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If you’re self-employed and thinking about opening a retirement plan, first off, congratulations! That’s a big deal for any business owner. But before we dive into the nitty gritty of SEP IRAs and how they compare with 401(k) plans, let’s cover some of the SEP basics. SEP stands for Simplified Employee Pension Plan. SEPs are tax-deferred retirement plans that are created by employers. Contributions are only made by employers and can be made at any point up until your taxes are filed for the year. Employers are not required to contribute every year and can decide each year how much they’d like to contribute.

Because of this flexibility and generally minimal administrative requirements, SEPs are popular retirement accounts for self-employed individuals and other small business owners. Whether it’s the best fit for you and your business can depend on multiple factors such as your business goals, whether you want to make employer contributions, and the number of employees you have, to name a few.

Who may be best fit for a SEP?

Self-employed individuals

SEP IRAs are easy to establish and maintain. If your self-employment income is high, a SEP IRA is a convenient way to help maximize your retirement contributions and minimize administration. SEP IRAs aren’t subject to annual DOL reporting requirements1 and the contribution limits for a SEP IRA ($58,000 for 2021 and $61,000 for 2022) are significantly higher than for a traditional or Roth IRA ($6,000 for 2021 and 2022, annually).

Individuals who own a small business as a side gig

Side gigs and freelance roles often have unpredictable incomes. SEPs have flexible contribution rules that allow you to contribute when times are good and skip contributions when business might not be as healthy as you’d like. In addition, you have until your tax filing deadline to contribute for the previous year.

Family-owned businesses

Since SEPs require the employer to make contributions to all eligible employees, they are a great option for family-owned businesses. Business owners can share business profits with family, while saving for retirement and getting a tax deduction in the process. And if cash flow is unpredictable, the flexibility to decide whether or not to contribute each year is valuable.

Who might want to consider a 401(k)?

Growing small businesses

If you have a few employees and want to provide them with a retirement plan without making employer contributions, a 401(k) could be a good alternative to a SEP IRA.

As your business grows, a 401(k) can be used to attract and retain talent as well. Features such as vesting can give employees an incentive to stay longer, and an employer match can act as an extra incentive to attract employees.

Still not 100% sure? This side-by-side chart of a SEP IRA and 401(k) should help.

Retirement plan feature SEP IRA 401(k)
Deferral or employer contribution limit Lesser of $58,000 for 2020 ($61,000 for 2022) or 25% of compensation2 $58,000 for 2021 ($61,000 for 2022)when combined with employer contributions ($19,500 for 2021 ($20,500 for 2022)for employee contributions)3
Employee catch-up contributions Not available Available, $6,500 per year for 2021 ($6,500 for 2022) if age 50 and over
Contribution frequency Flexible, however all contributions must be made by the due date of filing your federal income tax return (plus extensions). Every time payroll is processed
Who can contribute to the plan? Employer only (or self employment income) Employer and Employee
Plan design options Eligibility (no customization) Eligibility, vesting, matching, new comparability or flat dollar profit sharing allocations, plan loans, exclusions etc.
Annual filings and administration No annual filings1, minimal administrative duties Requires annual filing with the IRS, multiple notices to participants, payroll deduction every pay period, annual non-discrimination testing, and potentially plan audits by IRS and DOL
Opt-out requirements Employee cannot opt out Employee can opt out of employee deferrals
Employee eligibility requirements Must be included if attained the age 21, worked 3 of the last 5 years, and earned at least $650 (in 2021) or $650 (in 2022) from your business for the year.4 Can have more restrictive requirements for eligibility to partcipate.
SECURE Act tax credits Available if eligiblity requirements are met Available if eligibility requirements are met

Another way to look at this is by thinking about the type of features that are most important to you. Here you can see the different services and features Guideline provides for both types of retirement plans.

Retirement plan feature Guideline SEP IRA Guideline 401(k)
Tax-deferred savings
Access to Guideline investment portfolio with auto-reblanacing
Loan availibility
Flexible contribution schedule
Employee contribution
Employer contribution
Carryback contributions (i.e. you can make contributions for a given year until April 15 of the following year)
Flexible allocation method for profit sharing

At Guideline, our SEP IRAs and 401(k) plans are two distinct products, but they share a similar structure. Both offer professionally managed portfolios and automatic rebalancing without added investment management fees. And both are easy to set up, easy to manage and easy to get support when needed—all for a low monthly fee.

Whether you set up a SEP IRA or 401(k) — you’ll be opening an easy, affordable, retirement plan that can help you save for your future.

This content is for informational purposes only and is not intended to be construed as tax advice.  You should consult a tax professional to determine what types of tax deductions you are eligible to claim.

1 While there are no DOL reporting requirements for SEP IRAs, employer contributions are reported to the IRS on the employer’s tax return. Learn more.

2 If you are self employed, contributions are generally limited to 20% of your net income. Contribution limits to a SEP IRA are subject to cost-of-living adjustments annually. Learn more

3 The limit on employee elective deferrals to a 401(k) plan is subject to cost-of-living adjustments annually. Learn more.

4 Your plan may use less restrictive requirements to determine eligibility. Learn more.