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. It's an IRA that lets you contribute up to 25% of your net self-employment income, or $69,000 per year (as of 2024), whichever is less. A regular IRA caps you at $7,000 per year. The trade-off is simplicity: a SEP IRA has almost no paperwork to set up, but you can't borrow from it, and if you have employees, you must contribute the same percentage for them that you contribute for yourself.

You open a SEP IRA through a bank, brokerage, or investment firm the same way you'd open any IRA. The money grows tax-deferred, and you pay income tax when you withdraw it in retirement. You can set up a SEP IRA until the tax filing deadline for that year—usually April 15 of the following year—which gives you time to decide after you know your income.

Key Takeaways

  • A SEP IRA lets you contribute up to 25% of your net self-employment income or $69,000 per year, much higher than a regular IRA's $7,000 limit.
  • You can open a SEP IRA as late as your tax filing deadline, so you can wait until after the year ends to decide how much to contribute.
  • If you have employees, you must contribute the same percentage of salary for them as you do for yourself, which can make a SEP expensive if you have staff.
  • Money in a SEP IRA grows tax-deferred, but you cannot borrow against it or withdraw early without paying a 10% penalty plus income tax.

Who should open a SEP IRA

A SEP IRA makes sense if you're self-employed, a freelancer, a contractor, or a small business owner with no employees (or only a handful). The higher contribution limit means you can save significantly more than a regular IRA allows. If you have a side business in addition to a W-2 job, you can open a SEP IRA based on your self-employment income from the side work alone.

A SEP IRA is less useful if you have full-time employees. Because you must contribute the same percentage for each employee as you do for yourself, adding staff can quickly become expensive. For example, if you contribute 20% of your own income and you have three employees earning $50,000 each, you must also contribute 20% of their salaries—$10,000 per employee per year. A Solo 401(k) or a SIMPLE IRA may be better choices if you have employees.

How contributions work and when you can make them

You calculate your SEP IRA contribution based on your net self-employment income, which is your business income minus half of your self-employment tax. The IRS provides a worksheet to figure this out, and your tax preparer can calculate it for you. You don't have to contribute the same amount every year—you can contribute nothing in a year your business loses money, or contribute the maximum when business is good.

You can make contributions for a tax year until the deadline to file your tax return, including extensions. If you file by April 15, that's your deadline. If you file an extension, you can contribute until October 15. This flexibility means you can wait until after the year ends to see how much profit you made, then decide how much to set aside.

Tax treatment and withdrawal rules

Contributions to a SEP IRA reduce your taxable income for the year you make them. If you contribute $30,000 to a SEP IRA in 2024, you report that $30,000 as a deduction on your tax return, lowering your taxable income. The money inside the account grows without being taxed each year—you only pay tax when you withdraw it.

You cannot withdraw money before age 59½ without paying a 10% early withdrawal penalty plus income tax on the amount withdrawn. There are narrow exceptions: disability, medical expenses above 7.5% of your adjusted gross income, and a few others. You cannot borrow against a SEP IRA the way you can with a 401(k). Starting at age 73, you must take required minimum distributions each year, calculated based on your age and account balance.

SEP IRA versus Solo 401(k)

A Solo 401(k) is another option for self-employed people with no employees. It allows higher total contributions than a SEP IRA in some cases, and it lets you borrow against the account. However, a Solo 401(k) requires more paperwork and record-keeping. A SEP IRA is simpler to set up and maintain, which is why many solo business owners choose it.

If you have employees, a Solo 401(k) won't work—you'd need a regular 401(k) or a SIMPLE IRA. A SIMPLE IRA has lower contribution limits than a SEP but lower employer contribution requirements. Talk to a tax professional about which structure fits your situation.

Setting up a SEP IRA: the actual steps

Choose a financial institution—a bank, brokerage like Fidelity or Vanguard, or an investment firm. Most have SEP IRA options available online. You'll provide your name, Social Security number, and basic business information. You'll choose how to invest the money: stocks, bonds, mutual funds, or a mix. The institution will give you a document to sign that establishes the plan.

That's it. There's no IRS form to file to set up a SEP IRA, no approval process, and no annual reporting requirement unless you have employees. If you do have employees, you must give them a copy of the plan document and notify them of their rights. You report contributions on your tax return when you file.

What happens if your business situation changes

If you hire your first employee, you must start contributing to their SEP IRA at the same percentage you contribute for yourself. If you already have a SEP IRA with money in it, that money stays in the account—you don't lose it. You simply have to start making matching contributions for the employee going forward.

If you close your business or stop being self-employed, your SEP IRA doesn't close. The money stays invested and grows until you withdraw it. You can still make contributions for the year you close the business, as long as you had self-employment income that year.

Frequently Asked Questions

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

Yes, but your total contributions to both accounts in a single year cannot exceed the SEP IRA limit. If you contribute $7,000 to a regular IRA, you can only contribute $62,000 to a SEP IRA that year (assuming the $69,000 limit applies). Most people with a SEP IRA skip the regular IRA to avoid this complication.

What if I have a spouse who's also self-employed?

Each spouse can open their own SEP IRA based on their own self-employment income. You file separate tax returns, so each person's contribution is calculated independently. If you file jointly, you can still each have a SEP IRA—the joint filing status doesn't change how SEP contributions work.

Can I withdraw money from my SEP IRA to pay business expenses?

No. A SEP IRA is a retirement account, not a business account. Money you put in is locked until age 59½ (with limited exceptions). If you need cash for business expenses, keep that money in your business account, not in a retirement account.

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

No. You can contribute in years when your business is profitable and skip years when it's not. This flexibility is one reason self-employed people choose a SEP over a Solo 401(k), which has more rigid rules about contributions.