What Is a SEP IRA? Simplified Employee Pension Plan Explained

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A SEP IRA (Simplified Employee Pension individual retirement account) is a retirement plan that lets an employer, including a self-employed person, make tax-deductible contributions to traditional IRAs set up for themselves and their eligible employees. Only the employer contributes under the SEP. The money goes straight into each person’s own IRA, vests immediately, and follows traditional IRA rules from then on. For 2026, the employer can contribute up to the lesser of 25% of an employee’s compensation or $72,000. That ceiling is far higher than the regular IRA limit, which is the main reason freelancers, sole proprietors and small-business owners use the plan.

How a SEP IRA works

A business usually adopts a SEP by signing a written SEP agreement, often the IRS model Form 5305-SEP or a financial institution’s prototype document, then opens, or has employees open, a traditional IRA for each participant. Unlike a 401(k), a SEP carries none of the testing and administrative work, and generally none of the ongoing operating costs, that come with a conventional employer-sponsored plan.

Some providers require the receiving account to be specifically labeled a SEP IRA. Others will accept SEP contributions into any traditional IRA. Either way, the account is legally a traditional IRA.

The roles are split like this:

• The employer decides whether to contribute in a given year and how much, deposits the money, and takes the tax deduction.
• The IRA trustee or custodian holds the assets, decides which investments are available, accepts deposits, sends annual statements and handles required IRS filings for the accounts.
• The participant chooses investments from what the custodian offers and owns the account outright.

The employer does not pick investments and does not carry the fiduciary burden of running a menu of funds the way a 401(k) sponsor does.

Immediate vesting

Every dollar contributed to a SEP IRA is 100% vested the moment it is deposited. A 401(k) can make employer contributions vest over several years. A SEP cannot, so an employee who leaves the next day keeps the full balance.

Flexible funding

The business is not locked into an annual commitment. It can contribute a large percentage in a profitable year, a small one the next, and nothing when cash is tight. Whatever percentage it chooses for a year must apply uniformly to all eligible employees, including the owner.

Who can be covered

Any business can set up a SEP: sole proprietors, partnerships, corporations and S corporations. The plan document sets the eligibility rules. The strictest requirements an employer may impose are:

1. Age 21 or older.
2. Worked for the employer during any part of at least three of the immediately preceding five years.
3. Received at least $800 in compensation from the employer for 2026.

An employer may choose looser terms, such as no service requirement, but not tighter ones. Anyone who meets the plan’s conditions must be included. Part-time and seasonal workers count if they satisfy the terms.

Two groups may be excluded even if they would otherwise qualify:

• employees covered by a union collective bargaining agreement in which retirement benefits were bargained for in good faith
• nonresident aliens who receive no U.S.-source wages or other compensation for services from the employer

Leaving out an eligible employee is a plan error that has to be corrected, usually by making the missed contributions.

SEP IRA contribution limits

For 2026, the employer contribution to each participant cannot exceed the lesser of 25% of compensation or $72,000. Only the first $360,000 of compensation can be used in the calculation. The 25% figure caps the percentage. It is not a required rate, so an employer can contribute 3%, 10% or anything up to the limit, provided it is the same rate for everyone.

There is no separate employee salary-deferral feature in a standard SEP, so employees cannot elect to put part of their paycheck into it as they can with a 401(k). A participant can still make regular contributions to their own traditional or Roth IRA, subject to the ordinary IRA limit: $7,500 for 2026, plus a $1,100 catch-up for people age 50 or older.

Contributions for a tax year can generally be made up to the due date of the business’s tax return for that year, including extensions. That gives owners time to see the year’s profit before deciding on a rate.

How self-employed owners calculate their contribution

Owners paid W-2 wages. An owner of a corporation, including an S corporation, who receives wages simply applies the plan’s rate to those wages, the same way as for any employee. At 25%, reaching the $72,000 cap would take $288,000 of W-2 compensation ($72,000 ÷ 0.25).

Sole proprietors and partners. These owners have no wages, so the base is net earnings from self-employment. That figure is business profit minus the deductible half of self-employment tax and minus the SEP contribution itself. Because the contribution reduces the base it is calculated from, the plan rate is converted to a reduced rate:

Reduced rate = Contribution rate ÷ (1 + Contribution rate)

With a 25% plan rate, the reduced rate is 0.25 ÷ 1.25 = 20%.

Worked example (hypothetical). A sole proprietor has $100,000 of net profit for 2026 and a plan rate of 25%. Assume the full profit is subject to the combined 15.3% self-employment tax, there are no other businesses or wages, and the person is well under the Social Security wage base.

Applying 25% directly to the $100,000 profit would produce $25,000, overstating the allowable contribution by more than $6,000, and excess contributions are subject to correction and penalty. IRS Publication 560 has a rate table and worksheet for self-employed individuals.

Example with employees (hypothetical)

A business owner with W-2 wages of $150,000 has one eligible employee earning $50,000. The owner wants to contribute 15% for themselves, which is $22,500. Because the percentage must be uniform, the employee must also receive 15%, or $7,500. The business deducts the full $30,000. If the owner instead picked 5%, the amounts would be $7,500 and $2,500. If the business skipped the year, neither would receive anything.

Taxes, withdrawals and rollovers

Tax treatment. Employer contributions to a traditional SEP IRA are deductible by the business and are generally excluded from the employee’s current income. The money grows tax-deferred, so earnings can compound without annual tax until they are withdrawn. Taxable withdrawals are taxed as ordinary income in the year received.

Roth option. The SECURE 2.0 Act of 2022 allows employers to let employees treat SEP contributions as Roth contributions. Those contributions are included in the employee’s income now in exchange for potentially tax-free qualified withdrawals later. Whether this is available depends on the employer’s plan and the custodian’s support.

Withdrawals. SEP money can be withdrawn at any time, because it is IRA money. A withdrawal before age 59½ generally triggers a 10% additional tax on top of income tax unless an exception applies.

No loans. A 401(k) or other qualified plan may let participants borrow up to the lesser of 50% of their vested balance or $50,000. A SEP does not allow loans for anyone, including the owner.

Rollovers. SEP contributions and earnings can be rolled over tax-free to other IRAs and eligible retirement plans under the same transfer and rollover rules that apply to traditional IRAs.

Required minimum distributions. Traditional SEP IRA balances are subject to IRA required minimum distribution rules, which currently begin at age 73.

SEP IRA vs. solo 401(k)

A solo (individual) 401(k) is the main alternative for a self-employed person with no employees other than a spouse. Both allow employer contributions, but they reach the overall limit differently.

The deferral is what changes the math at moderate incomes. Take an owner with W-2 wages of $190,000 in 2026. In a solo 401(k), a $24,500 deferral plus a 25% employer contribution of $47,500 reaches the $72,000 maximum. A SEP with the same wages allows at most $47,500. Reaching $72,000 through a SEP alone would take $288,000 of wages.

The SEP’s advantages are simplicity and flexibility: less paperwork, contribution decisions after year-end, and it still works if the business hires staff. The solo 401(k) offers higher contributions at a given income and the option to borrow, at the cost of more administration.

SEP IRA vs. traditional IRA vs. Roth IRA

These three accounts are often confused because a SEP IRA is technically a traditional IRA. The differences come down to who contributes, how much, and when tax is paid.

Traditional IRA

You contribute and may deduct the contribution, depending on income and workplace plan coverage. The money grows tax-deferred, withdrawals are taxed as ordinary income, and RMDs begin at 73. The 2026 limit is $7,500, or $8,600 with the catch-up at 50 and older. It tends to suit people who expect a lower tax bracket in retirement.

Roth IRA

Contributions are made with after-tax money, and qualified withdrawals in retirement are tax-free. The original owner has no RMDs, so funds can stay invested and pass to heirs. Contributions share the same 2026 limits as a traditional IRA and are restricted at higher incomes. A Roth is usually the better fit for someone who expects a higher bracket later.

SEP IRA

The employer contributes, up to the 2026 cap of $72,000, and deducts the contributions. For a self-employed owner, that deduction is theirs. The account otherwise behaves like a traditional IRA, and having a SEP does not prevent you from also funding your own traditional or Roth IRA.

Limitations of a SEP IRA

• Uniform contributions. An owner with employees cannot give staff a smaller percentage than their own.
• Immediate vesting. No vesting schedule can reward tenure or recover contributions when employees leave.
• Broad coverage. Under the eligibility rules, long-tenured part-timers can qualify.
• No employee deferrals. Staff who want to save their own money through payroll cannot do so in a standard SEP.
• No loans and no catch-up provision. Savers age 50 or older who want extra room must rely on their personal IRA catch-up or a different plan type.
• Lower ceiling at moderate incomes. Because the limit is a percentage of pay, a self-employed person with modest earnings may save much less than in a solo 401(k).

FAQs

The Bottom Line

A SEP IRA fits freelancers, sole proprietors and small-business owners who want a high contribution ceiling with minimal paperwork and the freedom to set the amount after year-end. Owners with staff must fund everyone at the same rate, and those with moderate incomes and no employees may save more through a solo 401(k), which adds an employee deferral and optional loans at the cost of more administration.