SEP vs. SIMPLE vs. Qualified Plans: How to Choose a Retirement Plan When You Have Employees

The day you hire your first employee, your retirement plan decision stops being only about you. A solo owner can pick whatever shelters the most income at the lowest hassle. An employer has to answer a harder question: which plan treats your team fairly, stays affordable in a lean year, and still gives you meaningful tax savings? Get it wrong and you either overpay in mandatory contributions during a downturn or discover at tax time that the generous contribution you planned for yourself has to go to everyone.

IRS Publication 560 — Retirement Plans for Small Business — lays out the three families of plans side by side: SEP plans, SIMPLE plans, and qualified plans such as 401(k)s and profit-sharing plans. This guide walks through what Publication 560 actually says about each, with 2026 contribution limits, so you can match the plan to your business.

The Three Families at a Glance​

Before the details, here is the shape of the choice:

• SEP (Simplified Employee Pension): employer-only contributions, no annual IRS filing, generous limits, but every eligible employee gets the same percentage of pay you give yourself.
• SIMPLE (Savings Incentive Match Plan for Employees): employees contribute from their paychecks and you must add either a match or a fixed contribution every year. Only for businesses with 100 or fewer employees.
• Qualified plans (401(k), profit-sharing, defined benefit): the highest ceilings and the most design flexibility — Roth options, vesting schedules, loans — in exchange for annual testing, Form 5500 filings, and real administrative cost.

Publication 560 covers all three because the IRS expects small employers to compare them, not to default to whichever one their payroll provider advertises first.

SEP Plans: Maximum Flexibility, One Big Catch​

A SEP is the simplest plan an employer can run. You set up a SEP IRA for yourself and each eligible employee, then contribute as the employer. There are no employee salary deferrals, no annual IRS filing for the employer, and you can vary the contribution from year to year — including skipping a year entirely when cash is tight.

SEP contribution limits for 2026​

Your contribution for each participant is limited to the lesser of:

• 25 percent of the employee's compensation (20 percent of net adjusted self-employment income if you are self-employed, because the contribution itself reduces the base), or
• 72,000 dollars, the defined-contribution limit for 2026.

Only the first 360,000 dollars of compensation counts toward the percentage. There are no catch-up contributions in a SEP — the 50-and-over extra allowance that 401(k) and SIMPLE plans offer does not exist here.

Who you must cover​

This is the catch. Under the most restrictive eligibility rules the IRS permits, you must cover every employee who is at least 21 years old, has worked for you in three of the last five years, and earned at least 800 dollars in 2026. You may adopt looser rules — covering brand-new hires, for example — but you cannot adopt stricter ones. Part-time and seasonal workers who meet the tests must be included.

And the contribution percentage must be uniform: if you put 20 percent of your own pay into your SEP IRA, you put 20 percent of every eligible employee's pay into theirs. Contributions vest immediately — the money is the employee's from day one.

That uniformity rule is what makes a SEP cheap for a solo owner and potentially expensive the moment you have staff. A 15 percent contribution on your own 200,000-dollar salary is 30,000 dollars for you — plus 15 percent of every eligible employee's salary on top.

SEP setup deadline​

A SEP can be set up and funded as late as your tax-filing deadline, including extensions. That makes it the only plan you can still adopt for 2026 in the spring of 2027, which is a genuine planning advantage: you decide the contribution after you know the year's final numbers.

SIMPLE Plans: Shared Funding With Mandatory Employer Money​

A SIMPLE plan splits the funding job. Employees contribute from their paychecks through salary reduction, and you as the employer must contribute every year — either a match or a fixed amount. In exchange, the plan is cheap to run and exempt from the nondiscrimination testing that qualified plans face.

Only employers with 100 or fewer employees who earned at least 5,000 dollars in the prior year may maintain a SIMPLE IRA plan, and you generally cannot maintain any other retirement plan at the same time.

SIMPLE contribution limits for 2026​

• Employees may contribute up to 17,000 dollars in salary reduction (18,100 dollars under the higher limit Congress added for employers with 25 or fewer employees).
• Participants age 50 or older may add a catch-up contribution of 4,000 dollars (3,850 dollars under one of the alternate SECURE 2.0 limits).
• Workers ages 60 through 63 may qualify for a higher "super catch-up" of up to 5,250 dollars.

The employer contribution you cannot skip​

Each year you must choose one of two formulas:

1. Dollar-for-dollar match of each employee's contribution, up to 3 percent of compensation. You may reduce the match as low as 1 percent in any two years out of five.
2. 2 percent nonelective contribution for every eligible employee, whether or not they contribute anything themselves. The 2 percent applies to compensation up to the 360,000-dollar annual limit for 2026.

Unlike a SEP, there is no zero year. Even in a loss year, the SIMPLE employer contribution is due. Like a SEP, employer money vests immediately.

SIMPLE deadlines and quirks worth knowing​

• New SIMPLE IRA plans must generally be established by October 1 to take effect that calendar year — plan ahead, because unlike a SEP you cannot create one at tax time.
• Each fall, before the 60-day election period that starts November 2, you must notify employees which employer contribution formula you will use for the coming year.
• Withdrawals within the first two years of participation face a 25 percent early-distribution penalty instead of the usual 10 percent — the steepest early-withdrawal penalty in the retirement system. Make sure employees understand this before they enroll.

Qualified Plans: 401(k)s, Profit-Sharing, and Beyond​

Qualified plans are the customizable end of the spectrum. A 401(k) lets employees defer salary, lets you match or share profits, and supports features the simpler plans cannot: Roth contributions, vesting schedules that reward tenure, and participant loans. A profit-sharing plan lets you vary employer contributions with profitability. A defined-benefit pension can shelter very large amounts for high-earning owners, at the cost of actuarial complexity and mandatory funding.

401(k) contribution limits for 2026​

• Employees may defer up to 24,500 dollars, plus an 8,000-dollar catch-up at age 50 or older (with a higher super catch-up of up to about 11,500 dollars for ages 60 through 63).
• Total contributions per participant — employee deferrals plus employer match, profit sharing, and forfeitures — are capped at 72,000 dollars (plus catch-ups).
• Compensation counted for plan purposes is capped at 360,000 dollars.

What you take on in exchange​

Qualified plans must pass annual nondiscrimination tests proving they do not disproportionately favor highly compensated employees — unless you adopt a safe-harbor 401(k) design with mandatory employer contributions that exempts you from most testing. You must also file Form 5500 every year and provide participant disclosures. Expect to pay a third-party administrator, typically a four-figure annual fee for a small plan, plus per-participant charges.

Congress softens that startup cost: employers with up to 50 employees can claim a tax credit covering up to 100 percent of plan startup costs, capped at 5,000 dollars per year for the first three years, plus an additional credit for employer contributions in some cases. If administration cost is the reason you are avoiding a 401(k), price the plan net of that credit before deciding.

Head-to-Head: Which Plan Fits Your Situation?​

Choose a SEP if your income is lumpy and your staff is small​

The SEP's killer feature is the optional contribution. A contractor with one part-time assistant, a consultant whose revenue swings 40 percent year to year, or an owner who wants to decide the contribution after year-end closing will not find a simpler vehicle. The price is uniformity: model the all-employees cost at your target percentage before committing, because the math that looks great solo can double once two or three employees qualify.

Choose a SIMPLE if you have steady payroll and want employees to fund most of it​

A SIMPLE suits the 5-to-30-person shop with predictable revenue — the dental practice, the agency, the retail store. Employees who want to save get a tax-advantaged paycheck deduction, and your required cost is bounded: at most a 3 percent match, or a flat 2 percent for everyone. The trade-off is rigidity. You owe that contribution in bad years too, and the 17,000-dollar employee limit is well below a 401(k)'s 24,500 dollars, so high-saving owners may feel constrained.

Choose a qualified plan if you want to maximize owner savings alongside employees​

Once the owner wants to shelter substantially more than a SIMPLE allows — or wants Roth treatment, vesting schedules, or loans — a 401(k), often with profit sharing layered on, is the answer. A safe-harbor 401(k) with a 3 percent nonelective contribution costs roughly what a SIMPLE costs in employer money while giving every participant access to the 24,500-dollar deferral limit and the 72,000-dollar total cap. The extra administration is real, but for a profitable business with employees it is usually the best after-tax deal of the three.

The hiring tripwire: revisit the decision when headcount changes​

Many owners set up a solo 401(k) or SEP while solo, then hire without revisiting the plan. Hiring your first eligible employee can disqualify a solo 401(k) design and can detonate SEP costs through the uniformity rule. Treat every hire that crosses an eligibility threshold as a trigger to re-run the comparison — ideally with your CPA before the plan year starts, not after.

Common Mistakes Publication 560 Is Trying to Prevent​

1. Forgetting part-time and seasonal workers in a SEP. If they meet the age, service, and pay tests, they are in. Excluding them is an operational failure the IRS can require you to correct with make-up contributions plus earnings.
2. Missing the SIMPLE October 1 setup deadline. A business formed late in the year has a short-plan-year exception, but an existing business that waits until December cannot start a SIMPLE for that year.
3. Skipping the annual SIMPLE employee notice. The pre-November-2 notice of next year's employer formula is mandatory, not a courtesy.
4. Contributing different SEP percentages to different employees. The rate must be uniform across all eligible participants, owner included.
5. Assuming a SEP allows catch-up contributions. It does not. Owners 50 and older who need the extra room should compare a 401(k) or SIMPLE instead.
6. Running a SIMPLE alongside another plan. With narrow exceptions, maintaining a second qualified plan in the same year disqualifies the SIMPLE.
7. Ignoring the two-year 25 percent SIMPLE withdrawal penalty. Employees who roll money out early get a nasty surprise; disclose it at enrollment.

Tracking Plan Contributions in Your Books​

Whichever plan you choose, employer contributions are a deductible business expense — but only if your books can prove what you paid, for whom, and for which plan year. SEP and profit-sharing contributions made after year-end for the prior year are a classic bookkeeping trap: the cash leaves in March, the deduction belongs to last year, and a cash-basis set of books will happily attach it to the wrong return.

Keep a simple schedule per plan year listing each participant, eligible compensation, the contribution rate, and the amount paid with its date. Reconcile that schedule to both your payroll records and your tax return before filing. If you run a 401(k), the Form 5500 asks for participant counts and contribution totals that should tie straight back to that schedule — discrepancies are exactly what triggers follow-up questions.

Keep Your Retirement Plan Books Audit-Ready​

Choosing between a SEP, a SIMPLE, and a qualified plan is only half the job; documenting the contributions year after year is the other half. Clear records of who was eligible, what rate applied, and when the money moved turn a potential IRS headache into a five-minute lookup. Beancount.io provides plain-text accounting that gives you complete transparency and control over your financial data — no black boxes, no vendor lock-in. Get started for free and see why developers and finance professionals are switching to plain-text accounting.