SEP IRA — overview and eligibility
A SEP IRA is a simplified retirement plan designed for self-employed individuals and small-business employers. Contribution limits are far higher than a Traditional IRA's, but only the employer contributes — not the employee. This article covers who qualifies, how contributions work, and what to expect over the life of the account.
Steps / Explanation
A Simplified Employee Pension Individual Retirement Account (SEP IRA) is a tax-deferred retirement account established by an employer for the benefit of employees, including the business owner. The Internal Revenue Service (IRS) defines SEP IRAs under Internal Revenue Code §408(k). The defining feature is that only the employer contributes — employees do not make their own contributions out of their pay.
At Retired.com, a SEP IRA is held as a Self-Directed IRA (SDIRA) — the contribution rules and tax treatment are the same as any SEP IRA, but the range of investments you can hold inside the account is wider. See "What is a Self-Directed IRA (SDIRA)?".
Who can establish a SEP IRA
Any employer can establish a SEP IRA, including:
Sole proprietors — a one-person business with no employees. Common SEP IRA configuration.
Self-employed individuals with side income (1099 income, consulting, freelance, single-member LLC).
Small businesses with employees — partnerships, LLCs, S corporations, C corporations.
The plan is established by the employer (which may be you, if you're self-employed) using IRS Form 5305-SEP or a custodian's prototype document. Once established, each eligible employee — including the business owner — has their own SEP IRA where contributions are deposited.
Who is an eligible employee
If your business has employees, you must include any employee who meets all of these IRS-defined requirements (you can be less restrictive but not more):
Age 21 or older.
Worked for the business in at least 3 of the immediately preceding 5 years.
Earned at least the IRS-defined minimum compensation threshold for the year (set annually, indexed to inflation).
This is one of SEP IRAs' main constraints: if you have employees who meet these thresholds, you must make a proportional contribution for each of them (see "Contribution rules" below). For business owners with employees, this often makes a different plan structure — a "Solo 401(k) — overview and eligibility" (for owner-only plans) or a "SIMPLE IRA — overview and eligibility" — more appropriate.
Contribution rules
Three rules drive SEP contributions:
Employer contributions only. Employees do not make elective deferrals to a SEP IRA. The employer makes a contribution into each eligible employee's account.
Contribution limit per IRS. The maximum contribution is the lesser of 25% of compensation or the annual dollar cap set by the IRS. The cap is significantly higher than the Traditional/Roth IRA limit — published in IRS Publication 560 each year. For self-employed individuals, the math uses net earnings from self-employment, which after the deduction for self-employment tax effectively reduces the rate to about 20%.
Uniform percentage requirement. Whatever percentage of compensation the employer contributes, that same percentage must apply to every eligible employee. You cannot contribute 25% for yourself and 5% for staff.
Contributions are discretionary year to year — the employer is not required to contribute in any given year. When the employer does contribute, the percentage must be uniform.
Because dollar figures change annually, this article does not list specific amounts. For the current year's limits and minimum compensation thresholds, see IRS Publication 560 or contact the Service Team.
Tax treatment
A SEP IRA has the same tax framework as a Traditional IRA:
On contribution. Employer contributions are deductible to the business in the year of contribution. The contributions are not taxable income to the employee.
During growth. Investment earnings inside the account are not taxed as they accrue — tax-deferred growth.
On distribution. Distributions are taxed as ordinary income in the year received. The same 10% early-withdrawal additional tax under Internal Revenue Code §72(t) applies for distributions before age 59½ unless an exception applies. See "Early withdrawal — penalties and exceptions".
We recommend consulting a tax advisor or attorney for guidance specific to your situation.
Required Minimum Distributions and other rules
A SEP IRA follows the same downstream rules as a Traditional IRA:
Required Minimum Distributions (RMDs) apply at the age set by your year of birth under the SECURE 2.0 Act. See "Required Minimum Distributions (RMDs) — rules and deadlines".
Prohibited-transaction rules apply (IRC §4975). See "Prohibited transactions — what they are and why they matter".
Roth conversions are permitted from a SEP IRA, with the converted amount taxed as ordinary income in the year of the conversion. See "Roth conversions — how they work".
Rollovers between a SEP IRA and a Traditional IRA, or between a SEP IRA and a 401(k), are permitted under the standard rollover rules.
SEP IRA vs. Traditional IRA — the short version
For a sole proprietor with no employees, the simplest way to think about it: a Traditional IRA caps you at the standard annual contribution limit (a few thousand dollars). A SEP IRA can let you contribute many times that — up to 25% of net self-employment earnings — but the dollar amount depends on your business income. If your business has variable income, the SEP's discretionary structure (no required contribution in any given year) is often a fit.
For a business with employees, the uniform-percentage rule is the key constraint. If you can comfortably contribute the same percentage for each eligible employee that you contribute for yourself, SEP works. If you can't, SIMPLE IRA or Solo 401(k) (for the right business structure) may fit better.
We recommend consulting a tax advisor or attorney for guidance specific to your situation.
Common questions
Can I have a SEP IRA and a Traditional or Roth IRA in the same year?
Yes. Contributions to a SEP IRA do not affect your ability to contribute to a personal Traditional or Roth IRA, though the personal IRA's annual limit is separate from the SEP IRA's limit. The Roth IRA's MAGI phase-out rules still apply.
If I have employees, can I contribute different amounts for them and for myself?
No. The uniform-percentage rule requires that whatever percentage of compensation you contribute for yourself, you must contribute the same percentage for every eligible employee. You can contribute 0% in any given year, but you cannot vary the percentage by employee.
Can a SEP IRA accept employee elective deferrals?
No. SEP IRAs are employer-contribution-only. If you want a plan that allows employee elective deferrals, look at a "SIMPLE IRA — overview and eligibility" or "Solo 401(k) — overview and eligibility".
How does a SEP IRA work for a sole proprietor with no employees?
Cleanly. You are the only "employee" the rules apply to. You can contribute up to the SEP cap on your own net self-employment earnings, take the business deduction, and avoid the uniform-percentage complexity that arises with employees.
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