A SEP IRA lets you set aside money for retirement with higher contribution limits than a regular IRA, and it's designed for self-employed people and small business owners.

SEP stands for Simplified Employee Pension. The account works like a traditional IRA — your contributions reduce your taxable income for the year, and you pay taxes on the money when you withdraw it in retirement. The main difference is how much you can put in: a SEP IRA lets you contribute up to 25% of your net self-employment income, or $69,000 per year (as of 2024), compared to $7,000 in a regular IRA.

You open a SEP IRA through a bank, brokerage, or investment company the same way you'd open any IRA. There's no paperwork with the IRS beyond what you file on your tax return. If you have employees, you must contribute the same percentage of their salary that you contribute for yourself — this is the trade-off for the higher limits.

Key Takeaways

  • A SEP IRA allows contributions up to 25% of net self-employment income or $69,000 per year, much higher than a regular IRA's $7,000 limit.
  • You must contribute the same percentage for any employees you have, so hiring staff increases your retirement savings obligation.
  • Contributions are tax-deductible in the year you make them, and withdrawals in retirement are taxed as ordinary income.
  • A SEP IRA is simpler to set up and maintain than a solo 401(k) or defined benefit plan, with no annual IRS filing requirement.

Who should open a SEP IRA

A SEP IRA makes sense if you're self-employed, run a small business, or earn significant side income. You don't need employees to open one — many freelancers, contractors, and gig workers use SEP IRAs as their main retirement account. The account is particularly useful if your income varies year to year, because you only decide how much to contribute when you file your taxes, not at the start of the year.

If you have employees, a SEP IRA is still simpler than a 401(k), but the required employer contribution changes the math. Say you contribute 20% of your income for yourself; you must also contribute 20% of each employee's salary. This can become expensive quickly, which is why some business owners with staff choose a solo 401(k) instead (which has no employee contribution requirement if you're the only employee).

How much you can contribute each year

Your SEP IRA contribution limit is the lesser of 25% of your net self-employment income or the annual dollar limit. For 2024, that dollar limit is $69,000. The percentage is calculated on your net profit after you subtract half of your self-employment tax, which is why the actual percentage works out to roughly 18.6% of gross self-employment income, not a full 25%.

You decide how much to contribute each year when you file your tax return — you're not locked into a percentage. One year you might contribute 15%, the next year 25%, depending on your income and cash flow. This flexibility is one reason self-employed people prefer SEP IRAs to 401(k)s, where contributions are usually committed earlier in the year.

Tax treatment and withdrawals

Contributions to a SEP IRA reduce your taxable income dollar-for-dollar in the year you make them. If you contribute $30,000 in 2024, your taxable income drops by $30,000. You don't pay taxes on the money until you withdraw it, and withdrawals are taxed as ordinary income at whatever tax rate applies when you retire.

You can withdraw money starting at age 59½ without penalty. Withdrawals before that age are subject to a 10% early withdrawal penalty plus income tax, with some exceptions (disability, medical expenses, and a few others). At age 73, you must begin taking required minimum distributions, which means the IRS forces you to withdraw a calculated amount each year and pay taxes on it.

SEP IRA versus solo 401(k)

Both accounts let self-employed people save more than a regular IRA, but they work differently. A SEP IRA has a higher contribution limit (25% of income up to $69,000) but requires you to contribute the same percentage for employees. A solo 401(k) has a lower limit ($69,000 total, but split between employee and employer contributions) and doesn't require employee contributions if you're the only worker.

A SEP IRA is easier to set up and maintain — you open it at any financial institution and file no annual paperwork with the IRS. A solo 401(k) requires more setup and annual Form 5500 filing if your account balance exceeds $16,000. If you have no employees and want simplicity, a SEP IRA usually wins. If you have employees and want to avoid contributing for them, a solo 401(k) is the better choice.

Setting up a SEP IRA

Open a SEP IRA by contacting a bank, brokerage, or investment company — Fidelity, Vanguard, Charles Schwab, and most others offer them. You'll fill out a simple form and choose how to invest the money (stocks, bonds, mutual funds, or a mix). There's no IRS approval process; the account is active as soon as the financial institution confirms it.

If you have employees, you must give them written notice of the SEP IRA and allow them to open their own accounts at the same institution. You then contribute the same percentage of their salary that you contribute for yourself. Keep records of the notice you gave employees and the contributions you made each year, in case the IRS asks questions during an audit.

Frequently Asked Questions

Can I have both a SEP IRA and a regular IRA?

Yes, but your regular IRA contributions may not be tax-deductible if you have a SEP IRA and earn above certain income thresholds. The IRS limits total contributions across all IRAs. It's usually simpler to put all your retirement savings into the SEP IRA and skip the regular IRA.

What happens to my SEP IRA if I hire an employee?

You must start contributing the same percentage for that employee as you do for yourself. If this becomes too expensive, you can switch to a solo 401(k) or another plan type, though you'll keep the existing SEP IRA balance and continue to manage it.

Can I withdraw money from my SEP IRA before retirement?

You can withdraw at any time, but withdrawals before age 59½ are subject to a 10% penalty plus income tax on the full amount. A few exceptions exist (disability, medical hardship), but they're narrow. It's best to treat a SEP IRA as money you won't touch until retirement.

Do I have to contribute to my SEP IRA every year?

No. You decide each year whether and how much to contribute. This flexibility is useful if your income fluctuates. However, if you have employees, you must contribute the same percentage for them in any year you make contributions for yourself.

What if my business has no profit one year?

You don't have to contribute anything. Since contributions are based on net profit, a loss or break-even year means zero contribution. This is another advantage of a SEP IRA over a 401(k), where you might have committed to contributions earlier in the year.