What is a SEP IRA?

Small business owners can choose from a variety of retirement savings solutions. The SEP IRA continues to be a popular choice for self-employed individuals and small business entrepreneurs looking to create a flexible retirement savings option for their employees.

SEP is an acronym for Simplified Employee Pension, an individual retirement account which allows employers to contribute to traditional IRAs, set up for their roster of employees. This simplified method is easy to use, and grants business owners the ability to contribute toward their employees’ retirement as well as their own savings.


Who can open a SEP IRA?

Any business owner with one or more employees, or anyone who makes their main income from freelance work, can open a SEP IRA.

This retirement savings solution is available to businesses of all sizes; this includes sole proprietorships, corporations, partnerships, and nonprofit organizations, and self-employed business owners who serve as the single employee in their company. As an employer, you’ll face no filing requirement, and this type of individual retirement account solution is easy to open and maintain.

Who contributes to a SEP IRA?

With a SEP IRA, only the employer contributes.

Employers can make contributions up to:

1. 25 percent of the employee’s compensation

2. $58,000 — currently the same contribution limit for 401(k)s

Employers must contribute the lesser option of the two. The first option—25 percent of compensation—is also the limit for how much you can contribute to each eligible employee.

When you calculate contribution amounts, only the first $290,000 of your employees’ income can be considered. For example, say you choose to make a contribution equal to 15 percent of each employee’s annual salary.

If one of your employees has a salary of $300,000, your contributions are cut off at $290,000. Therefore, the contribution would be 15 percent of $290,000, which comes out to $43,500.

Are contribution limits the same for self-employed individuals?

If you’re self-employed, your annual contribution limits are different. You may only contribute up to 25 percent of net adjusted self-employment income (not including contributions for yourself)—up to $58,000 for 2021.

Special rules apply when figuring your maximum deductible contribution. See Deduction Limit for Self-Employed Individuals.

Do I have to make contributions every year?

As an employer, you aren’t required to fund contributions to a SEP IRA every year. However, when you do make contributions, you are required to contribute to your own SEP IRA and the SEP IRAs of all of your eligible employees.

Keep in mind that you cannot make any contributions on the condition that your employee must keep part of them within the SEP IRA account. Any contribution you make belongs to the employee—no strings attached.

Are catch-up contributions allowed with a SEP IRA?

No. SEP IRAs are only funded by employer contributions, while catch-up contributions are specific to employee elective deferrals.

However, if your employer allows you to make traditional IRA contributions to your company’s SEP IRA account, you may have the opportunity to make catch-up IRA contributions.

As an employer, do I need to contribute the same percentage of salary for all participating employees?

Most SEP IRAs require that employers make contributions that are proportional to their employees’ salary or wages; as a result, every employee’s contribution should be the same percentage of salary.

Which employees are eligible for participation in a SEP IRA?

Any employee can participate in a SEP IRA as long as he or she:

  • Is at least 21 years old
  • Has worked for the company for 3 of the last 5 years
  • Has received at least $650 in compensation during the year

There are certain circumstances that would allow an employer to exclude employees from a SEP IRA. These circumstances include the following:

  • Any employee covered by a union agreement, whose retirement benefits were already agreed upon by the union and the employer
  • Nonresident alien employees who do not make U.S. wages, salaries, or receive personal services compensation

As an employer, am I required to contribute for a participant that no longer works for my company on the last day of the year?

Yes. If the employee is otherwise eligible, they must be given any SEP contribution, regardless of whether they work at your company on the last day of the year or not. This includes any employee who dies or quits working before you make the contribution for the year.

Are SEP IRAs best for small businesses?

Employers are required to make contributions to any employee that the IRS deems eligible, and these contributions must be an equal percentage of compensation to your own. For example, if you want to contribute 20 percent of your own compensation, you’ll also be required to contribute 20 percent of that employee’s compensation to his or her plan.

If you do make contributions, they must be based on a written allocation formula. They cannot discriminate in favor of highly compensated employees. When you contribute, you must contribute to the SEP-IRAs of all participants who actually performed personal services during the year for which the contributions are made, including employees who die or quit before you make the contributions for the year.

Therefore, SEP IRAs are well-suited to companies with few employees. Employers looking for flexibility can benefit from this plan; for example, you can elect to provide contributions based on the profitability of your business in a given year.

What are the benefits of an SEP IRA plan for an employer?

Employers can reap the benefits of an SEP IRA in several ways:

  1. This retirement savings plan is relatively easy to set up and maintain
  2. It comes with low administrative costs
  3. It offers flexible annual contributions, which is especially important to business owners that may struggle with cash flow
  4. Your contributions are tax deductible
  5. Unlike a 401(k), no fiduciary liability

What are the benefits of a SEP IRA for employees?

Employees also benefit from a SEP IRA. The following benefits can be extremely incentivizing to your employees:

1. A high contribution limit, up to $58,00
2. Can be combined with traditional IRA or a Roth IRA
3. Employees don’t pay taxes on SEP contributions
4. Employees have full control of funds in SEP IRA

What are SEP IRA contributions taxed?

Contributions to a SEP IRA are made with pre-tax earnings; all investment growth that occurs in the account is tax-free. Upon withdrawal, SEP IRA funds are taxed at federal marginal income tax rates after the account owner is aged 59 ½—similarly to a traditional IRA.

What are the penalties for an early distribution of SEP IRA funds?

If you decide to withdraw your SEP IRA funds before reaching age 59 1/2, you may subject to an additional 10 percent tax, along with income taxes.

After the account owner is age 70 ½, there is a required minimum taxable withdrawal that occurs annually. The amount of this minimum withdrawal is calculated by the IRS; their calculations are based on the life expectancy of the account owner, and the year-end account balance.

How do I set up a SEP IRA retirement savings option for my company?

1. Execute a written agreement that details benefits for all eligible employees

During this step, you must create a formal written agreement to provide benefits to all of your company’s eligible employees. The agreement must be completed and signed by the due date of your company’s tax return. This written agreement can be completed through IRS model Form 5305-SEP.

, or you can let our team of professionals design a prototype SEP for your company. We can customize an individually designed SEP, tailored to suit your company’s needs. During our drafting process, we’ll work to include special features that benefit your company and match your financial capabilities.

2. Provide employees with pertinent information about the agreement

You must now provide every eligible employee with pertinent information regarding the SEP eligibility requirement, and lay out the general guidelines and rules of the plan. If you’re using IRS form 5305-SEP, you need only give employees a copy of the SEP agreement. For individually designed SEPs, you may be required to provide employees with additional documentation.

3. Set up an IRA for each eligible employee

You are responsible for ensuring that each of your eligible employees has established a SEP IRA and receives the correct SEP contributions; if you fail to do so, the IRS may disqualify your SEP plan.

Our advisors can walk you through this process, step by step, to ensure your company follows all legal stipulations and regulations. Every business owner deserves peace of mind when it comes to retirement planning; whether you’re a self-employed entrepreneur or manage a team of 50 people, our IRA management offerings can provide you with the support you need.

How does a SEP IRA stack up against other retirement savings plans?

To understand how a SEP IRA compares to other IRA types, defer to this chart, which details contribution limits and income limits of three of the most popular retirement solutions.

Plan Type Income Limits Contribution Limit in 2021
Roth IRA • Single or head of household: You must earn less than $125,000 to fully contribute to a Roth IRA; 125,000 – $140,000 partial contribution

Married filing jointly or a qualified widow(er): You must earn less than $198,000 to fully contribute to a Roth IRA, $198,000 – $208,000 partial contribution

$6,000 / $7,000 if over 50 (personal contribution)
SEP IRA Compensation up to $290,000 in 2021 of an employee’s compensation may be considered. $58,000 or 25% of an employee’s compensation (employer contribution only)
Traditional IRA None, but your ability to deduct contributions may be eliminated or limited if you or a spouse is covered by a work retirement plan. $6,000 / $7,000 if you’re over 50 (personal contribution)

*It’s important to note that with Roth IRA, the phase out is within a certain range, depending upon tax filing status. The numbers in this table show the endpoint of the modified adjusted gross income range in which you can’t contribute.

SEP IRAs provide a great deal of flexibility, and there are many tax advantages for both employer and employee. This retirement savings plan continues to be a popular option for the self-employed and small business owners. Benefit from high contribution limits and begin building a sturdy retirement savings account.

Contact GuidedChoice today and learn about our managed IRA solutions, including SEP IRAs, SIMPLE IRAs, traditional IRAs, and more.