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Simplified Employee Pension Plan (SEP IRA)

What is a Simplified Employee Pension Plan (SEP IRA)?

Small business retirement plan. A simplified employee pension (SEP or SEP IRA) is a retirement account that self-employed individuals or small business owners (with one or more employees) can set up. The SEP IRA allows them to put away up to $66,000 in 2023 (($61,000 in 2022 & $58,000 in 2021) toward retirement.

The contributions are made with pre-tax dollars, and the tax is applicable only when the plan holder starts taking withdrawals. Those employed cannot contribute to SEP IRAs; however, the employer or business owner has to make all the contributions on behalf of the employees.

Much like a traditional IRA, the contributions are tax-deferred, the investments grow tax-deferred until retirement (the withdrawals are taxed as income).

SEP IRA Contribution Limit

So, how much you can contribute to your SEP IRA and what are the contribution limit for the SEP?The answer is, for 2023 , self-employed individuals or business owners can effectively put away up to 25% of their net income in a SEP IRA. However, the contribution should not exceed the maximum contribution limit of $66,000 ($61,000 in 2022 & $58,000 in 2021).

What are the pros and cons of a SEP IRA?

Advantages of a SEP IRA

  • Effective way to save for your retirement: When you are self-employed, you don’t have many options for tax-advantaged retirement savings. SEP IRA can help you save for retirement.
  • Easy to establish: After you fill out an IRS form, the broker can easily guide you through setting up a SEP IRA.
  • Tax-deferred contributions: In SEP IRA, your contributions are tax-deferred. It means that you receive a tax deduction today (contributions made with pre-tax dollars), but your withdrawals are taxed.
  • Flexibility: You can choose not to make contributions every year for yourself and on behalf of your employees.
  • Make larger contributions: With SEP IRA, the contribution limits are higher than traditional and Roth IRAs, as well as a 401(k).

Disadvantages of a SEP IRA

  • No catch-up contributions: Unlike other IRAs and 401(k) plans, there are no catch-up contributions if you’re over the age of 50. However, the higher contribution limits may compensate for this disadvantage.
  • Employees must be treated the same as you: SEP IRA is an employer only contribution plan. Since employees do not make any contributions, you must contribute the same percentage of employee compensation as yours.
  • No Roth option: If you prefer making after-tax contributions and enjoying after-tax contributions, then with SEP IRA, you aren’t so lucky. Since there is no Roth option, your contributions are tax-deferred, your money also will grow tax-deferred, but your withdrawals are taxed. You will also have to adhere to required minimum distributions when you are of a certain age.


Who can open a SEP IRA?

SEP IRAs are the best retirement plans for self-employed individuals or small business owners with few or no employees.

As of 202, the IRS rules outlined the following criteria to qualify for a SEP IRA:

  • You have worked for the employer in at least three of the previous five years
  • You must be at least 21 years old
  • You have received a minimum of $750 in compensation from the employer during the current year

Employers may exclude the following types of employees from participating in a SEP IRA, even if they are eligible:

  • Employees who are nonresident aliens and not receiving any service compensation or U.S. wages from the employer
  • Employees who are covered in a union agreement that bargains for retirement benefits

How does SEP IRA Work?

A SEP IRA does not come with many start-up or operating costs, unlike many employer-sponsored plans. Since many employers can contribute to their own retirement at higher levels than conventional IRAs, a SEP IRA becomes an attractive option. And individuals can set up a SEP for their self-employed business and even participate in an employer’s retirement plan if they are also employed elsewhere.

SEP IRA accounts enjoy the same tax benefits and investment options as any other traditional IRAs. Also, the same transfer and rollover rules apply. Additionally, when you, as an employer, make SEP IRA contribution, you receive a tax deduction for the amount contributed. With a SEP IRA, your business doesn’t need to make annual contributions. You can decide whether or not to contribute and how much to contribute each year.

Business owners and employers are not responsible for making investment decisions. The IRA trustees assess eligible investments, and the individual employee account holder makes the investment decisions. The IRA trustee also does all the paperwork involved, including depositing contributions, filing the required documents with the IRS, and sending annual statements.

Opening a SEP IRA: How do I open a SEP IRA?

You can easily open a SEP IRA online. Choose an account provider and then follow the steps outlined by the IRS for setting up your SEP IRA:

  • 01

    Draft a formal agreement either through your account provider or with IRS Form 5305-SEP.

  • 02

    Inform your eligible employees about SEP IRA. Give them a copy of IRS Form 5305-SEP or provide information through your account provider.

  • 03

    Establish separate SEP IRAs for each eligible employee with the account provider.

Rules for SEP IRAs

  • It’s not for all businesses

    Not all businesses can start SEP IRAs. Sole proprietors, partnerships, and corporations can establish SEPs. The SEP IRA is primarily designed to encourage retirement benefits among businesses that would otherwise not set up employer-sponsored plans. The income cannot be too high as the 2023 eligible compensation limit for setting up a SEP IRA is $330,000 (up from $305,000 in 2022 & $290,000 in 2021).

  • You cannot borrow from your SEP IRA

    Unlike qualified retirement plans, the Internal Revenue Service (IRS) does not allow you to borrow money from your SEP IRA. You cannot use it as collateral for loans. However, you can roll your money from your SEP IRA to other qualified retirement plans.

  • Not all employees are eligible to participate in a SEP IRA

    Certain types of employees may be excluded from participating in a SEP IRA, even if they would otherwise be eligible based on the plan’s rules. Some examples are:

    • Workers who are covered in a union agreement that bargains for retirement benefits
    • Workers who are nonresident aliens with nor service compensation from the employer or without any U.S. wages.
  • You can withdraw fund from SEP IRA anytime

    SEP IRA contributions and earnings can be withdrawn at any time, without showing any evidence of financial hardship. However, a withdrawal is taxable in the year received. And if the participant makes a withdrawal before age 59½, it is termed as an early withdrawal and may be subjected to a 10% tax penalty and other applicable tax liability.

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