What Is a SEP IRA?

What we’ll cover

• SEP IRAs are retirement accounts for business owners and those that are self-employed.
• SEPs offer higher contribution limits than other IRAs and can be ideal for business owners with few or no employees.
• The 2023 maximum annual contribution limit for a SEP plan is $66,000 ($69,000 for 2024) or 25% of compensation, whichever is lesser.

It’s a Simplified Employee Pension Individual Retirement Account. A SEP IRA is a retirement account that offers tax advantages for business owners and those that are self-employed.

They work much like traditional IRAs where the money you contribute may grow tax-deferred until retirement. Contributions are also tax deductible, up to a certain amount.

How does a SEP IRA work?

SEPs can be attractive options for small business owners because they can be easy to set up and maintain. It’s up to the business owner to set up the SEP and decide when and how much they’ll contribute for their employees. However, employees own and control their accounts, including any investment decisions.

Who can open a SEP IRA?

While technically any employer can open a SEP, they are generally recommended for business owners with few or no employees.

If you’re a business owner offering a SEP IRA, you contribute on behalf of your employees, and the IRS requires that you contribute equally to all accounts.

So for instance, if you want to contribute 20% of your own salary toward a SEP, you also have to contribute 20% of each eligible employee’s salary.

What are the SEP IRA eligibility requirements for employees?

If you’re a small business owner, you must include employees in the SEP plan if they:

• Are 21 years or older.
• Have worked for the business in at least 3 of the last 5 years.
• Receive at least $750 in compensation from your business for the year (2023 and 2024).

You may also choose less restrictive requirements for your plan (e.g., 18 years or older, three months of service).

How to set up a SEP IRA

The first step is to choose an account provider for your SEP IRA. There are a number of financial institutions to choose from, so do some research to find one that works for you. Once you’ve chosen where to open your account, the IRS requires the following:

1. Create a written agreement for all eligible employees. The IRS provides a model plan document (Form 5305-SEP) as a template. Your account provider may also have a template.
2. Give employees information about the SEP IRA. (This may seem obvious, but yes, you have to tell your employees about their retirement plan options).
3. Set up a SEP IRA account for each employee.

Keep in mind that these are just the basic steps. Visit the IRS website for more details on how to establish a SEP.

How much can you contribute to a SEP IRA?

This is where the SEP IRA shines in comparison to a traditional or Roth IRA, which only allows you to contribute up to $6,500 in 2023 ($7,500 for those age 50 or older - see IRS's Catch-Up Contributions) and $7,000 in 2024 ($8,000 for those age 50 or older).

With a SEP IRA, employers can contribute up to $66,000 in 2023 and $69,000 in 2024 – or 25% of an employee’s compensation, whichever is less. (Just remember that business owners have to contribute equal percentages to each employee’s account.)

Good to know: One drawback is that SEP IRAs do not allow catch-up contributions.

Can I contribute to a traditional or Roth IRA in addition to a SEP?

Generally, yes. This can get a little confusing though because a SEP IRA is technically just an individual retirement account that holds contributions under a SEP plan.

Here’s the deal: Even though your employer must contribute to your SEP IRA, you may also be able to contribute to the account. Alternatively, you could open up a separate Roth or traditional IRA and contribute your own money that way.

Just keep in mind that whatever individual contributions you make cannot exceed the total annual contribution limit for IRAs. See the IRS's SEP Plan FAQs for more details or consult a tax professional if you have any questions.

What other SEP IRA rules do I need to know about?

Here are some other things to keep in mind if you’re considering a SEP IRA:

• Employer contributions vest immediately, which means the contributions don’t have to be earned based on an employee’s tenure. It’s a great benefit for the employee, but a potential downside for the employer, who may want to use vesting as a way to keep people from leaving too soon.
• If you’re participating in a SEP plan and withdraw your money prior to age 59½ you’re generally subject to income tax and a 10% penalty. After age 59½ you’ll be subject to income tax but no penalty.

How do I know if a SEP IRA is right for me?

Given the high contribution limits, a SEP IRA may be a great option if you’re a one-person shop. SEP IRAs can be easy to set up and administer, which is probably music to your ears if you run your own business. Generally speaking, they also have low administrative costs and allow you to contribute on your own terms each year.

If you have questions on whether a SEP IRA is right for you, consult a financial advisor or tax professional. You can also visit IRS.gov for more information.