Most people include an individual retirement account, or IRA, among their retirement savings tools — but not all IRAs are the same. One potentially valuable IRA for small businesses or self-employed workers is the Simplified Employee Pension, or SEP. While this lesser-known investment opportunity isn’t offered by all brokerages, it has some unique rules you should be familiar with before opening one.
SEP IRA, defined
A SEP IRA is a type of traditional IRA that allows employers to make tax-deductible contributions on behalf of employees, including self-employed individuals. Some key features of SEP IRAs include:
Easy setup and lower administrative costs for employers
Flexible employer contributions year-to-year
Higher contribution limits
Immediate 100% vesting
Read more: Looking for ways to bump up your savings? Consider tools like buckets and boosters.
How a SEP IRA works
Employers must select a financial institution to hold the employees’ retirement accounts. The same investment, distribution, transfer and rollover rules apply to both traditional IRAs and SEP IRAs. Money contributed to the account is tax-deductible for the employer, and retirement investments grow tax-deferred.
The funds in a SEP IRA are owned and managed by individual employees, but contributions can only be made by the employer. If you’re self-employed, you can make tax-deductible contributions into your own SEP IRA or consider an individual 401(k), a retirement account designed for self-employed individuals without any full-time employees.
SEP IRA rules
In 2024, SEP IRA contribution limits are 25% of your pay or $69,000, whichever is less. An employer who offers a SEP IRA is not required to contribute a minimum amount in any given year. However, employers must contribute the same amount to all SEP IRA accounts — their own and those of all eligible employees.
If you’re an employer and have employees who want to take part in your plan, they must be:
21 or older
Have worked for you for in any three of the past five SEP plan years
Made a minimum of $750 in 2024
As an employer, deposits into a SEP IRA must be made before you file your business tax return for that year. The SEP IRA contribution deadline is the due date of (including extensions) for filing your federal income tax return for the year.
What are the advantages of a SEP IRA?
A SEP IRA can provide the flexibility small businesses and sole proprietorships need to provide for themselves and their employees’ retirement.
A major perk of SEP IRAs is their immediate vesting — the money in your account is yours right away.
Advantages for employers
In more profitable years, you can contribute an amount that makes sense for you. But since SEP IRAs don’t require a minimum annual contribution, businesses have the flexibility to forgo contributions in leaner years. SEP IRAs also allow employers to deduct their contributions in the year they’re made, reducing taxable income.
SEP IRAs are simple to set up and easy to manage, with contribution limits that are higher than other types of IRAs. Putting away tax-advantaged funds in these larger amounts can really amp up earning potential for you and your employees.
Advantages for employees
A major perk of SEP IRAs is their immediate vesting — the money in your account is yours right away. Employees are also able to invest the funds in their SEP IRA as they see fit, making them a useful supplement to individual retirement savings vehicles.
SEP IRAs share other benefits with traditional IRA funds, like the potential for money to grow tax-deferred. And when funds are withdrawn in retirement, they’re taxed at the same rate as ordinary income, following regular income tax bracket rates.
What are the disadvantages of a SEP IRA?
There are a few potential disadvantages unique to SEP IRAs, including:
No increased “catch-up” contribution limit for those 50 and older.
Employers are required to contribute the same percentage to all SEP IRAs, including their own.
Like traditional IRAs, you’ll pay income-based taxes and a 10% penalty if you take out money before age 59½.
How can I set up a SEP IRA?
Both business owners and any eligible employees must read through and fill out IRS Form 5305-SEP independently or through your account provider. Set up an account for each employee, following your provider’s instructions.
Taking steps toward SEP
If a SEP IRA is available and applicable for your working scenario, this retirement savings tool could offer you some unique benefits.
