When it comes to saving for retirement as a small business owner, there are several options to consider: SEP IRAs, SIMPLE IRAs, and 401(k) plans. Each plan has its unique advantages and limitations, and understanding the differences can help you make the best choice for your business and employees.
SEP IRA (Simplified Employee Pension)
- Designed for: Self-employed individuals or small business owners who want flexibility.
- Contributions: Employer-only contributions; up to 25% of compensation or $70,000 for 2025. All employer contributions are a uniform % of compensation.
- Administration: Minimal paperwork, no annual IRS filings.
PROS:Flexible contributions; high contribution limits; easy setup. | CONS:Employees cannot contribute; employer must contribute for all eligible employees in an equal % of their compensation. More costly for employers due to required contributions and required payroll amount to maximize their own retirement benefit. |
SIMPLE IRA (Savings Incentive Match Plan for Employees)
- Designed for: Small businesses with 100 or fewer employees.
- Contributions: Employee salary deferrals plus mandatory employer contributions (either match or fixed 2% of compensation).
- Administration: Moderate; fewer requirements than a 401(k), but more than a SEP.
PROS:Simple to administer; employees can contribute; encourages employee participation. | CONS:Lower contribution limits ($16,500 employee deferral + $3,500 catch-up for 2025); mandatory employer contributions; fewer plan design options. |
401(k) Plan
- Designed for: Businesses of all sizes looking to provide a robust retirement benefit.
- Contributions: Employees can defer up to $23,500 in 2025, plus employer contributions up to a combined limit of $70,000; catch-up contributions of $7,500 for employees over 50. Much more flexibility on % of compensation required to contribute to employees.
- Administration: Slightly complex; requires annual filings, non-discrimination testing, and notices.
PROS:High contribution limits; flexible plan design (eligibility, vesting, profit sharing, matches, loans, contribution %); attracts and retains employees. The expectation in the hiring market today. | CONS:Higher administrative requirements; costlier to maintain. However, SECURE 2.0 tax credits can offset administrative fees and employer contributions. |
Key Comparison Table
Feature | SEP IRA | SIMPLE IRA | 401(k) |
| Employee Contributions | ❌ | ✔ | ✔ |
| Employer Contributions | ✔ Uniform % of compensation | ✔ (mandatory) 3% match or 2% non-elective | ✔ (optional/match) Differing % of compensation High flexibility and control Most optimal contribution amount |
| Max Contribution (2025) | 25% of compensation / $70,000 | $16,500 + $3,500 catch-up | $23,500 + $46,500 employer = $70,000; $7,500 catch-up |
| Catch-up Contributions | ❌ | ✔ ($3,500) | ✔ ($7,500) |
| Administration | Minimal | Minimal – Moderate | Moderate |
| Flexibility | Low | Low | High |
| Vesting (Non Safe Harbor) | 100% vested immediately | 100% vested immediately | Cliff Vesting (0%, 0%, 100%) 2-6 Year Graded (20% annually, 100% vested after 6 years) |
| Plan Design Options | Limited | Limited | Extensive |
| Employee Loans | ❌ | ❌ | ✔ |
| Opt-out Ability | ❌ | ✔ | ✔ |
Why a 401(k) is Often the Best Choice
While SEP and SIMPLE IRAs are easier to administer and ideal for very small businesses or self-employed individuals, 401(k) plans provide the highest flexibility, contribution limits, and benefits for both employers and employees. They also serve as a powerful tool for attracting and retaining top talent.
Case Study: Small Business Owner with 10 Employees
Imagine Jane, the owner of a 5-employee marketing agency. She wants to help her employees save for retirement while maximizing her own contributions. A SEP IRA would require her to contribute for all employees in the same % of compensation, limiting her flexibility. A SIMPLE IRA would restrict contribution amounts and still require mandatory employer contributions. A 401(k), however, allows Jane to contribute, better optimize the allocation of employer contributions, and introduce various features such as vesting, loans, and more. Assume that Jane makes $150,000 and is age 50, and employs 5 people with compensation ranging from $55,000 to $95,000. For purposes of this example, assume all the employees are age 40 and we run a simple Profit Sharing formula.
As you can see, the 401k plan allows Jane to contribute more into the plan and receive a higher % of the overall employer contributions. Although a 401k plan is “more expensive” than SEP or SIMPLE, the incremental administrative cost pales in comparison to the benefits of an optimized retirement plan. With a 401k, Jane gets to receive significantly more in contributions from the employer vs a SEP and SIMPLE and gets a larger % of the overall contribution. In addition, Jane can contribute much more out of her own paycheck into the plan! Lastly, Jane can feel safe knowing that she is offering the best type of retirement plan available in the marketplace today, which can lead to longer employee retention and ultimately a healthier business.
Conclusion:
For small business owners looking to optimize retirement benefits for themselves and their employees, a 401(k) plan is typically the superior option. While SEPs and SIMPLEs have their place, particularly for very small or part-time businesses, the flexibility, higher contribution limits, and robust plan features of 401(k)s make them the best long-term choice. Also, with a dedicated retirement plan administrator like The Pension Source and ample tax credits, the administrative hassle and out-of-pocket cost for starting a 401k plan has never been lower. Reach out if you’d like to learn more.
In a self-service, chatbot driven industry, we remain committed to offering a white-glove, people-first customer experience. If you or your clients want a tailored tax-advantaged retirement plan that is low-hassle, please reach out to The Pension Source.
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