What is a SEP IRA? how it works

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A SEP IRA, or Simplified Employee Pension IRA, is a retirement plan for self-employed people and small business owners that allows employer-only contributions to traditional IRAs set up for eligible employees. It’s different because it offers much higher contribution limits than a traditional or Roth IRA while keeping setup and administration relatively simple, according to the IRS.

If you want flexible contributions, tax deductions, and a straightforward retirement plan for a small business, a SEP IRA can be a strong choice. But it can be expensive if you have employees, because eligible workers typically must receive the same contribution percentage as the owner.

What is a SEP IRA?

A SEP IRA is a retirement plan that lets employers make contributions to traditional IRAs for employees. The IRS says any size business, including self-employed individuals, can set up a SEP.

In plain words, this is a simple employer-funded retirement plan that works particularly well:

• self employed person
• Freelancers and contractors
• sole proprietors
• participation
• LLC
• Corporations with a small number of employees

Key Insights: SEP IRAs are funded only by the employer. Employees don’t make salary-deferral contributions the way they can to a 401(k) or SIMPLE IRA.

How does a SEP IRA work?

A SEP IRA works by allowing the employer to contribute to a traditional IRA set up for each eligible employee. Those contributions are typically tax-deductible for the business, and the money grows tax-deferred until withdrawn in retirement.

Here is the basic structure:

• Employer sets up SEP plan
• A SEP IRA is opened for each eligible employee
• The employer decides whether to contribute each year
• Contribution vests immediately
• Withdrawals in retirement are taxed as ordinary income

One of the biggest advantages is flexibility. The IRS says employers can decide each year whether to make contributions, which can help if business income fluctuates.

Who can open a SEP IRA?

A SEP IRA can be opened by any size business, including any self-employed individual. This includes sole proprietors, partnerships, LLCs, and corporations.

Who can use it?

• self employed person
• Freelancer and Gig Worker
• independent contractor
• small business owner
• participation
• corporation
• LLC

Who is eligible to participate in a SEP IRA?

The IRS sets a standard baseline for employee eligibility. For 2026, an eligible employee must generally:

• be at least 21
• Have worked for at least one employer 3 out of the last 5 years
• at least got $800 In compensation from employer in 2026

An employer may choose a less restrictive rule, but not a more restrictive one.

tip: If you have employees, check eligibility carefully before choosing a SEP IRA. A plan that seems simple for a solo business owner may become more expensive once employees qualify.

What are the SEP IRA contribution limits for 2026?

For 2026, SEP IRA contributions are limited to:

• 25% of employee compensation
• $72,000

The IRS also increased the compensation threshold used in retirement-planning calculations to $360,000 for 2026. This makes SEP IRAs more generous than traditional and Roth IRAs, which have much lower annual contribution limits.

Example

If an eligible employee earns $150,000 and the business contributes 25%, the contribution for that year will be $37,500.

However, for self-employed people, the calculation is not always as simple as taking 25% of gross income. The IRS formulas for self-employed SEP contributions adjust for self-employment taxes and other factors, so many business owners use tax software or a CPA to calculate the exact maximum.

What are the main IRS rules for SEP IRAs?

The main SEP IRA rules are fairly straightforward.

Main SEP IRA Rules

• Employer contribution only: Employees do not contribute directly to a SEP IRA
• Immediate implications: Contributions are made immediately by the employee
• Equal Contribution Percentage: If you contribute for yourself, you generally must contribute the same percentage of compensation for eligible employees.
• Flexible Annual Funding: Subject to IRS limits, you can choose how much to contribute each year or not.
• Traditional IRA Tax Treatment: Withdrawals are generally taxed as ordinary income, and early withdrawals may be subject to a 10% penalty unless an exception applies.

What are the tax benefits of a SEP IRA?

A SEP IRA can provide meaningful tax benefits.

main tax benefits

• Employer contributions are generally tax-deductible for the business
• Investments grow tax-deferred until withdrawn
• Contributions can help reduce current taxable business income

The tradeoff is that withdrawals in retirement are typically taxed as ordinary income, just like traditional IRA distributions.

SEP IRA vs. Traditional IRA vs. Roth IRA: What’s the difference?

A SEP IRA is very different from a traditional or Roth IRA when it comes to contribution size and who can fund it.

Speciality	september ira	traditional ira	roth ira
best for	Self-employed people and small business owners	earned income people	People with earned income and eligible income level
who contributes	employer only	Person	Person
2026 contribution capacity	Up to $72,000, subject to limits	Very low annual IRA limits	Very low annual IRA limits
tax treatment now	employer deduction	often deductible	after tax contribution
tax treatment later	taxed on withdrawals	taxed on withdrawals	Qualified Withdrawal Tax-Free
rmd	Yes	Yes	No lifetime RMD for original owner

The biggest reason people choose a SEP IRA is contribution room. If a business has employees, the biggest reason for them leaving it is employee costs.

What are the advantages and disadvantages of SEP IRA?

Pros

• Higher contribution limits: till $72,000 For 2026, subject to IRS rules
• easy setup: The IRS allows employers to set up SEPs with a formal written agreement, which is often used Form 5305-September
• Flexible Contribution: You can decide whether to contribute or not from year to year
• Tax-Deductible Contributions: Helpful in reducing taxable business income
• Other IRA ownership can be combined with: Subject to IRA rules, you can still have a traditional or Roth IRA

Shortcoming

• Employer contribution only: Employees cannot contribute directly to a SEP IRA
• Equal Contribution Percentage for Eligible Employees: Can be expensive if you have staff
• No catch-up contributions: SEP IRAs do not have age-50 catch-up contributions like some other retirement plans.
• RMDs apply: SEP IRAs follow IRA RMD rules starting at age 73.
• Early withdrawal may attract penalties: Generally, 10% before age 59½, unless an exception applies

How do you open a SEP IRA?

Opening a SEP IRA is usually pretty straightforward.

Steps to Open a SEP IRA

1. Choose a financial institution that offers SEP IRAs.
2. execute a formal written contract, often using IRS Form 5305-September If it fits your business structure.
3. Set up a SEP IRA for each eligible employee.
4. Fund the account based on your chosen contribution amount and IRS limits.
5. Choose your investment.

The IRS says you can generally set up a SEP by the due date of a business’s tax return for the year you want to contribute, including extensions for the year you want to contribute.

When does a SEP IRA make sense?

A SEP IRA is often most useful if you:

• are self employed
• running a business with few or no employees
• Want higher contribution limit
• Want the flexibility to contribute more in good years and less in weak years
• Want a simpler plan than a solo 401(k) or a more complex employer plan

This may be especially attractive to high-income self-employed people who want a larger tax cut and faster retirement-plan funding.

When might a SEP IRA not be the best choice?

A SEP IRA may be less attractive if:

• You have multiple employees who are eligible for contributions
• You want employees to contribute from their salary
• You want catch-up contributions after age 50
• You want a plan that is better suited for predictable employee deferments

In those cases, it may make sense to compare a SIMPLE IRA or Solo 401(k).

final take to go

The SEP IRA is a retirement plan designed for self-employed people and small business owners who want higher contribution limits, flexible employer funding, and tax-deductible contributions. For 2026, the contribution limit is the lesser of 25% of compensation or $72,000, making it one of the most powerful retirement tools available to eligible business owners.

This is often very suitable for solo business owners and those with high incomes. But if you have employees, the equal-percentage contribution rule may make a SEP IRA more expensive than it first appears.

Information is accurate as of April 10, 2026.