Understanding SEP IRA Plans

A Simplified Employee Pension (SEP) IRA is a retirement savings plan designed for small business owners and self-employed individuals. SEP IRAs offer high contribution limits with minimal administrative requirements, making them ideal for businesses with few or no employees.

How SEP IRAs Work

1. Business Setup: Employer establishes the SEP plan
2. Individual Accounts: Each participant has their own IRA
3. Employer Contributions: Only employer makes contributions
4. Equal Treatment: Same contribution percentage for everyone
5. Immediate Vesting: Employees own contributions immediately

2025 Contribution Limits

• Maximum Annual Contribution: $70,000
• Maximum Percentage: 25% of compensation
• Maximum Compensation Considered: $345,000
• Self-Employed Adjustment: Contribution rate/(1 + contribution rate)

Employee Eligibility Requirements

All employees must be included if they meet ALL of the following criteria:

• Age 21 or older
• Worked for the business in at least 3 of the last 5 years
• Received at least $750 in compensation during the year (2025 limit)

Self-Employed Contribution Calculation

The contribution calculation for self-employed individuals is more complex than for employees. You must first reduce your net self-employment earnings by half of your self-employment tax, then apply a modified contribution rate.

Step-by-Step Calculation:

1. Start with net profit from Schedule C
2. Subtract one-half of self-employment tax
3. Apply the adjusted contribution rate: Rate ÷ (1 + Rate)
4. Result cannot exceed annual maximum ($70,000 for 2025)

Advantages of SEP IRAs

• High Contribution Limits: Much higher than traditional IRAs
• Easy Setup: Minimal paperwork and administration
• Flexible Contributions: Not required to contribute every year
• Tax Deductible: Contributions reduce current taxable income
• No Required Minimums: Until age 73
• Employee Control: Participants manage their own investments

Disadvantages of SEP IRAs

• Employee Coverage: Must include all eligible employees
• Equal Contributions: Same percentage for everyone
• No Employee Contributions: Only employer can contribute
• No Loans: Cannot borrow from SEP IRA
• Limited Flexibility: Fewer options than 401(k) plans

SEP IRA vs Other Retirement Plans

SEP IRA vs Solo 401(k)

• SEP Pros: Simpler administration, can have employees
• Solo 401(k) Pros: Higher contribution limits for high earners, loan option
• Best for SEP: Businesses with employees or those wanting simplicity
• Best for Solo 401(k): High-earning solopreneurs

SEP IRA vs SIMPLE IRA

• SEP Pros: Higher contribution limits, more flexible
• SIMPLE Pros: Employee contributions allowed, lower admin burden
• Best for SEP: Higher-earning business owners
• Best for SIMPLE: Businesses wanting employee participation

Tax Considerations

• Deductible Contributions: Reduce current year taxes
• Tax-Deferred Growth: No taxes on investment gains
• Taxable Withdrawals: Ordinary income tax rates apply
• Early Withdrawal Penalty: 10% before age 59½ (with exceptions)
• Required Minimum Distributions: Begin at age 73

Setting Up a SEP IRA

1. Choose a Provider: Bank, credit union, or investment company
2. Complete Form 5305-SEP: Establishes the plan
3. Notify Employees: Provide plan information
4. Open Accounts: Each participant needs their own IRA
5. Make Contributions: By tax filing deadline + extensions

Contribution Timing and Deadlines

• Tax Year Contributions: Can be made until tax filing deadline
• Extensions Apply: Up to October 15 with valid extension
• No Catch-Up Required: Can skip years if needed
• Amendment Allowed: Can establish plan even after year-end

Common SEP IRA Mistakes

• Not including all eligible employees in contributions
• Contributing different percentages to different employees
• Incorrect self-employed contribution calculations
• Missing contribution deadlines
• Not considering the cost of employee contributions
• Mixing up SEP contributions with regular IRA limits

When to Consider a SEP IRA

A SEP IRA might be right for you if:

• You're self-employed or have a small business
• You want high contribution limits with low administration
• You have few or no employees (or don't mind contributing for them)
• Your income varies year to year
• You want flexibility in contribution timing