SEP IRA Guide: Rules, Contribution Limits & Who Qualifies
How a SEP IRA Works
A SEP IRA is essentially a traditional IRA that receives employer contributions. The business owner sets up the plan and establishes a SEP IRA account for each eligible employee (including themselves). Contributions are made by the employer and are immediately 100% vested — the employee owns the money right away.
The contribution percentage must be uniform: if you contribute 20% of your own compensation, you must contribute 20% for every eligible employee. This is the most important rule to understand, because it can make SEP IRAs expensive for businesses with employees.
SEP IRA Contribution Limits (2024)
| Limit | Amount |
|---|---|
| Maximum annual contribution | $69,000 or 25% of compensation (whichever is less) |
| Compensation cap considered | $345,000 |
| Self-employed effective rate | ~20% of net self-employment income (after SE tax deduction) |
| Catch-up contributions (age 50+) | Not available in SEP IRAs |
For self-employed individuals, the math is slightly different. You first subtract half of your self-employment tax from your net earnings, then apply the 25% contribution limit. The effective maximum is approximately 20% of net self-employment income.
Eligibility Requirements
Any business can establish a SEP IRA — sole proprietorships, partnerships, LLCs, S-corps, and C-corps. There is no minimum or maximum business size. However, you must include any employee who meets all three criteria:
1. Is at least 21 years old.
2. Has worked for you in at least 3 of the last 5 years.
3. Has earned at least $750 in compensation during the current year.
You can set less restrictive eligibility requirements (e.g., including employees after 1 year), but you cannot make the rules stricter than the IRS defaults above.
SEP IRA vs Solo 401(k) vs SIMPLE IRA
| Feature | SEP IRA | Solo 401(k) | SIMPLE IRA |
|---|---|---|---|
| Best for | Self-employed with few or no employees | Self-employed with no employees | Small businesses with up to 100 employees |
| Max contribution (2024) | $69,000 | $69,000 ($76,500 with catch-up) | $16,000 ($19,500 with catch-up) |
| Employee contributions | No | Yes (employee + employer) | Yes (employee + employer match) |
| Roth option | No | Yes | No |
| Loan provision | No | Yes | No |
| Required for all eligible employees | Yes — equal percentage | N/A (no employees) | Yes — matching or non-elective |
| Setup complexity | Very simple (IRS Form 5305-SEP) | Moderate | Simple |
Tax Treatment
SEP IRA contributions are tax-deductible for the business. For sole proprietors, the deduction goes on Schedule 1 of Form 1040 (it is an “above-the-line” deduction that reduces your adjusted gross income). Contributions grow tax-deferred inside the IRA, and withdrawals in retirement are taxed as ordinary income.
There is no Roth option for SEP IRAs. If you want tax-free growth, consider a Roth IRA (if your income qualifies) or a Solo 401(k) with Roth contributions.
Withdrawal Rules
SEP IRA withdrawal rules are identical to traditional IRA rules. Withdrawals before age 59½ are subject to a 10% early withdrawal penalty plus ordinary income tax. Required minimum distributions (RMDs) begin at age 73 (as of 2024). Standard exceptions to the early withdrawal penalty apply — first-time home purchase ($10,000 limit), qualified education expenses, and others.
How to Set Up a SEP IRA
Step 1: Complete IRS Form 5305-SEP (a two-page document — one of the simplest retirement plan documents in existence).
Step 2: Open SEP IRA accounts at a brokerage for yourself and each eligible employee. Most major brokerages (Vanguard, Fidelity, Schwab) offer SEP IRAs with no account fees.
Step 3: Make contributions by your business tax-filing deadline (including extensions). For sole proprietors, that is April 15 (or October 15 with an extension).
Step 4: Provide eligible employees with information about the plan. There is no annual Form 5500 filing requirement for SEP IRAs (unlike 401(k) plans).
Key Takeaways
- SEP IRAs allow contributions of up to 25% of compensation (max $69,000 in 2024) — among the highest limits of any retirement plan.
- Only the employer contributes — employees cannot add their own money to a SEP IRA.
- Contributions must be the same percentage for all eligible employees, which can be costly for businesses with staff.
- Setup is extremely simple (IRS Form 5305-SEP) with no annual filing requirements.
- For solo self-employed individuals, a Solo 401(k) often offers more flexibility (Roth option, loans, higher effective limits at lower income levels).
Frequently Asked Questions
Can I have a SEP IRA and a traditional or Roth IRA?
Yes. A SEP IRA does not prevent you from contributing to a traditional IRA or Roth IRA. However, SEP IRA participation means your traditional IRA deduction may be limited based on your income level.
When is the deadline to set up and fund a SEP IRA?
You can establish and fund a SEP IRA up to your business tax-filing deadline, including extensions. This means a sole proprietor filing an extension can set up and contribute to a SEP IRA as late as October 15 — making it one of the most flexible plans for last-minute tax planning.
Can I contribute to a SEP IRA if I also have a 401(k) at my day job?
Yes. If you have self-employment income on the side, you can open a SEP IRA for that income. The 401(k) limits at your day job are separate from your SEP IRA employer contribution limit.
What happens to my SEP IRA if I hire employees?
Once eligible employees join, you must contribute the same percentage for them as you do for yourself. If you contribute 15% of your own compensation, you owe 15% for each eligible employee. This is why many small businesses switch to a SIMPLE IRA or 401(k) when they start hiring.
Can I reduce or skip contributions in a down year?
Yes. SEP IRA contributions are discretionary — you can contribute any amount from $0 to the maximum each year. There is no requirement to contribute every year, which gives you flexibility to adjust based on cash flow.