SEP IRA: a Quick and Simple Guide

SEP IRA
As a self-employed business owner, you may be looking for the right kind of plan to save for retirement. But it is easy to become overwhelmed about which is best for your situation or company.

The SEP IRA may be one of the most effortless accounts for self-employed individuals to set up and keep going. It may also be one of the less costly plans for business owners.

It certainly requires much less time spent on paperwork than a traditional 401k account. I know. I’ve had both.

A SEP IRA account has many advantages over other retirement accounts, but only after carefully considering the pros and cons against other types of retirement accounts should you decide.

If you are an employee of a small business or self-employed, you can enroll in this account. Only the employer will make contributions to the account.

What is a SEP IRA?

The SEP in the SEP IRA stands for ‘Simplified Employee Pension.’ This account is essentially like a traditional IRA account but allows for much higher contributions. Each eligible person will have an account opened on their behalf.

The SEP IRA has several benefits besides the higher contribution levels, including the ease of setup and account maintenance and the ability to be 100% vested once the account is established.

A SEP IRA account contributions are also tax deductible on income taxes. The investments made are tax-deferred until the funds are withdrawn.

A business owner with or without employees can establish a SEP IRA.

Who is Eligible for a SEP IRA?

A SEP IRA account may be the right option for employers who want to contribute high amounts to their retirement accounts and contribute to partners in the company or employees in a small business.

You are eligible to contribute to a SEP IRA if you are a business owner, a part of a partnership, or a sole proprietor.

You are also eligible for this type of retirement account if you earn any income from self-employment, even when you have a full-time job elsewhere and are enrolled in another retirement plan.

An advantage to having a SEP IRA account is that, unlike other plans, there are no income limits.

Part-time employees who are 21 years or older, have worked three out of the previous five years and earned the plan must cover $500 or more years. Employers can choose to provide coverage for employees under 21 at their discretion.

SEP IRA Rules

  • A SEP IRA account must be set up and funded by the tax filing deadline of the sole proprietorship or the business if it has been incorporated.
  • To establish a SEP IRA, you must have an agreement in writing to make provisions for eligible employees.
  • The owner of a self-employed business is considered an employee when relating to a SEP IRA account and an employer.
  • There is an agreement form, Form 5305-SEP, available from the IRS.
  • Unlike a traditional 401k retirement account, you can not borrow against the funds in a SEP IRA account.

SEP IRA Withdrawal Rules

Withdrawing from a SEP IRA isn’t without risks; contributions made before age 59 ½ may be subject to a 10% penalty, and RMDs must begin the year after you turn 70 ½.

To ensure you don’t face costly penalties, know your tax return date and make sure that any withdrawals are made before then. Make sure pre-tax contributions are withdrawn first to avoid any extra taxes.

SEP IRA Contribution Limits

The amount of a SEP IRA contribution is capped at 25% of compensation. In 2023, the contribution allowance is at $66,000 annually. Contributions are not mandatory in every year where there is a net profit.

You also do not need to maintain a certain level of contributions. You have the freedom to make a choice.

For instance, you can make the full contribution one year and only a smaller percentage the following year.

You can also contribute nothing in the following year, even if there was a net profit.

The money is yours for employees with a SEP IRA account once the employer makes an account contribution. Only the employer makes contributions to the account.

SEP IRA vs. Solo 401k

Let’s compare the two self-employed retirement plan types:

A SEP IRA is designed for self-employed individuals or small business owners who want to make tax-deferred contributions toward their golden years.

Like a traditional individual retirement account (IRA), the SEP offers higher contribution limits with business bonus benefits.

For those who have no employees beyond their spouse, there’s the Solo 401k – an individual retirement plan with higher overall contribution limits than the SEP IRA.

Understanding how each plan works can help determine which makes more sense for your situation. Learn more by checking out our big comparison of all self-employed retirement accounts.

Find a Good SEP IRA Calculator

If you are considering a SEP IRA account but are not completely confident that it is the right account for your retirement savings or your business, you can check your actual figures by using a calculator specific to the SEP IRA account.

There are several retirement fund calculators available online. Enter your information to see if this account is right for your situation and retirement savings.

Where to Open a SEP IRA?

SEP IRAs can be established at a bank, mutual fund, brokerage house, or any other financial institution.

Common places to open one include Vanguard, Schwab, and Fidelity. A SEP IRA account can be established for a business typically within a day after the agreement form is completed.

Betterment, the Roboadvisor I used for some of my taxable investing, offers a SEP IRA. Visit my review of Betterment for more info.

You can also set up a SEP IRA with Vanguard like I did. They have minimums on their funds, so be sure to have lots of cash ready to get started with them.

Again, many options are available for retirement accounts for small business owners and the self-employed.

Compare the SEP IRA to other traditional retirement accounts to see which has the most advantages for your situation.

Steps to Open a SEP IRA

Setting up a SEP IRA is relatively simple:

First, choose an IRA custodian who can open and maintain your SEP IRA.

Then, decide how much you want to contribute each year, taking into account any limitations on deductibility.

Next, complete the necessary paperwork with the custodian and arrange for funds to be transferred or deposited into the account, including applicable contribution forms or related tax documents such as a Form 1040-ES.

Finally, monitor contributions throughout the year and make sure to report them appropriately on your annual tax return.

Are you planning to open a SEP IRA? What do you like about the account?

Avatar About Philip Taylor, CPA

Philip Taylor, aka "PT", is a CPA, blogger, podcaster, husband, and father of three. PT is also the founder and CEO of the personal finance industry conference and trade show, FinCon.

He created Part-Time Money® back in 2007 to share his advice on money, hold himself accountable (while paying off over $75k in debt), and to meet others passionate about moving toward financial independence.

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  1. Avatar Bret @ Hope to Prosper says

    My apologies, it looks like you did cover this under your section on SEP IRA Rules.

  2. Avatar Bret @ Hope to Prosper says

    One thing you forgot to mention is that a SEP IRA may require you to start accounts for your employees. So, if you are an Entreprenuer who wants to contribute to your own retirement, but not all of your employees, a SEP IRA may not be ideal.

    I’m not an accountant or tax specialist, so you should check it out yourselves first. But, I believe the contribution laws for a SEP changed around 1997.

  3. PT,

    Aren’t there different rules as to when you can open one? End of year vs. End of Tax Year?