How Much Can a SEP IRA Reduce My Taxes?

Want to lower your tax bill this year? A SEP IRA might be one of the best ways to do it. 

If you’re self-employed or a small business owner that earns enough net income, you can deduct up to $70,000 in 2025 (up from $69,000 in 2024) by maxing out your contributions. That’s a huge tax break and a powerful way to grow your retirement savings at the same time!

Are you self-employed or run a business with no employees? You may be eligible for a Solo 401k, which can have even more tax benefits than a SEP IRA and takes just a few clicks to set up. Learn more in our free Solo 401k Handbook.

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The Solo 401k Handbook

Everything you need to know in a handy ebook format.

How Retirement Plan Contributions Lower Your Taxes

Most retirement plans fall into one of two categories: Traditional or Roth. SEP IRAs work similarly in some ways but have key differences.

✅ Traditional retirement accounts (like a Traditional IRA) let you contribute pre-tax dollars—meaning you haven’t paid income taxes on that money yet. Your contributions lower your taxable income for the year, but when you withdraw funds in retirement, you’ll pay ordinary income tax on them.

❌ Roth retirement accounts don’t offer any tax deductions upfront. You contribute with after-tax money (income you’ve already paid taxes on), but the trade-off is that your withdrawals in retirement are completely tax-free.

SEP IRA Contributions Are Tax Deductible – Here’s How It Works

A SEP IRA gives you one of the biggest tax breaks available for retirement savings. Every dollar you contribute can lower your taxable income, which means you pay less in taxes that year.

✏️ Example: Let’s say you earn $50,000 and contribute $20,000 to your SEP IRA. Instead of paying taxes on the full $50,000, your taxable income drops to $30,000—which could save you thousands in taxes.

A SEP IRA has much higher contribution limits than a Traditional IRA or even a 401k.

✅ Traditional IRA: Max contribution of $7,000 ($8,000 if 50+) in 2024 and 2025
✅ 401k (through an employer): Max contribution of $23,000 ($30,500 if 50+) in 2024, and $23,500 ($31,000 if 50+) in 2025
✅ SEP IRA: Max contribution of $70,000 in 2025, up from $69,000 in 2024 (you can contribute up to 25% of your compensation, up to the annual limit)

If you max out your SEP IRA, you could reduce your taxable income by up to $70,000 in 2025 – a massive tax deduction. 

📝 Important Note: A SEP IRA only allows pre-tax contributions, just like a Traditional IRA or a 401k. There’s no Roth option, so while you get tax savings now, you’ll owe taxes when you withdraw in retirement.

Equal Percentage Contributions

If you have employees, a SEP IRA requires you to make equal percentage contributions for them as you do for yourself. 

✏️ Example: If you contribute 25% of your own income into your SEP IRA, you must also contribute 25% of each eligible employee’s compensation into their SEP IRAs. All contributions you make to your employees’ accounts are also tax deductible.

To qualify for SEP IRA contributions, an employee must:

✅ Be at least 21 years old

✅ Have worked for your business in at least 3 of the last 5 years

✅ Have earned at least $750 in 2024 and $750 in 2025

This rule applies whether you have one employee or many, so keep that in mind when planning contributions.

What If I’m an Employee?

If you’re an employee, you can’t contribute to a SEP IRA yourself. You can only receive contributions from your employer. That means you won’t get a tax deduction for SEP IRA contributions, since they don’t come out of your paycheck.

But you still have options to lower your taxable income:

✅ Contribute to a Traditional IRA – Even though the limits are lower ($7,000 in 2024, or $8,000 if you’re 50+), this can still reduce your taxable income.

✅ Open a Solo 401k (if you have a side hustle) – If you have self-employment income and no employees, a Solo 401k can allow you contribute up to $70,000 in 2025, giving you a much bigger tax deduction. You’ll only be able to contribute income earned from your side hustle and you’ll need to generate enough income to qualify to max out your Solo 401k. Income earned from your W2 employer will not be eligible for your Solo401k. 

📝 Important Note: If your employer offers a SEP IRA, make sure you understand how much they’re contributing on your behalf – this is essentially free retirement money!

How Much Should I Earn to Max Out My SEP IRA?

In 2025, Your SEP IRA contribution is capped at either 25% of your compensation or $70,000, or $69,000 for 2024 ($66,000 for 2023, $61,000 for 2022, $58,000 for 2021 and $57,000 for 2020).

So, to max out your contributions, you’ll need to earn a certain amount of pre-tax income each year.

Here’s how the math works:

✅ 2024 Contribution Limit: $69,000 – You’d need to earn around $345,000 pre-tax (25% of $345,000 = $69,000)

✅ 2025 Contribution Limit: $70,000 – You’d need to earn around $350,000 pre-tax (25% of $350,000 = $70,000)

If your income is below these amounts, you can still contribute 25% of your earnings, but you won’t hit the maximum limit.

📝 Quick Note: The 25% rule applies to business owners with employees too. So if you have staff, remember that any contributions you make for yourself must also be made for them at the same percentage.

How to Report Your SEP IRA Tax Deductions

When you contribute to a SEP IRA, you must report it to the IRS using the IRS Form 5498. This form is due by the federal tax filing deadline, which is typically April 15 each year. If the deadline falls on a weekend or holiday, it moves to the next business day.

You can also request a 6 month extension, giving you until October 15 to file. 

📝 Important: If you miss the deadline, your contributions won’t count for the current tax year. They’ll be applied to the following year’s tax return instead.

When Can I Withdraw Money from My SEP IRA?

You can start withdrawing from a SEP IRA without penalties once you turn 59½. If you take money out before that age, you’ll owe a 10% early withdrawal penalty on top of ordinary income taxes.

You’re not obligated to make withdrawals until you reach the age of 73, which is when the required minimum distributions (RMD) kick in. Once you turn 73, you’ll have to take distributions each year until your account is fully depleted.

Are withdrawals from a SEP IRA taxed?

Yes, all withdrawals from a SEP IRA are taxed as regular income since your contributions were made with pre-tax dollars.

Are There Retirement Plans with Bigger Tax Breaks Than a SEP IRA?

Yes, but only if you qualify for a Solo 401k and are 50 years of age or older. A Solo 401k has the same contribution limits as a SEP IRA, but also offers catch-up contributions for those who are at least 50 years old. This means you can put away even more money.

✅ 2024 Contribution Limit for 50+: $76,500 (includes a $7,500 catch-up contribution)

✅ 2025 Contribution Limit for 50+: $77,500 (includes a $7,500 catch-up contribution)

A Solo 401k also comes with a Roth option. In order to get the full tax deduction, you’ll need to make all your contributions to a Traditional Solo 401k, not the Roth Solo 401k.

If you’re 50 or older and qualify for a Solo 401k, you can get a tax deduction of up to $76,500 for 2024 and $77,500 for 2025, making this the largest possible tax deduction you can get from any retirement plan.

📌 Also read: SEP IRA vs Solo 401k