IRS Publication 560: SEP, SIMPLE IRA, and 401(k) Plans

IRS Publication 560 is the agency’s guide to retirement plans for small businesses and self-employed people. It covers three plan families: Simplified Employee Pensions (SEPs), SIMPLE IRAs, and qualified plans such as 401(k)s, profit-sharing plans, and defined benefit pensions. For 2026, the annual additions limit for a defined contribution plan is $72,000, and the maximum annual benefit under a defined benefit plan is $290,000. The publication walks through how each plan works, who can participate, how much you can contribute and deduct, and what filings the plan triggers.

SEP Plans

A SEP is the simplest option in the publication. There’s no complex plan document to draft, and in most cases no annual government filing. You adopt a short written agreement, and the IRS offers a model, Form 5305-SEP, that many employers use to set the plan up in one sitting.¹

Only the employer contributes. Employees can’t defer salary into a SEP. For 2026, the maximum contribution per participant is the lesser of 25% of the employee’s compensation or $72,000.² Compensation counted for that calculation is capped at $360,000 per employee.³

When you do contribute, every eligible employee has to receive the same percentage of compensation. You cannot put 15% away for yourself and 5% for your staff. An eligible employee is someone who has reached age 21, worked for you in at least three of the last five years, and earned at least $800 during the year (the 2026 figure, adjusted for inflation).¹³

The real appeal of a SEP is flexibility. You can contribute generously in profitable years and skip contributions when cash is tight. You can also establish and fund a SEP for a tax year as late as the filing deadline for your business return, including extensions.⁴ That makes the SEP one of the few plans you can set up retroactively after the tax year closes.

SIMPLE IRA Plans

A SIMPLE IRA is built for businesses with 100 or fewer employees who each earned at least $5,000 in the prior year. That headcount includes full-time, part-time, seasonal, and leased workers.⁵ Unlike a SEP, a SIMPLE IRA lets employees defer part of their salary, and the employer must contribute every year regardless of profits.

An employer running a SIMPLE IRA generally can’t sponsor any other retirement plan at the same time. Narrow exceptions exist, such as when the other plan covers only collectively bargained employees or when a recent business acquisition triggers a transition.⁶

Employer Contribution Options

Each year, the employer picks one of two formulas:

A 2% non-elective contribution to every eligible employee’s compensation, regardless of whether the employee defers anything. Compensation counted is capped at the annual limit ($360,000 for 2026).
A dollar-for-dollar match on employee deferrals, up to 3% of the employee’s compensation. Only employees who actually defer get the match.

An employer using the matching formula can reduce the match to as low as 1% of compensation, but only for two out of any five-year period. Employees must be notified of the lower match before the annual election period begins.⁷ All contributions vest immediately, so employees own both their deferrals and the employer’s money from day one.

2026 SIMPLE IRA Deferral Limits

For 2026, an employee can defer up to $17,000 into a SIMPLE IRA. Employees 50 and older can add a $4,000 catch-up, bringing them to $21,000. Under SECURE 2.0, employees aged 60 through 63 qualify for an enhanced catch-up of $5,250, for a total of $22,250.⁸

Certain “applicable” SIMPLE plans where the employer makes enhanced contributions carry slightly higher deferral ceilings: $18,100 for the base limit, with an adjusted catch-up of $3,850 for participants 50 and older.⁸

The 25% Early Withdrawal Penalty

If an employee pulls money out of a SIMPLE IRA within the first two years of participation, the early withdrawal penalty jumps from the usual 10% to 25%. That’s among the steepest early withdrawal penalties in any retirement account, and it catches people off guard. After the two-year mark, the standard 10% penalty applies to withdrawals taken before age 59½.⁹

Qualified Plans: Profit-Sharing, 401(k), and Defined Benefit

Qualified plans give you the most design flexibility and the highest contribution ceilings, but they carry real administrative costs. You need a formal plan document, and most small businesses hire a third-party administrator to handle compliance testing and government filings. That typically runs $50 to $100 per participant per year for a small 401(k).

Profit-Sharing Plans

A profit-sharing plan lets the employer make discretionary contributions to employee accounts. The employer decides each year how much to contribute; amounts can vary year to year or be skipped entirely. Total annual additions to any one employee’s account across all defined contribution plans can’t exceed the lesser of 100% of compensation or $72,000 for 2026.³

401(k) Plans

A 401(k) is a type of profit-sharing plan that layers on employee salary deferrals. For 2026, employees can defer up to $24,500 of pay. Participants 50 and older can add another $8,000, for a total of $32,500. Under SECURE 2.0, participants aged 60 through 63 get a higher catch-up of $11,250, allowing them to defer up to $35,750.⁸

Standard 401(k) plans have to pass annual non-discrimination tests so the plan doesn’t favor highly compensated employees over everyone else. Failing forces corrective action, usually either refunding excess deferrals to higher-paid participants or making extra employer contributions for lower-paid ones. Many small businesses sidestep this by adopting a Safe Harbor 401(k), which automatically satisfies the testing requirements. Safe Harbor status requires the employer to make either a 3% non-elective contribution to every eligible employee or a matching contribution equal to 100% of the first 3% deferred plus 50% of the next 2%.¹⁰

Long-Term Part-Time Employee Eligibility

Starting with plan years beginning in 2026, 401(k) plans must let long-term part-time employees participate. Under SECURE 2.0, a part-time worker who completes at least 500 hours of service in two consecutive years must be given the opportunity to make salary deferrals. Hours worked in 2024 and 2025 count toward meeting that threshold for 2026 eligibility.¹¹ This is a meaningful change for small businesses that lean on part-time staff and previously excluded them.

Defined Benefit Plans

Defined benefit plans promise a specific monthly retirement benefit calculated from factors like years of service and compensation history. They’re the most complex qualified plan and require annual actuarial valuations to figure out how much the employer must contribute. Required contributions can swing dramatically year to year based on investment performance.

For 2026, the maximum annual benefit that can be paid from a defined benefit plan is $290,000.³ Employers with high incomes and a short window to save for retirement sometimes use these plans specifically because the required contributions can far exceed the $72,000 annual additions limit on defined contribution plans. The actuarial math works backward from the promised benefit, so the annual funding obligation grows as retirement approaches.

Deducting Contributions

The deduction is the reason most small businesses set these plans up. For defined contribution plans like SEPs, profit-sharing plans, and 401(k)s, the employer can deduct contributions up to 25% of the total compensation paid to all participating employees during the year.¹² Employee salary deferrals into a 401(k) don’t count against that 25% employer deduction limit.

Contributions must be made by the due date of the employer’s federal income tax return, including extensions. Miss that deadline and the deduction is lost for the prior tax year.

The Self-Employed Calculation

If you’re a sole proprietor or partner, figuring out your own contribution is more involved than calculating contributions for your employees. The math is circular: your deductible contribution depends on your net earnings, but your net earnings depend on the deduction you’re calculating.¹³

In practice you start with net profit from self-employment, subtract the deductible portion of self-employment tax, and then apply a reduced contribution rate rather than the plan’s stated rate. A plan that allows 25% for employees effectively allows only about 20% of your adjusted net earnings for your own contribution. Publication 560 includes a worksheet that walks through the reduction step by step.¹⁴ The reduced rate applies only to your own contribution. Contributions for common-law employees still use the full 25% rate against their compensation.

Excess Contributions and the 10% Excise Tax

Contributing more than the deductible limit triggers a 10% excise tax on the nondeductible amount. It applies to SEPs, SIMPLE IRAs, and all qualified plans.¹⁵ The tax is reported on Form 5330 and applies each year the excess stays in the plan. Watch this closely in years where compensation or profits change sharply, because last year’s contribution level might exceed this year’s deduction limit.

Tax Credits for Starting a Plan

A small business that sets up a new retirement plan can claim a credit that offsets a substantial portion of the startup costs. The credit under IRC Section 45E is available for the first three years and directly reduces tax liability rather than just lowering taxable income. How much you get depends on headcount:

Businesses with 50 or fewer employees can claim 100% of eligible startup costs, up to the greater of $500 or $250 times the number of non-highly compensated employees eligible to participate, capped at $5,000.
Businesses with 51 to 100 employees can claim 50% of eligible startup costs, with the same dollar limits.

Eligible startup costs cover setting up the plan, administering it, and educating employees about it.¹⁶

SECURE 2.0 added a separate credit tied to what the employer actually contributes. For businesses with 50 or fewer employees, the credit equals a percentage of employer contributions up to $1,000 per employee earning $100,000 or less. It starts at 100% in the first two plan years and phases down: 75% in year three, 50% in year four, and 25% in year five. Businesses with 51 to 100 employees get a reduced version. Together, these credits can substantially cut the net cost of employer contributions in a plan’s early years.

Annual Reporting: Form 5500

Most SEP and SIMPLE IRA plans are exempt from annual government filings, which is one of the strongest arguments for choosing them. Qualified plans, including 401(k)s and defined benefit plans, must file Form 5500 each year with the Department of Labor and the IRS. The form reports the plan’s financial condition, investments, and operations.¹⁷

Which version you file depends on how many participants you have and how the plan is structured:

Large plans with 100 or more participants with account balances file the full Form 5500 and need an independent audit by a qualified public accountant. Plans between 80 and 120 participants may continue filing as a small plan under the 80-120 rule if they filed that way the previous year.
Small plans with under 100 participants may file the simplified Form 5500-SF, which doesn’t require an audit.
One-participant plans covering the owner (and spouse) are exempt from filing entirely if total plan assets across all one-participant plans maintained by the employer are $250,000 or less. Once assets cross that threshold, the plan must file Form 5500-EZ.¹⁸

Penalties for missing a Form 5500 are steep. The IRS penalty is $250 per day, capped at $150,000 per return. The DOL penalty can reach $2,529 per day with no cap.¹⁹ A forgotten filing can quietly accumulate tens of thousands of dollars in penalties before anyone notices. Plan administrators also have to provide required notices to participants about plan features and funding status, with separate penalties for lapses there.

Fixing Plan Errors Through EPCRS

Mistakes are common, and the IRS has a formal system for correcting them. The Employee Plans Compliance Resolution System (EPCRS) provides three paths depending on the type and severity of the error.

Many operational failures can be self-corrected without filing anything with the IRS or paying a fee. Eligible problems include accidentally excluding an employee who should have been in the plan, failing to make promised contributions, and loan administration errors. The key condition is that the sponsor must have been following established compliance procedures when the mistake happened. A plan document sitting in a drawer doesn’t count as procedures in place.²⁰

Whether a failure qualifies as “insignificant” (correctable at any time) or “significant” (correctable only within a set timeframe) depends on several factors: the percentage of plan assets involved, the number of affected participants relative to total participants, how long the error continued, and whether correction began promptly after discovery. No single factor decides the outcome.²⁰

Document failures, like running a plan on outdated documents or missing a required amendment deadline, cannot be self-corrected. Those go through the IRS Voluntary Correction Program, which involves an application and potentially a fee. Catching errors early and fixing them through EPCRS is far cheaper than waiting for an audit to find them.

Prohibited Transactions

Federal law strictly limits dealings between a retirement plan and the people connected to it. A prohibited transaction happens when plan assets are used to benefit the account holder, a fiduciary, certain family members, or businesses owned by those individuals. Common examples: selling property from the plan to a family member, leasing plan-held real estate to yourself, or using plan investments to generate personal commissions.

The tax consequences are severe. The IRS imposes an initial excise tax of 15% of the amount involved for each year the transaction remains uncorrected. If it’s not unwound within the taxable period, an additional tax of 100% of the amount involved applies.²¹ The disqualified person who participated pays the tax, not the plan itself. In self-directed plans like solo 401(k)s, the account holder and the disqualified person are often the same individual, so both penalties fall on one person.

These rules trip people up most often with self-directed accounts. If you have a solo 401(k) that holds real estate, you can’t live in the property, manage renovations yourself, or hire your children to perform maintenance. The line between a legitimate plan investment and self-dealing is where most compliance failures happen.

1
Internal Revenue Service. Simplified Employee Pension Plan (SEP)
2
Internal Revenue Service. SEP Contribution Limits (Including Grandfathered SARSEPs)
3
Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs
4
Internal Revenue Service. Retirement Plans FAQs Regarding Simplified Employee Pensions
5
Internal Revenue Service. SIMPLE IRA Plan Fix-It Guide – You Have More Than 100 Employees Who Earned $5,000 or More in Compensation for the Prior Year
6
Internal Revenue Service. Retirement Plans FAQs Regarding SIMPLE IRA Plans
7
Internal Revenue Service. Retirement Topics – SIMPLE IRA Contribution Limits
8
Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500
9
Internal Revenue Service. SIMPLE IRA Withdrawal and Transfer Rules
10
Internal Revenue Service. Compensation Definition in Safe Harbor 401(k) Plans
11
Internal Revenue Service. Additional Guidance with Respect to Long-Term, Part-Time Employees
12
Office of the Law Revision Counsel. 26 USC 404 – Deduction for Contributions of an Employer to an Employees Trust or Annuity Plan and Compensation Under a Deferred-Payment Plan
13
Internal Revenue Service. Self-Employed Individuals – Calculating Your Own Retirement Plan Contribution and Deduction
14
Internal Revenue Service. IRS Publication 560 – Retirement Plans for Small Business
15
Office of the Law Revision Counsel. 26 USC 4972 – Tax on Nondeductible Contributions
16
Internal Revenue Service. Retirement Plans Startup Costs Tax Credit
17
U.S. Department of Labor. Form 5500 Series
18
Internal Revenue Service. Instructions for Form 5500-EZ
19
Internal Revenue Service. 401(k) Plan Fix-It Guide – You Haven’t Filed a Form 5500 This Year
20
Internal Revenue Service. Retirement Plan Errors Eligible for Self-Correction
21
Office of the Law Revision Counsel. 26 USC 4975 – Tax on Prohibited Transactions