What Is A SEP IRA? (How It Works, Rules, Eligibility)

Saving for retirement can be challenging when you run your own business or work for yourself. Without access to a traditional employer-sponsored plan, finding a tax-efficient way to build long-term savings becomes even more important.

That is where a SEP IRA can help. Designed for self-employed individuals and small business owners, a SEP IRA offers higher contribution limits than a Traditional or Roth IRA and flexible rules for annual contributions.

Below is a closer look at how a SEP IRA works, who qualifies, and the key rules to know before you start contributing.

What is a SEP IRA?

A Simplified Employee Pension (SEP) IRA is a retirement plan designed for self-employed individuals and small business owners. It works like a Traditional IRA but allows much higher contribution limits, giving business owners the opportunity to save a larger percentage of their income for retirement.

Employers can contribute to their own SEP IRA and to the accounts of eligible employees. Unlike other retirement plans, employees do not make contributions to a SEP IRA. All contributions come from the employer.

Standard SEP contributions are made with pre-tax dollars and are tax-deductible for the employer. The funds grow tax-deferred until withdrawn, and distributions are taxed as ordinary income in retirement. 

A SEP IRA is also known for its simplicity. It is easy to open through most financial institutions and requires little administrative work compared with other employer plans such as a 401k. Employers can decide how much to contribute each year or skip a contribution entirely if the business has a down year.

📝 Note: A SEP IRA does not require annual IRS filings for most employers, which makes it a cost-effective and low-maintenance option for small businesses that want to offer a retirement benefit without complex plan administration.

Basic Rules of a SEP IRA

✅ Who can open one: Business owners and self-employed individuals can establish and contribute to a SEP IRA.

✅ Eligible business types: All business structures qualify, including sole proprietorships, partnerships, and corporations.

✅ Employees allowed: Unlike a Solo 401k, a SEP IRA can include full-time W-2 employees.

✅ Tax advantages: Employer contributions are tax-deductible. Earnings in the account grow tax-deferred until withdrawn in retirement.

✅ Employer-only contributions: Employees cannot contribute directly to a SEP IRA. Only the employer makes contributions.

✅ Equal contributions rule: Employers must contribute the same percentage of compensation to each eligible employee’s account. For example, if you contribute 10% of your own pay, every eligible employee must receive 10% of theirs.

✅ Employee eligibility: An employee qualifies if they are at least 21 years old, have worked for the business in three of the past five years, and earned at least $750 in 2025.

✅ Immediate vesting: All contributions belong fully to the employee once deposited.

✅ Account control: Employees have complete ownership and control of their SEP IRA, including how the funds are invested.

✅ Withdrawals: You can take qualified distributions starting at age 59½. Withdrawals are taxed as ordinary income. Early withdrawals before that age typically incur a 10% penalty plus income tax.

✅ Required minimum distributions (RMDs): Withdrawals must begin each year starting at age 73.

📝 Note: The equal-contribution rule is one of the most important aspects of a SEP IRA. It ensures fairness among employees but also means employers should plan contributions carefully each year.

Who Is Eligible for a SEP IRA?

A SEP IRA is designed to be flexible. Business owners of any size can open and contribute to one. It is also available to individuals who earn income through self-employment, freelance work, or contract services.

You are generally eligible for a SEP IRA if you meet any of the following conditions:

✅ You are self-employed. This includes freelancers, consultants, and independent contractors.
✅ You own a business. Both incorporated and unincorporated business owners qualify.
✅ You employ others. You can have one employee or many and still be eligible.
✅ You earn freelance income. Even without formal business registration, income reported on a Schedule C can make you eligible.

You can have no employees or employ hundreds and still qualify for a SEP IRA. However, because SEP rules require equal percentage contributions for all eligible employees, the plan tends to work best for business owners with few or no employees.

Do I need to be incorporated?

No. You do not have to be incorporated to open a SEP IRA. Sole proprietors, partnerships, LLCs, and corporations can all set up and contribute to a SEP IRA. The structure of your business does not limit eligibility. It only affects how contributions are calculated for tax purposes.

📝 Note: A SEP IRA can be an excellent fit for self-employed professionals who want a straightforward way to save for retirement without the administrative burden of more complex plans like a 401k.

How Does a SEP IRA Work?

A SEP IRA is funded entirely by employer contributions. Employees do not make elective salary deferrals, which makes the plan straightforward to manage and easy to maintain year after year.

✅ Employer-funded plan: Only the employer contributes to a SEP IRA. These contributions are tax-deductible for the business if made pre-tax. If the plan provider offers Roth SEP contributions, those amounts are made with after-tax dollars and are not deductible.

✅ Equal percentage contributions: One of the most important rules of a SEP IRA is that the employer must make equal percentage contributions for every eligible employee, including themselves. For example, if you choose to contribute 25% of your own compensation, you must contribute 25% of each eligible employee’s pay as well. This ensures fairness across all participants in the plan.

Who Qualifies as an Eligible Employee

An employee is considered eligible if they meet all of the following requirements:

If any employee meets these conditions, you are required to include them in your SEP contributions at the same percentage you contribute for yourself. Once contributions are deposited, they are immediately 100% vested, meaning employees fully own their SEP IRA funds right away. They also have complete control over how their accounts are invested.

Because of the equal-percentage rule, SEP IRAs can become expensive for businesses with many employees. The plan is typically best suited for self-employed individuals or small business owners with few or no employees.

📝 Note: If you have no employees, a Solo 401k may be a better fit. It can allow both employer and employee contributions, plus features like Roth salary deferrals and participant loans, depending on the provider.

Pros and Cons of a SEP IRA

Benefits of a SEP IRA:

✅ Simple setup and administration. A SEP IRA is easy to establish and maintain. It requires minimal paperwork and no annual IRS filings for most employers.

✅ Cost-effective for small businesses. It is one of the most affordable ways to offer a retirement benefit to employees, especially compared to a traditional 401k.

✅ Tax-deductible contributions. Employer contributions made on a pre-tax basis are deductible for the business. Earnings grow tax-deferred until withdrawn in retirement.

✅ High contribution limits. For 2025, contributions can reach up to $70,000, often more than 10× the limit of a Traditional IRA. The amount depends on compensation and the 25% contribution cap.

✅ Flexible contribution schedule. Employers are not required to contribute every year. You can change contribution amounts (or skip them entirely) depending on your business’s financial performance.

✅ Immediate vesting for employees. All contributions made to an employee’s SEP IRA are immediately 100% vested. Employees cannot contribute directly but still fully own and control their individual accounts.

Disadvantages of a SEP IRA:

❌ Equal contribution requirement. You must contribute the same percentage of compensation for all eligible employees, including yourself. This rule can make the plan costly if you have many employees.

❌ Limited Roth availability. Although SECURE 2.0 permits Roth SEP contributions, not all providers support them yet.

❌ No catch-up contributions. Unlike a Solo 401k or Traditional IRA, SEP IRAs do not allow additional contributions for participants aged 50 or older.

SEP IRA Contribution Limits

A SEP IRA allows higher contributions than a Traditional or Roth IRA, making it one of the most flexible options for business owners who want to save more as their income grows.

✅ Contribution maximums: For 2025, employers can contribute up to 25% of compensation, capped at $70,000. The maximum amount of compensation that can be used to calculate this 25% is $350,000.

✅ Employer-only contributions: Only employers can contribute to a SEP IRA. Employees cannot make elective contributions. Pre-tax contributions are tax-deductible for the business, while Roth SEP contributions (if offered) are after-tax and included in the employee’s income.

✅ Tax treatment: Contributions grow tax-deferred until retirement. Withdrawals are taxed as ordinary income once distributions begin. There are no catch-up contributions for those aged 50 or older under current SEP IRA rules.

Does a SEP IRA Allow Roth Contributions?

Yes, but only if your plan provider supports them. Under SECURE 2.0, employers may permit Roth SEP contributions, sometimes called a “Roth SEP.” These are made with after-tax dollars and are not deductible, but qualified withdrawals can be tax-free.

If you have no full time employees, you can opt to open a Solo 401k instead. This plan typically includes Roth and pre-tax contribution options and may allow participant loans, depending on plan terms.

Are Contributions Required Every Year?

No. Contributions to a SEP IRA are completely discretionary. Employers can decide how much to contribute each year or skip contributions altogether if business income is lower. This flexibility makes the SEP IRA an appealing choice for business owners with variable income.

📝 Note: Even though contributions are optional, they must always be made uniformly across all eligible employees using the same percentage of compensation rule.

SEP IRA Contribution Deadline

A SEP IRA offers generous flexibility not only in contribution amounts but also in timing. Contributions can be made up until your business’s tax filing deadline, including extensions.

Standard deadlines: For calendar-year businesses, contributions are generally due by the tax return due date:

With extensions: If you file a timely tax extension, the contribution deadline is extended to the extended filing date. This is typically October 15 for calendar-year sole proprietors and C corporations, and September 15 for S corporations and partnerships.

For the 2025 tax year, calendar-year filers without an extension generally have until April 15, 2026, to make their SEP IRA contributions.

📝 Note: Contributions are only deductible for the tax year in which they are made, so ensure deposits are finalized before the filing deadline or extended due date.

When Can You Withdraw?

The withdrawal rules for a SEP IRA are the same as a Traditional IRA. You can begin taking qualified distributions once you reach age 59½. Any withdrawals made before this age are subject to ordinary income tax and a 10% early withdrawal penalty, unless an IRS exception applies.

Required Minimum Distributions (RMDs)

A SEP IRA is also subject to required minimum distributions (RMDs). You must begin taking withdrawals each year once you turn 73 years old.

Failing to take an RMD may trigger an excise tax of 25% of the amount not withdrawn. However, this penalty can be reduced to 10% if the missed distribution is corrected promptly within the IRS correction window.

What Can I Invest In With a SEP IRA?

Your investment options in a SEP IRA depend on the financial institution or plan provider you choose. In most cases, investments work the same way as with a Traditional or Roth IRA, offering a familiar range of choices.

✅ Common investment options: Most SEP IRAs allow you to invest in stocks, bonds, mutual funds, and exchange-traded funds (ETFs). These options make it easy to build a diversified portfolio tailored to your retirement goals and risk tolerance.

✅ Provider limitations: The exact selection of investments depends on your provider’s platform. Some financial institutions offer broad access to markets, while others may have limited fund choices or brokerage features.

✅ Self-directed SEP IRAs: You can also open a self-directed SEP IRA, which expands your investment choices beyond traditional securities. With this type of account, plan participants can invest in alternative assets such as real estate, private equity, precious metals, or cryptocurrencies.

📝 Note: While self-directed accounts offer more flexibility, they also come with greater complexity and risk. Alternative investments may require additional due diligence and can trigger unique tax reporting requirements, so it is best to work with a qualified financial or tax professional before pursuing them.

SEP IRA vs Solo 401k

A SEP IRA and a Solo 401k are both strong retirement plan options for self-employed individuals, but they differ in flexibility, contribution methods, and eligibility.

Benefits of a Solo 401k:

A Solo 401k offers several features that a SEP IRA does not. It allows Roth salary deferrals, age-50 catch-up contributions, and participant loans (up to the lesser of $50,000 or 50% of the vested account balance, if the plan allows loans). These features give Solo 401k participants more control and flexibility in managing contributions and withdrawals.

Contribution comparison:

Both plans share a similar maximum contribution limit, but the Solo 401k can reach that limit with less income because it combines both employer and employee contributions. A SEP IRA, by contrast, only allows employer contributions, which are capped at 25% of compensation.

Employee restrictions:

The Solo 401k is limited to business owners with no full-time employees, other than a spouse. Once your business hires employees who work more than 1,000 hours per year, the Solo 401k is no longer an option. At that point, a SEP IRA becomes the more practical choice for ongoing retirement contributions.

SEP IRA vs Traditional IRA

A Traditional IRA and a SEP IRA share many similarities in tax treatment, investment options, and withdrawal rules. Both allow tax-deferred growth, and pre-tax contributions are deductible. If Roth contributions are offered in a SEP IRA, those are after-tax and not deductible.

Contribution limits:

Eligibility:

A Traditional IRA can be opened by anyone with earned income, regardless of employment type. A SEP IRA, however, is available only to business owners or self-employed individuals.

Income source:

If you earn income solely as an employee, you can contribute to a Traditional IRA. If you earn business or self-employment income, you may open and contribute to a SEP IRA.

📝 Note: Both SEP and Traditional IRAs follow the same withdrawal and RMD rules. Qualified distributions begin at age 59½, and required minimum distributions start at age 73.

How to Open a SEP IRA

You can open a SEP IRA with most banks and brokerages that offer IRAs.

Step 1: Choose your account provider.

Select a financial institution or brokerage that offers SEP IRAs. Consider factors such as investment choices, account fees, customer service, and whether the provider supports Roth SEP contributions if you want that option.

Step 2: Create a formal written agreement.

Establish your plan using a written agreement that defines participation rules and contribution terms. Your provider may supply this form, or you can use IRS Form 5305-SEP to set up the plan directly.

Step 3: Inform all eligible employees.

You must notify every eligible employee about the SEP IRA plan. Provide them with a copy of Form 5305-SEP or any equivalent documents your provider offers that describe the plan’s features and contribution rules.

Step 4: Set up individual SEP IRAs.

Open a separate SEP IRA account for each eligible employee through your chosen provider. The employer will make contributions directly into these accounts based on the same percentage of compensation rule.

Step 5: Fund the plan.

Decide how much to contribute for the year (up to the allowable limit) and deposit the contributions before your tax filing deadline.

📌 Also read: Retirement Plan Options For Business Owners

Can You Have a SEP IRA and a Traditional IRA?

Yes — you can have both a SEP IRA and a Traditional IRA at the same time. The two accounts are treated separately, and contributions to one do not reduce or limit contributions to the other.

If you are a business owner, the contributions you make to your SEP IRA as an employer do not affect how much you can contribute to your own Traditional IRA. You can contribute the full amount to each plan, as long as you meet the income and eligibility requirements.

If you are an employee, your employer’s SEP contributions also do not count toward your personal Traditional IRA limit. You can still make your own IRA contributions for the year.

However, your ability to deduct Traditional IRA contributions may be limited if your income exceeds the IRS thresholds for your filing status. The deduction phase-out ranges depend on whether you or your spouse are covered by a workplace retirement plan.

Can You Have a SEP IRA and a Roth IRA?

Yes, you can have both. The two accounts are separate, and each follows its own set of contribution and tax rules.

If your SEP plan provider permits it, you may also make Roth SEP contributions under the SECURE 2.0 provisions. These contributions are made with after-tax dollars and are not deductible, but qualified withdrawals in retirement can be tax-free.

Your Roth IRA contributions remain distinct and are still subject to the IRS’s income-based eligibility limits. Even if you contribute to a SEP IRA through your business, you can continue to fund a Roth IRA as long as your income falls within the annual threshold.

Wrapping It Up

A SEP IRA is a simple and flexible way for business owners and self-employed individuals to build retirement savings. It combines high contribution limits with straightforward setup and minimal paperwork.

The plan fits best for small businesses or solo earners who want a tax-advantaged option without the complexity of a 401k. Those with employees should plan contributions carefully since each eligible worker must receive the same percentage.

A SEP IRA can work alongside other accounts, such as a Traditional or Roth IRA, to create a balanced mix of tax-deferred and tax-free savings. Make sure to review the current IRS rules and deadlines before contributing so your plan stays compliant and effective over time.

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