401k vs SEP IRA Key Rules and Differences

If you run a business, you may be deciding between setting up a SEP IRA or a 401k. Both are employer-sponsored retirement plans, but they serve slightly different purposes.

A SEP IRA is often used by business owners who want a straightforward way to save for retirement, though it can also be extended to employees. A 401k is more commonly chosen by employers who want to provide a structured retirement benefit for their workforce.

Each plan comes with its own rules for contributions, administration, and costs. For example, SEP IRAs are generally easier to manage because they typically don’t require an annual Form 5500 filing. However, the equal-percentage contribution rule can become more expensive as the number of employees increases.

We’ll discuss all the differences and key things to consider between the two accounts below.

How a SEP IRA works

A SEP IRA is designed for business owners, including self-employed individuals, who want to save for retirement through their business. Unlike Traditional or Roth IRAs that anyone can open, SEP IRAs are available only if you have business income.

Key Features of a SEP IRA

📝 Note: Employees cannot make their own contributions to a SEP IRA, unlike in a 401k.

The Equal Percentage Contribution Rule

If you have employees, SEP contributions must be made at the same percentage of compensation for each eligible worker.

✏️ Hypothetical Example: 

If you contribute 10% of your salary to your SEP IRA, you must also contribute 10% of every eligible employee’s salary to their accounts.

Pros and cons:

✅ Simple to administer
❌ Can become expensive with a larger workforce (e.g., 50 or 100 employees)

For this reason, SEP IRAs are often a better fit for businesses with no employees or only a few workers.

Employee Eligibility

To qualify for employer-funded contributions, an employee generally must:

What If You Have Zero Employees?

You may still open a SEP IRA and contribute up to the annual limit. However, if you have no employees, you may also qualify for a Solo 401k, which provides additional features such as direct account control and the ability to make employee deferrals.

How a 401k works

A 401k is typically established by businesses that want to provide a structured retirement benefit for employees. It is not required by the IRS, but many companies offer it to stay competitive when attracting and retaining talent.

Key Features of a 401k

📝 Note: A SEP IRA can also offer a Roth option under SECURE 2.0, but not every provider includes it.

Tax Advantages for Employees

This flexibility makes 401k plans generally more attractive to employees compared to SEP IRAs, since they can actively contribute toward their retirement savings.

Administrative Duties for Employers

A 401k requires more time and cost to manage compared to a SEP IRA. Employers must handle:

By comparison, SEP IRAs involve fewer ongoing administrative requirements and typically no annual tax filings.

401k Matching

Employers are not required to make contributions in a 401k, but many choose to offer matching contributions as an incentive.

✏️ Hypothetical Example: 

Dollar-for-dollar match up to 5% of compensation. If an employee earns $100,000 and contributes $10,000, the employer match would be $5,000.

Typical employer matches range from 3% to 6% of salary. Matching amounts may vest immediately or after a set schedule depending on plan terms.

📌 Also read: Companies With The Highest Employer Matches

Key Differences Between a 401k and SEP IRA

Here are the main differences between a SEP IRA and 401k.

Feature	SEP IRA	401k
Who Can Set Up Each Plan	Any business owner, including sole proprietors, partnerships, and corporations. Common for self-employed individuals. Must be set up by the business, not employees.	Created by employers to provide retirement benefits to employees. Solo 401k available for self-employed individuals with no staff.
Employee Eligibility Rules	Must include all eligible employees: at least age 21, worked 3 of the last 5 years, and earned at least $750 (2025). Employers cannot exclude eligible employees if they contribute.	Employers may set eligibility rules within IRS limits. Commonly requires age 21 and one year of service. Recent law changes expand access for long-term, part-time workers.
Investment Options	Broad investment choices, similar to Traditional or Roth IRAs: stocks, mutual funds, ETFs, bonds, etc.	Typically limited to an employer-selected menu, often mutual funds and similar investments.
Contribution Limits (2025)	Employer-funded only, up to 25% of compensation, capped at $70,000. No catch-up contributions for age 50+.	Combined employee + employer contributions capped at $70,000. Employees may defer $23,500, plus $7,500 catch-up if age 50+.
Contribution Types	Usually pre-tax employer contributions. Roth SEP option may be available if the employer adopts it.	Can include both Traditional (pre-tax) and Roth (after-tax) options. Employees may choose one or both if available.
Loans	Not permitted. SEP IRAs cannot offer loans.	May allow loans up to the lesser of $50,000 or 50% of vested balance. Must generally be repaid within 5 years (longer if for a primary residence).
Employer Match	Not applicable. Employees cannot make elective deferrals, so no match option.	Employer match is optional but common, often 3%–6% of salary. Matching rules vary by plan.
Equal Percentage Contributions	Required: employer must contribute the same % of compensation for all eligible employees.	Not required. Employer contributions are optional and flexible.
Withdrawal Rules	Withdrawals before age 59½ usually face income tax plus 10% penalty, unless exception applies. Employer-funded amounts are pre-tax unless Roth SEP feature is offered.	Similar rules. Traditional 401k withdrawals are taxable; Roth 401k withdrawals are tax-free if qualified.
Required Minimum Distributions (RMDs)	RMDs begin at age 73. Employer contributions are generally pre-tax.	Traditional 401ks require RMDs at age 73. Starting in 2024, Roth 401ks are no longer subject to lifetime RMDs for the owner.

Who Can Set Up Each Plan

A SEP IRA can be established by any business owner, including sole proprietors, partnerships, or corporations. It is especially common among self-employed individuals who want a straightforward way to contribute toward retirement. Employees cannot create their own SEP IRA through their employer; it must be set up by the business.

A 401k, on the other hand, is created by an employer to offer retirement benefits to employees. Even self-employed individuals without staff can open a Solo 401k, which follows the same rules but removes the employee-administration side. This makes the 401k a flexible option depending on the size and goals of the business.

Employee Eligibility Rules

With a SEP IRA, the IRS requires employers to cover all eligible employees. In general, this means employees who are at least 21 years old, have worked in three of the last five years, and earned at least $750 in compensation (2025 threshold). Employers cannot exclude eligible employees if they themselves contribute.

A 401k offers more flexibility in eligibility rules. Employers can set their own requirements within federal limits. For example, a common setup requires employees to be 21 or older and complete at least one year of service. Recent law changes also expand access for long-term, part-time workers, which is an important consideration for growing businesses.

Investment Options

A 401k plan typically offers a limited investment menu selected by the employer/plan fiduciary, compared with the broader options available in IRAs. Employees can only invest in whatever options are provided by their employer’s plan provider. The plan menu often consists of a curated lineup (commonly mutual funds and similar vehicles), which varies by employer.

A SEP IRA generally provides a much wider range of investment options. You can invest in individual stocks, mutual funds, ETFs, and bonds.

Contribution Limits

For 2025, both SEP IRAs and 401k plans share the same overall defined contribution limit of $70,000. The difference lies in how contributions are made and who can fund the account.

A 401k plan separates contributions into two parts: employee elective deferrals and employer contributions. Employees may defer up to $23,500 of their salary in 2025, plus an additional $7,500 if they are age 50 or older. Employer matching or profit-sharing contributions can be added on top, as long as the combined total does not exceed the $70,000 annual cap.

A SEP IRA is funded entirely by the employer. Employees cannot make their own contributions, though some providers now offer a Roth SEP option at the employer’s discretion. For 2025, employers may contribute up to 25% of eligible compensation, capped at $70,000. SEP IRAs do not include catch-up contributions for workers age 50 or older.

Contribution Types

A 401k plan generally comes in two versions: Traditional and Roth.

A SEP IRA is typically funded with pre-tax employer contributions. Some providers now allow a Roth SEP feature at the employer’s discretion, but if it isn’t offered, contributions remain pre-tax and withdrawals are taxed at retirement.

Loans

One key difference between the two plans is that a 401k can allow loans, while a SEP IRA cannot. With a 401k, participants may borrow from their account balance if the plan includes a loan feature. The maximum loan amount is the lesser of 50% of the vested account balance or $50,000. Repayment is generally required within five years, although a longer term may be available if the loan is used to purchase a primary residence. Plans must also apply a reasonable interest rate.

A SEP IRA does not permit loans under any circumstance. Business owners who want access to loan features may consider rolling their SEP IRA into a Solo 401k, which can include plan loans, Roth contribution options, and employee elective deferrals if structured that way.

Taking a 401k loan is not a taxable event as long as repayment terms are met. However, if the loan is not repaid on time, it may be treated as a distribution. In that case, the outstanding balance could become subject to income tax, and if the borrower is younger than 59½, a 10% early withdrawal penalty may also apply.

401k Match

A 401k plan may include an employer match, although it is not required. Many companies use matching contributions as a way to encourage employee participation and strengthen their benefits package. Under this setup, the employer contributes additional funds to an employee’s account, typically based on a percentage of the employee’s salary or contributions. For example, a company might match dollar-for-dollar up to 5% of compensation.

By contrast, a SEP IRA does not include matching contributions. Employees cannot make elective deferrals into a SEP IRA, so there is nothing for an employer to match. All contributions in a SEP IRA are funded solely by the employer, and the amounts must follow the equal-percentage contribution rule for eligible employees.

Equal Percentage Contributions

A SEP IRA requires equal percentage contributions for all eligible employees. This means if you decide to contribute 10% of your own compensation to your SEP IRA, you must also contribute 10% of each eligible employee’s compensation to their accounts. This rule can increase costs as your workforce grows, making the SEP IRA more practical for businesses with few or no employees.

A 401k plan does not follow this rule. Employees make their own contributions through elective deferrals, and employers may choose to add matching or non-elective contributions. However, employer contributions are optional and not tied to a required equal-percentage formula.

Withdrawal Rules

The withdrawal rules for 401k plans and SEP IRAs share many similarities, though certain exceptions and features can differ. In both cases, you must generally reach age 59½ before taking qualified withdrawals without penalties. Early withdrawals are typically subject to ordinary income tax plus a 10% early distribution penalty, unless an exception applies.

A SEP IRA is funded by employer contributions, which are usually made on a pre-tax basis. As a result, distributions from a Traditional SEP IRA are taxed as ordinary income. If the employer includes a Roth SEP feature, contributions are made with after-tax dollars, and qualified withdrawals follow Roth tax treatment, meaning they can be tax-free.

A 401k plan provides more flexibility in contribution types. Withdrawals from a Traditional 401k are taxed as ordinary income, while Roth 401k withdrawals are tax-free once qualified. This gives employees an opportunity to plan ahead based on whether they prefer upfront tax savings or future tax-free income.

Required Minimum Distributions (RMDs)

Both SEP IRAs and Traditional 401k plans are subject to required minimum distributions (RMDs). Under SECURE 2.0, RMDs must begin at age 73. Once you reach this age, you are required to withdraw a set amount from your account each year until the account is fully distributed. The exact withdrawal amount is based on IRS life expectancy tables.

Starting in 2024, Roth 401k accounts are no longer subject to lifetime RMDs for the original account owner. This change aligns Roth 401ks more closely with Roth IRAs, which have never had RMD requirements for the owner.

Among common retirement accounts, the Roth IRA remains unique because it does not require lifetime RMDs for the owner, allowing assets to potentially grow longer on a tax-advantaged basis.

Wrapping It Up

Both SEP IRAs and 401ks provide tax-advantaged ways to save for retirement, but they function differently. A SEP IRA is generally simpler and fully employer-funded, making it a common choice for self-employed individuals or small business owners. A 401k, on the other hand, can combine employee and employer contributions and may include features like Roth options or loan availability.

The right fit depends on your situation — whether you have employees, your income level, and how much flexibility you want with contributions. It may help to review your long-term goals, consider the costs of each plan, and compare contribution and withdrawal rules to see which plan aligns with your financial needs.

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