A SEP IRA is a tax-advantaged retirement plan tailored for business owners and self-employed individuals that offers higher contribution limits than standard IRAs.
SEP stands for Simplified Employee Pension, a retirement solution that functions similarly to a traditional IRA but with enhanced features for businesses. Only employers can contribute to these accounts, including business owners who contribute to their accounts as an employer-to-employee. These plans maintain low administrative costs and require minimal paperwork, making them accessible options for businesses of various sizes.
For 2024, employers can contribute up to 25% of an employee’s compensation with a maximum of $69,000—in 2025, this limit increases to $70,000. Contributions are tax-deductible for the business, providing immediate tax benefits. The funds in SEP IRAs grow tax-deferred until retirement, when distributions are taxed as ordinary income.
Business owners must contribute the same percentage of compensation for all eligible employees as they do for themselves. Employees qualify for a SEP IRA when they are at least 21 years old, have worked for the company for three of the past five years, and have earned at least $750 during the year. The consistent contribution requirement ensures equitable treatment across the organization.
SEP IRAs offer significant flexibility for businesses experiencing fluctuating revenues. Employers can adjust contribution amounts annually or even skip contributions during challenging financial years without penalty. Let’s further explore the ins and outs of SEP IRAs.
How an SEP IRA works
A SEP IRA operates through employer-funded contributions, where businesses allocate a uniform percentage of each eligible employee’s compensation. These contributions are made pre-tax, directly reducing the employer’s taxable income while deferring taxes on the funds until employees withdraw them during retirement. For example, if a business contributes 15% of an owner’s $200,000 salary ($30,000), it must also contribute 15% of every eligible employee’s earnings.
Contributions are immediately vested, granting employees full ownership of all funds deposited into their accounts from day one. This contrasts with retirement plans that impose multi-year vesting schedules, ensuring workers retain contributions even if they leave the company. Employers face no annual filing obligations with the IRS, streamlining administration compared to 401(k) or pension plans.
Setting up a SEP IRA requires minimal paperwork: employers establish a written agreement, notify eligible staff, and open individual accounts. Contributions can be adjusted yearly or skipped entirely based on business performance, offering flexibility during fluctuating revenue cycles. This simplicity, combined with high contribution limits and tax efficiency, makes SEP IRAs particularly advantageous for small businesses and self-employed professionals seeking scalable retirement solutions.
Who is eligible for an SEP IRA?
SEP IRAs cater primarily to self-employed professionals, freelancers, and small business owners, whether they operate independently or employ staff. Businesses of all sizes—from sole proprietorships to corporations—can establish these plans, though they are most practical for organizations with fewer employees due to uniform contribution requirements.
Employer eligibility
Any U.S.-based entity, including sole proprietors, partnerships, LLCs, and corporations, qualifies to create an SEP IRA. There are no restrictions on industry or revenue, making the plan accessible to startups, seasonal businesses, and established enterprises. While SEP IRAs are structured under U.S. tax law, multinational companies with American operations may also utilize them for eligible U.S.-based employees’ benefits.
Employee eligibility
Employees must meet three criteria to participate:
- Age. At least 21 years old.
- Tenure. Employed for three of the preceding five years.
- Earnings. Received a minimum of $750 in annual compensation from the employer.
Employers may adopt less restrictive rules—such as lowering the age threshold or reducing the service period—but cannot impose stricter requirements. For example, a business could allow 19-year-old employees to participate, but cannot raise the minimum age to 25.
Exclusions
Certain employees can be excluded, including those covered by collective bargaining agreements with retirement benefits negotiated by a union and nonresident aliens lacking U.S.-sourced income. Additionally, employers are not obligated to include workers who fail to meet the eligibility criteria, such as part-time staff earning below the compensation threshold.
Flexibility for variable incomes
Freelancers and businesses with fluctuating revenue benefit from SEP IRAs, as contributions can vary annually or be paused entirely without penalties. This adaptability makes the plan particularly viable for gig economy workers, consultants, and seasonal enterprises seeking tax-advantaged retirement solutions.
SEP IRA contribution limits
In 2025, SEP IRA contributions are limited to 25% of an employee’s compensation or $70,000, whichever is lower, with compensation calculations capped at $350,000 annually. Employers—not employees—fund these accounts, and contributions remain tax-deductible for the business, reducing taxable income while deferring taxes on growth until withdrawal.
For example, a self-employed individual earning $280,000 could contribute up to $70,000 (25% of $280,000), while an employee earning $400,000 would have contributions calculated on the $350,000 cap, resulting in a maximum $87,500 contribution that is nonetheless limited to $70,000.
Unlike traditional IRAs, which restrict 2025 contributions to $7,000 ($8,000 for those aged 50+), SEP IRAs enable substantially higher savings. Employers must apply the same contribution percentage across all eligible staff, including owners, but retain flexibility to adjust or skip contributions annually based on business performance without penalties. This structure balances high savings potential with operational adaptability for small businesses.
Pros and cons of a SEP IRA
SEP IRAs provide distinct advantages for small businesses and self-employed professionals, though they also carry limitations that may affect specific compensation packages. Below is an analysis of their key benefits and drawbacks, grounded in IRS guidelines and financial best practices.
Advantages of SEP IRAs
- Higher contribution limits. SEP IRAs permit significantly larger annual contributions compared to traditional or Roth IRAs.
- Tax-deductible contributions. Employer contributions reduce taxable business income, offering immediate fiscal benefits. For example, a $50,000 contribution to employee accounts could lower a company’s taxable income by the same amount, directly reducing its tax liability.
- Administrative simplicity. Establishing an SEP IRA requires minimal paperwork—employers need only draft a plan agreement, notify eligible employees, and open accounts. Unlike 401(k) plans, no annual IRS filings or complex compliance requirements exist.
- Contribution flexibility. Employers can adjust contribution percentages annually or skip contributions entirely during lean financial years without penalties. This adaptability is particularly valuable for seasonal businesses or those with variable revenue streams.
- Immediate vesting. Employees immediately gain full ownership of all contributions, eliminating concerns about forfeiting funds if they change jobs. This contrasts with 401(k) plans, which may impose multiyear vesting schedules.
“Additionally, managing a SEP-IRA is simple through most firms,” says Mike Martin, finance industry professional with over 15 years of experience.
“Usually, they’ll have a selection of pre-packaged and managed investments you can buy into, shuffle funds between, and watch grow. These portfolios are balanced according to target retirement ranges or other goals and include a variety of assets, stocks, and other investments. Since it’s all managed behind the scenes by the brokerage, you don’t have to fiddle with individual purchases or watch the markets yourself,” Martin adds.
Disadvantages of SEP IRAs
- Mandatory employee contributions. Employers must contribute the same percentage of compensation to all eligible employees as they do for themselves. For instance, a business owner contributing 20% of their $300,000 salary ($60,000) must also allocate 20% to each eligible employee’s earnings, which can become costly for businesses with larger teams.
- No employee contributions. Unlike 401(k) plans, employees cannot make salary deferrals or supplemental contributions to their SEP IRAs, limiting their personal savings capacity.
- Roth option limitations. While the SECURE Act 2.0 introduced a Roth component for SEP IRAs in 2023, adoption remains limited due to unclear IRS guidelines and administrative hurdles. Most providers still offer only traditional, pre-tax SEP accounts.
- Impact on other retirement plans. SEP IRA contributions reduce the maximum amount employers can contribute to other plans, such as 401(k)s. For example, a $70,000 SEP contribution in 2025 would preclude additional employer contributions to a 401(k), potentially limiting tax diversification strategies.
- Exclusion of catch-up contributions. SEP IRAs do not allow individuals aged 50+ to make additional catch-up contributions, a feature available in 401(k)s and traditional IRAs. This may disadvantage older entrepreneurs seeking to bolster retirement savings.
For employers, “You cannot pick and choose to give only management, or only vested employees, access to the SEP-IRA,” warns Martin. “Your only other option is not to use a SEP-IRA at all.”
By weighing these factors, businesses can determine whether an SEP IRA aligns with their operational needs and long-term financial objectives.
SEP IRA vs. other retirement plans
SEP IRAs occupy a unique niche in retirement planning, offering distinct advantages over traditional IRAs and solo 401(k)s depending on a business’s structure and objectives.
SEP IRA vs. traditional IRA
SEP IRAs and traditional IRAs share tax-deferred growth but differ sharply in contribution capacity and eligibility. While traditional IRAs permit $7,000 annually ($8,000 for those 50+) in 2025, SEP IRAs allow employers to contribute up to 25% of compensation or $70,000—nearly tenfold higher. This makes SEP IRAs ideal for high-earning self-employed professionals or small business owners seeking to maximize tax-advantaged savings.
However, SEP IRAs lack employee contributions: only employers fund accounts, whereas traditional IRAs allow individual savers to contribute directly. Additionally, businesses with employees must contribute equally to all eligible staff under SEP rules, a requirement absent in traditional IRAs. Traditional IRAs remain preferable for individuals without self-employment income or access to employer-sponsored plans, particularly those prioritizing personal contribution control.
SEP IRA vs. solo 401(k)
Solo 401(k)s combine employer and employee contributions, enabling total 2025 contributions of $70,000 (or $77,500 with catch-up contributions for those 50+), surpassing SEP IRAs’ $70,000 cap when employee deferrals are included. Solo 401(k)s also offer Roth options, allowing after-tax contributions for tax-free withdrawals—a feature unavailable in SEP IRAs until recent legislative changes, though adoption remains limited.
SEP IRAs counterbalance these advantages with simpler administration: no annual IRS filings (Form 5500) or complex compliance requirements. They also permit contributions until the tax filing deadline, offering flexibility for businesses finalizing annual earnings. Solo 401(k)s suit self-employed individuals seeking higher savings capacity and tax diversification, while SEP IRAs appeal to those prioritizing ease of setup and minimal ongoing oversight.
Best use cases
SEP IRAs excel for solopreneurs and small teams valuing simplicity and high contribution limits without employee deferral options. Traditional IRAs serve individuals supplementing employer-sponsored plans or with modest savings goals.
Solo 401(k)s are optimal for high-earning self-employed professionals leveraging Roth options or aiming to maximize contributions through combined employer-employee funding. Businesses with international operations should note that these plans operate under U.S. tax law, requiring separate retirement solutions for non-U.S. employees.
Tax benefits and rules
SEP IRAs offer significant tax advantages for employers while providing tax-deferred growth for employees. Employer contributions are fully tax-deductible, reducing the business’s taxable income by up to $70,000 in 2025. For example, a self-employed individual contributing $50,000 to their SEP IRA could lower their taxable income from $200,000 to $150,000, potentially saving over $12,000 in federal taxes. These deductions apply regardless of whether the business operates as a sole proprietorship, partnership, or corporation.
Funds within a SEP IRA grow tax-deferred, meaning investments compound without annual tax liabilities on dividends, interest, or capital gains. Employees and business owners only pay taxes upon withdrawal during retirement, when distributions are taxed as ordinary income. However, withdrawals before age 59½ typically incur a 10% early penalty plus income taxes, though exceptions apply for permanent disability, unreimbursed medical expenses exceeding 7.5% of adjusted gross income, or qualified higher education costs.
Required Minimum Distributions (RMDs) mandate that account holders begin withdrawing funds by age 73, with penalties for non-compliance. Contributions must align with IRS limits, and excess amounts must be returned to avoid tax penalties. Employers have until their tax filing deadline, including extensions, to make contributions for the prior year, offering flexibility in cash flow management.
How to open and manage an SEP IRA
Establishing an SEP IRA involves straightforward steps, making it accessible for small businesses and self-employed professionals. Employers can initiate the process through financial institutions like Fidelity or Vanguard, which offer online applications and prototype plans to streamline setup.
The IRS mandates a written agreement, typically using Form 5305-SEP, which outlines contribution rules and eligibility criteria without requiring submission to tax authorities. Employers must retain this form and provide copies to eligible employees alongside details about contribution percentages and account management.
Eligible employees must open individual SEP IRA accounts, often facilitated by the employer’s chosen financial provider. Contributions can be made until the business’s tax filing deadline, including extensions, offering flexibility for cash flow management. For example, a sole proprietor filing taxes by October 15 can establish and fund an SEP IRA for the prior year as late as that date.
Ongoing management requires annual reviews of employee eligibility and contribution levels. Businesses with fluctuating revenues can adjust or skip contributions without penalties, provided they apply the same percentage to all eligible participants. Employers avoid Form 5500 filings required for 401(k) plans, reducing administrative burdens. Employees manage their own investments within their SEP IRAs, shifting responsibility for portfolio decisions away from the employer.
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Disclaimer: The information provided here is for general informational purposes only and should not be construed as legal advice. For personalized guidance, consult an immigration lawyer or local legal advisor.
