a 401k in the sense that it allows you to match contributions through both roles. For example, in many 401k accounts, employers will match the contributions that a person makes. If you’re self-employed, you can deposit a specific amount of your income into your account and also contribute a percentage of that amount by being represented as your own employer. The standard percentage that you are allowed to match in a Simple IRA is 3% of the net earnings.

Simple IRA Plans

What Does SEP IRA Stand For?

An SEP IRA is more specifically known as a Simplified Employee Pension IRA and is one of the more basic retirement savings options for self-employed workers. This type of retirement plan is easier to understand and break down than other forms. The money that you invest into the account is not taxed as a regular part of your income and will only be taxed once the account is distributed during your retirement years. For example, if you are paid $800 during a one-week period, you may decide to put $100 toward the SEP IRA. If this is the case, you will only be taxed on $700 of your income through quarterly and annual taxes.

Annual Limits

As you break down the various factors that distinguish SEP IRA accounts from Simple IRA accounts, you will notice a huge difference in the annual limits. An SEP IRA allows you to invest 25% of your net self-employment income with an annual maximum of $53,000 (as of 2016). For example, if your annual net income is $34,000, you can invest a maximum of $8,500 for the year. You would need to earn a net income of $212,000 to reach the maximum amount allowed.

A Simple IRA allows you to invest a higher percentage of your income, but it also has a much lower maximum limit. If you choose this type of account, you can invest up to 100% of your net income with a maximum of $12,500 (as of 2016). You can also invest an additional 3% of your net income as an employer contribution. Using the previous income example of $34,000, the annual maximum amount that you could invest into your retirement account would be $13,520. This is a difference of over $5,000 from the SEP IRA account option.

The limits increase for both of these accounts after you reach the age of 50. These increases allow you to build savings more quickly as you approach your retirement.

IRA savings

Penalties & Fees

As a self-employed worker, you can’t always predict when you'll run into financial difficulties. You can cash out of your IRA account at any time, but you’ll face large penalties as a result. For a SEP IRA account, the penalty rate is 10%; for a Simple IRA account, the penalty rate is much higher at 25%. If you want the freedom of knowing that you can potentially access the money before your retirement, you may want to consider opening an SEP IRA account.

Both of these account types may also have fees associated with them. These include annual fees, transfer fees, and administrative fees. The fees vary by company, so it’s important to compare different options and decide what works best for you.

Once you have chosen between Simple and SEP IRA options, be sure to compare the top lenders right here on our site.

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