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What you should know about SEP IRA

It is important to build a retirement fund for yourself or your employees if you are a business owner. One option is the SEP IRA.



If you’re an entrepreneur or self-employed, no one provides you with a pension plan. It’s important to build a retirement fund to support yourself and/or your dependents when you retire. If you have employees, you may also want to set up a retirement plan for them, and enjoy some tax breaks in the process.

Enter the Simplified Employee Pension plan, also known as SEP or SEP IRA. Let’s look at what this plan offers, how it works, and how you can use it.

What is a SEP IRA?

SEP IRAs are employer-sponsored retirement plans that allow employers to make tax-deductible contributions to a retirement fund on behalf of an eligible employee. Business owners and self-employed individuals can also use these IRA-based plans to save money for their own retirement, whether they work full-time or part-time.

Setting up a SEP IRA

SEP IRAs are easy and inexpensive to set up and available to businesses of any size, including sole proprietors, partnerships and corporations. The account needs to be opened with any qualified financial institution such as a bank or insurance company, after completing Form 5305-SEP.

Employees and business owners need to have a traditional IRA to be eligible for a SEP. It’s often easiest to open and maintain SEP IRAs for eligible employees if a single financial institution is used for all the accounts.

SEP IRA rules to keep in mind

Business owners who set up a SEP IRA for themselves also have to create one for each eligible employee and offer a uniform contribution rate for everyone. If you as an employer put 10 percent of your pay into a SEP IRA, you must contribute an equal percentage of each eligible employee’s pay as well.

Tax-deductible contributions to SEP IRA plans can be made up to the employer’s tax filing date. You can also opt not to make any contributions during a slow year, but then you cannot make a SEP IRA contribution for yourself either.


The SEP IRA contribution limit is higher than standard IRAs. (Photo by DepositPhotos)

How does a SEP IRA work?

SEPs are quite similar to traditional IRAs, and here are some basic points about how they work:

Ownership and Control

Employees and business owners retain control of the account and are responsible for choosing which stocks, mutual funds or other vehicles their funds will be invested in.


Employees and business owners can take the account with them if they leave an employer or the business closes down. They can also opt for a transfer or rollover of these funds to another IRA or 401(k).


Employees cannot choose how much their SEP IRA contribution will be, and cannot make contributions on their own behalf. Employers decide what percentage of pay will be contributed for every eligible employee on an annual basis, if any.


Withdrawals from the plan are taxed as ordinary income to the owner of the account. Distributions also incur a 10 percent early withdrawal penalty if they are made before the account owner turns 59.5 Like traditional IRAs, required minimum distributions begin after 70.5 years of age.


Employers can claim employee contributions as deductions on business tax returns. Sole proprietors’ contributions can be claimed on personal tax returns. Contributions do not incur taxes for the account owner, but earnings such as interest or gains from investment are taxable.

SEP IRA Contribution Limits

The SEP IRA contribution limit is higher than standard IRAs, and employers can contribute up to $53,000 or 25 percent of an employee’s eligible compensation, whichever is lower. If an employee owns another defined contribution plan, the total annual contribution for both cannot exceed $53,000.

Remember, SEP IRA contribution for self-employed individuals is more complex, so it’s a good idea to consult a professional for expert advice.

(Featured image by DepositPhotos)

DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation for writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.

Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He has over three decades of experience working with investments and retirement planning, and over the last 10 years has turned his focus to self-directed accounts and alternative investments. Rick regularly posts helpful tips and articles on his blog at SD Retirement as well as, SAP, MoneyForLunch, Biggerpocket, SocialMediaToday, and NuWireInvestor. If you need help and guidance with traditional or alternative investments, get in touch with Rick.