Your SEP and SIMPLE Questions Answered
By Ben Maas, CIS, CIP, CISP
We just lost a major client and our revenue is down. As the business owner, I’m worried about sustaining the employer per-payroll matching contribution to our SIMPLE IRA. I’ve heard that I can’t reduce or suspend the contribution mid-year. Is there any other way to help my business maintain positive cash flow?
You are correct: the SIMPLE IRA plan contribution method (matching or nonelective) cannot be changed mid-year. To change the contribution method or amount, an employer must amend its plan document as of the first day of the coming year. It also must notify its employees of the change at least 60 days before the start of the year by completing the participation notice and summary description.
But there is a way to give yourself a bit of breathing room. Even though you can’t change the contribution rate, the employer contribution itself (matching or nonelective) is not required until the business’s tax return due date, plus extensions.
Therefore, you can ease your financial burden in the short-term by waiting to make the required matching contributions until your business’s tax return due date, plus extensions. Be aware, however, that if an employee leaves employment during the year and closes the SIMPLE IRA to which contributions were being made, that you must still provide any employer contribution to which the employee is entitled, even if it means opening a SIMPLE IRA on his behalf to receive it.
One of our clients who is a self-employed Traditional IRA owner made a 2023 IRA contribution before discovering that it would be nondeductible because his wife is covered by a retirement plan at work and their joint modified adjusted gross income exceeds $228,000. Now he wants to establish a SEP plan and recharacterize his original Traditional IRA contribution as a SEP contribution for 2023. May he do this?
No. While SEP plan contributions are made to Traditional IRAs, a SEP plan contribution may not be made until the employer signs the SEP plan agreement. Although your client cannot recharacterize the contribution, he is allowed to remove the regular Traditional IRA contribution as an excess (along with the net income attributable). Once he has done so and has signed the SEP plan agreement, he can then use that money to fund a SEP contribution.
Do SEP and SIMPLE IRAs have the same contribution limit?
No. For 2023, the SEP plan contribution limit is the lesser of 25 percent of compensation, or $66,000. Remember, only employer contributions are used to fund a SEP plan. The SIMPLE IRA contribution limit is determined differently. The maximum deferral that a SIMPLE IRA owner who is under age 50 may make for 2023 is $15,500. The employer is allowed to make a dollar-for-dollar matching contribution of up to 3 percent of compensation. Because the match is dollar-for-dollar, the match amount can never exceed the deferral limit. So even if the SIMPLE IRA owner’s compensation is such that a 3% match would exceed the $15,500 deferral limit, the match would be capped at $15,500. As a result, the total amount that can be contributed to a SIMPLE IRA for 2023 is $31,000 if the SIMPLE IRA owner is under age 50. But if the SIMPLE IRA owner is 50 or older in 2023, she is allowed to make a $3,500 “catch-up” contribution, bringing the total contribution amount to $34,500. So a sole proprietor whose aim is maximizing her contribution may find a SEP plan more appealing than a SIMPLE IRA. But as her business grows and she starts hiring employees, she might decide to switch to a SIMPLE IRA, which allows for employee deferrals instead of solely relying on employer contributions. If higher contributions in a deferral type plan are desired, this business owner may eventually choose to transition from a SIMPLE IRA to a 401(k) plan.
