SEP IRA

A SEP IRA (Simplified Employee Pension IRA) is a retirement account designed for self-employed people and small business owners. It allows contributions of up to 25% of net self-employment income, far exceeding the $7,000 standard IRA limit, with the entire amount tax-deductible.

How it works

A SEP IRA is a personal retirement account, but with much higher contribution limits than a standard IRA. You can contribute up to 25% of your net self-employment income, subject to a cap (currently $69,000 per year for 2024).

For example: if you are a freelancer earning $100,000 in net self-employment income (after business expenses and half of self-employment tax), you can contribute $25,000 to your SEP IRA. If you earn $200,000, you can contribute $50,000 (limited by the cap).

All contributions are tax-deductible, reducing your self-employment income for the year.

Who can open one

• Self-employed sole proprietors. Freelancers, consultants, contractors.
• Business owners with no employees. You can have a SEP even if you have a side business alongside your main job.
• Small business owners. If you have employees, they must be included in the SEP (you must contribute the same percentage for them as for yourself), which is why many switch to a SIMPLE IRA or solo 401(k) once they have staff.

Setup and administration

A SEP IRA is extraordinarily simple to set up. You can open one at any brokerage (Fidelity, Vanguard, Schwab, etc.) in 15 minutes online. There is no annual tax filing (unlike a 401(k) or solo 401(k)), making it the simplest retirement plan for self-employed people.

Contribution mechanics

Contributions are made by the business owner (you), not withheld from payroll. You can contribute at any time before the tax return filing deadline (including extensions). For the 2024 tax year, you can contribute up to April 16, 2025.

The contribution amount is calculated as 25% of net self-employment income, where “net” means gross business income minus half of self-employment tax and the SEP contribution itself.

SEP vs. other self-employed options

SEP IRA vs. Solo 401(k):

• SEP allows slightly higher contributions in some scenarios, but 401(k) allows you to take loans from your balance.
• SEP is simpler to administer; 401(k) requires annual tax filings (Form 5500) if the balance exceeds $250,000.
• SEP is easier to explain to a CPA.
• Solo 401(k) is better if you want the flexibility of loans or if your income varies.

SEP IRA vs. Traditional IRA:

• SEP allows contributions up to 25% of income or $69,000; traditional IRA caps at $7,000.
• Both are pre-tax and tax-deferred.
• SEP is only for self-employed or business owners.

SEP IRA vs. SIMPLE IRA:

• SEP has higher contribution limits ($69,000 vs. $16,000).
• SIMPLE requires employer-employee dynamics (even if you are both); SEP is simpler with no employees.
• If you have employees, SIMPLE is often chosen because the SEP requires you to contribute equally for employees.

Catch-up contributions

If you are 50 or older, you cannot make “catch-up” contributions (the +$1,000 IRA catch-up does not apply to SEPs). However, your 25% limit is higher anyway, so SEPs naturally accommodate older investors.

Withdrawals and tax treatment

Withdrawal rules follow standard IRA rules:

• You can withdraw starting at 59½ without penalty.
• Withdrawals before 59½ trigger a 10% penalty plus income tax (with some exceptions).
• Required minimum distributions begin at 73.

All withdrawals are taxed as ordinary income.

See also