Specialized Returns and Taxpayers · Retirement plans

Plans for self-employed persons (e.g., SEP and SIMPLE)

Both plans exist because a small employer will not run a 401(k), and both are built on individual retirement accounts rather than a trust. That is where the similarity ends. A SEP takes only employer money and the employee has no election at all; a SIMPLE is built on the employee’s salary reduction election and the employer’s obligation to match it. Every eligibility, timing and ceiling difference follows from that one fact.

The rule

Who must be covered in a SEP (IRC § 408(k)(2)). a simplified employee pension satisfies the participation requirement for a year only if the employer contributes for each employee who has attained age 21, has performed service for the employer during at least 3 of the immediately preceding 5 years, and received at least the indexed compensation amount from the employer for the year; employees covered by a collective bargaining agreement and non-resident aliens without US-source income may be excluded (IRC § 408(k)(2))^TY2026 the IRC § 408(k)(2)(C) compensation threshold for SEP participation is $800 for 2026, up from $750; the statutory figure is $450, indexed^TY2026 The three-of-five test counts any service in a year, not a full year of service, so a seasonal worker who appears for three consecutive summers has satisfied it.

How much, and to whom. contributions must not discriminate in favour of highly compensated employees, and are considered discriminatory unless they bear a uniform relationship to the compensation of each participating employee, subject to the permitted disparity rules of IRC § 401(l)(2) (IRC § 408(k)(3))^TY2026 the employer contribution to a SEP is bounded by the IRC § 415(c)(1) annual additions limit — the lesser of the dollar limit for the year or 100 percent of the participant’s compensation — and by the IRC § 404(h) deduction ceiling of 25 percent of compensation, with compensation itself capped at the IRC § 401(a)(17) amount^TY2026 The employee makes no contribution and has no election. There is no salary reduction in a SEP, so an employee who wants to save more must use a separate IRA of their own.

Vesting in a SEP is not a schedule. a SEP qualifies only if employer contributions are not conditioned on retaining any part of the amount contributed and the employer imposes no prohibition on withdrawals — which is what makes a SEP immediately and fully vested (IRC § 408(k)(4))^TY2026 Because the money goes into the employee’s own IRA and the employer may not restrict withdrawals, vesting is immediate as a structural matter rather than as a plan term.

Who may sponsor a SIMPLE. an eligible employer for SIMPLE purposes is one that had no more than 100 employees receiving at least $5,000 of compensation for the preceding year; an employer that establishes a plan and later fails the test is treated as eligible for the 2 following years, except where the failure arises from an acquisition, disposition or similar transaction (IRC § 408(p)(2)(C)(i))^TY2026 a salary reduction arrangement is not qualified for a year if the employer or a predecessor maintained a qualified plan under which contributions were made or benefits accrued for service in that year (IRC § 408(p)(2)(D))^TY2026

Who must be covered in a SIMPLE. all employees who received at least $5,000 in compensation from the employer during any 2 preceding years and are reasonably expected to receive at least $5,000 during the year must be eligible to make the salary reduction election or receive the nonelective contribution; employees described in IRC § 410(b)(3) may be excluded (IRC § 408(p)(4))^TY2026 Note how different this is from the SEP test: two preceding years at the statutory dollar floor and a reasonable expectation for the current year, against three of five years at a much lower indexed amount and an age floor.

The employer’s obligation. the employer must match elective contributions up to the applicable percentage of compensation for the year, which is 3 percent; an employer may elect a lower percentage of not less than 1 percent, but not if that would make the percentage lower than 3 in more than 2 years of the 5-year period ending with that year. For an employer with more than 25 employees receiving at least $5,000 of compensation in the preceding year that makes the IRC § 408(p)(2)(E)(i)(II) election, the applicable percentage is 4 percent (IRC § 408(p)(2)(A)(iii), (C)(ii))^TY2026 in lieu of matching, the employer may elect to make nonelective contributions of 2 percent of compensation for each employee eligible to participate who has at least $5,000 of compensation for the year, notifying employees within a reasonable period before the 60-day election period; compensation for this purpose is capped at the IRC § 401(a)(17) amount (IRC § 408(p)(2)(B))^TY2026 The difference in mechanics matters. The match is dollar for dollar on what the employee actually defers and stops at the applicable percentage; the nonelective contribution goes to every eligible employee whether they defer or not.

And an optional extra. the employer may in addition make nonelective contributions of a uniform percentage of up to 10 percent of compensation for each eligible employee with at least $5,000 of compensation for the year, capped at $5,000 per employee for the year (IRC § 408(p)(2)(A)(iv))^TY2026

Employee limits. the IRC § 408(p)(2)(E)(i)(III) limit on salary reduction contributions to a SIMPLE IRA or elective contributions under a SIMPLE 401(k) is $17,000 for 2026, up from $16,500; the higher limit at IRC § 408(p)(2)(E)(i)(I) or (II) is $18,100, up from $17,600^TY2026 the IRC § 414(v)(2)(B)(ii) catch-up limit for a SIMPLE 401(k) or SIMPLE IRA, for individuals aged 50 or over, is $4,000 for 2026, up from $3,500; the IRC § 414(v)(2)(E)(ii) age 60 to 63 catch-up for those plans remains $5,250 and the IRC § 414(v)(2)(B)(iii) limit for certain such accounts remains $3,850^TY2026

Vesting and timing. an employee’s rights to any contribution to a SIMPLE retirement account are nonforfeitable, with rules similar to the SEP withdrawal rules applying (IRC § 408(p)(3))^TY2026 elective contributions must reach the account no later than the close of the 30-day period following the last day of the month for which they are made, and matching or nonelective contributions by the IRC § 404(m)(2)(B) date; an employee may terminate participation at any time and each eligible employee may elect or modify during the 60-day period before the beginning of the year, or before first becoming eligible (IRC § 408(p)(5))^TY2026

The SIMPLE 401(k). a SIMPLE 401(k) meets the IRC § 401(k)(3)(A)(ii) nondiscrimination requirement if it satisfies the same contribution pattern — elective contributions up to the SIMPLE limit, a required match up to 3 percent or an elected 2 percent nonelective contribution, and the optional additional nonelective contribution — together with the exclusive plan requirement and the IRC § 408(p)(3) vesting requirement (IRC § 401(k)(11))^TY2026 It carries the same contribution pattern and the same immediate vesting, but it is a qualified plan, so it files a Form 5500 where the SIMPLE IRA files nothing.

For the self-employed person, compensation is the hard part. compensation for SIMPLE purposes means the amounts in IRC § 6051(a)(3) and (8), and for a self-employed person means net earnings from self-employment under IRC § 1402(a) determined without regard to the SIMPLE contribution itself; employee includes a self-employed individual within the meaning of IRC § 401(c)(1) (IRC § 408(p)(6))^TY2026 earned income for a self-employed participant means net earnings from self-employment under IRC § 1402(a), taken only from a trade or business in which the taxpayer’s personal services are a material income-producing factor, computed with regard to the IRC § 404 deduction itself and with regard to the IRC § 164(f) deduction for half of self-employment tax (IRC § 401(c)(2))^TY2026 contributions on behalf of a self-employed individual satisfy the IRC § 162 or § 212 conditions only to the extent they do not exceed that individual’s earned income, determined without regard to the IRC § 404 deduction, from the trade or business with respect to which the plan is established (IRC § 404(a)(8)(C))^TY2026 Earned income is computed after the plan contribution and after half the self-employment tax, which makes it circular — the contribution reduces the base on which the contribution is computed.

Current figures

How it works in practice

Decide first which plan the facts describe, because the two eligibility tests share no elements. A SEP question turns on age 21, three of the last five years, and a small compensation floor. A SIMPLE question turns on the statutory dollar floor in each of two preceding years and a reasonable expectation of the same this year, with no age test at all. Answering a SEP question with the SIMPLE test is the most common error in this area and it is easy to make because both plans feel like “the small employer plan.”

For the employer contribution, be precise about which of the two SIMPLE options is in play. The match is capped at the applicable percentage of compensation and is dollar for dollar within that cap, so an employee deferring less than the percentage gets less than the full amount and an employee deferring more gets no more (IRC § 408(p)(2)(A)(iii)). The nonelective contribution is a flat percentage of compensation paid regardless of the employee’s own deferral, including to employees who defer nothing. Substituting one calculation for the other produces a wrong number every time.

For a SEP maintained by a sole proprietor, do the circular computation properly rather than applying the deduction ceiling to gross self-employment income. Net earnings from self-employment are reduced by half the self-employment tax, and earned income for plan purposes is then reduced by the contribution itself. The practical effect is that the headline SEP percentage for an unincorporated owner works out to a smaller fraction of the pre-contribution figure.

Remember that a SIMPLE must be the employer’s only plan for the year. An employer that already has a 401(k), even a dormant one to which no contributions were made but under which benefits accrued, cannot maintain a SIMPLE for the same year. That single sentence disposes of a surprising number of “which plan should this client adopt” questions.

How this has changed

SECURE 2.0, Division T of Pub. L. 117-328, reworked the SIMPLE in three ways. It added IRC § 408(p)(2)(A)(iv), letting the employer make an additional uniform nonelective contribution capped both as a percentage of compensation and in dollars per employee, on top of the required match or the flat nonelective election. It added the IRC § 408(p)(2)(E)(i)(II) election under which a larger employer, as the statute defines one, may use higher deferral limits, with the applicable percentage for the match rising from three to four percent for that employer. And it raised the deferral and catch-up limits for smaller employers.

The same Act ended the rule that a SEP or SIMPLE could not accept Roth contributions. Designated Roth treatment is now available for both, which matters because the traditional analysis — deduct now, tax later — is no longer the only shape these plans take.

The compensation figures move annually: both the SEP participation threshold and the SIMPLE deferral limit rose for 2026, and both are set out in the figures above. The statutory dollar figures inside IRC § 408(p) — the eligible employer test, the participation test and the cap on the additional nonelective contribution — are not indexed and have not moved.

Exam focus

Know the two eligibility tests separately and precisely, and know that a SEP is employer-funded only. Expect a question that describes a part-time or seasonal employee and asks whether the employer may exclude them; the answer for a SEP is almost always no.

Know the SIMPLE employer options and how each is computed: a dollar-for-dollar match up to the applicable percentage, or the lower flat nonelective contribution to everyone eligible. Be able to run both calculations on the same facts.

Know that the SIMPLE must be the employer’s only plan for the year, that both SIMPLE forms vest immediately, and that the SIMPLE 401(k) files a Form 5500 while the SIMPLE IRA does not. For a self-employed owner, know that the contribution base is earned income after half the self-employment tax and after the contribution itself.

Check yourself

1. An employer’s SEP covers its three full-time staff. A part-time bookkeeper, aged 45, has worked ten hours a week for the last four years and earned $9,000 last year. Must the employer contribute for her?

Answer: Yes. IRC § 408(k)(2) sets no hours requirement. She is over 21, has performed service in at least three of the immediately preceding five years, and her compensation is far above the threshold. Part-time status is not one of the permitted exclusions, and omitting her would also breach the uniform relationship requirement of IRC § 408(k)(3)(C).

2. A SIMPLE IRA sponsor elects the 3 percent match. An employee earning $50,000 defers 5 percent. What goes into the account for the year?

Answer: $4,000. The employee’s own deferral is 5 percent of $50,000, or $2,500. The match is dollar for dollar on what she defers but stops at 3 percent of compensation, so $1,500. The match does not track the full 5 percent, and it is not reduced because she deferred more than the cap.

3. The same sponsor instead elects the 2 percent nonelective contribution. An employee earning $60,000 defers 1 percent. What goes into the account?

Answer: $1,800. The nonelective contribution is 2 percent of $60,000, or $1,200, paid regardless of what the employee defers, plus her own 1 percent deferral of $600. Note the contrast with the match: under the match this employee would have received only $600 of employer money.

4. An employer has maintained a profit-sharing plan for years, with contributions made for the current year. It now wants to add a SIMPLE IRA for a newly acquired division. May it?

Answer: No. IRC § 408(p)(2)(D) provides that an arrangement is not a qualified salary reduction arrangement for a year if the employer or a predecessor maintained a qualified plan under which contributions were made or benefits accrued for service in that year. The SIMPLE must be the employer’s only plan. The division would have to be brought into the existing plan, or the profit-sharing plan frozen for a full year first.

5. A sole proprietor with $80,000 of Schedule C profit and no employees is told her maximum SEP contribution is $20,000. Is that right?

Answer: No, it is too high. Twenty-five percent of $80,000 is $20,000, but earned income under IRC § 401(c)(2) is computed after the IRC § 164(f) deduction for half of self-employment tax and after the IRC § 404 contribution itself. Reducing the profit by roughly $5,652 of deductible self-employment tax gives about $74,348, and 20 percent of that — the equivalent of 25 percent of the post-contribution figure — is about $14,870.