If you are self-employed, a freelancer, or a small business owner, a SEP IRA (Simplified Employee Pension Individual Retirement Account) is one of the best retirement savings options available. It offers high contribution limits, easy setup, and significant tax benefits. In this guide, we will explain how SEP IRAs work and how to maximize their benefits.
What is a SEP IRA?
A SEP IRA is a retirement account that allows self-employed individuals and small business owners to make tax-deductible contributions for themselves and their employees. It works similarly to a Traditional IRA but with much higher contribution limits, making it ideal for those with significant self-employment income.
The simple version: A SEP IRA lets self-employed people contribute up to 25% of their net self-employment income (up to $70,000 in 2026) to a tax-deferred retirement account. It is easy to set up and maintain.
How a SEP IRA Works
- Open an account: Set up a SEP IRA at any brokerage firm
- Calculate contribution: Determine how much you can contribute based on income
- Make contribution: Contribute up to the deadline (tax filing date plus extensions)
- Tax deduction: Deduct the full contribution from your taxable income
- Invest the funds: Choose your investments within the account
- Grow tax-deferred: Pay no taxes until you withdraw in retirement
SEP IRA Contribution Limits 2026
SEP IRAs have generous contribution limits compared to other retirement accounts:
- Maximum contribution: Lesser of 25% of compensation or $70,000
- Self-employed calculation: Approximately 20% of net self-employment income after the self-employment tax deduction
- No catch-up contributions: Unlike other retirement accounts, there is no additional amount for those 50 and older
Example: Calculating SEP IRA Contribution
Jennifer is a freelance consultant with $150,000 in net self-employment income.
- Step 1: Calculate self-employment tax deduction (approximately $10,597)
- Step 2: Adjusted income = $150,000 - $10,597 = $139,403
- Step 3: Maximum SEP contribution = $139,403 x 20% = $27,881
Jennifer can contribute $27,881 to her SEP IRA, reducing her taxable income by the same amount.
Who Can Open a SEP IRA?
SEP IRAs are available to:
- Sole proprietors: Freelancers, consultants, gig workers
- Self-employed individuals: Anyone with self-employment income
- Small business owners: LLCs, partnerships, S-corps, C-corps
- Side hustle income: Even with a full-time job, you can have a SEP for self-employment income
SEP IRA Benefits
- High contribution limits: Up to $70,000 in 2026 - far more than Traditional or Roth IRAs
- Tax deductible: Contributions reduce your taxable income dollar-for-dollar
- Easy to set up: Minimal paperwork, often just a one-page form
- Flexible contributions: Contribute different amounts each year based on income
- No annual filing requirements: Unlike 401k plans, no Form 5500 required
- Late contribution deadline: Contribute up to tax filing deadline including extensions
- Investment flexibility: Wide range of investment options
SEP IRA Rules and Requirements
Eligibility Requirements
For sole proprietors with no employees, you only need to meet basic IRA requirements. If you have employees, eligible employees must be included if they:
- Are at least 21 years old
- Have worked for you in at least 3 of the last 5 years
- Have received at least $750 in compensation during the year
Equal Percentage Rule
If you have eligible employees, you must contribute the same percentage of compensation for all participants. You cannot contribute 25% for yourself and 10% for employees.
Important: The equal percentage requirement can make SEP IRAs expensive if you have employees. Consider a Solo 401k or SIMPLE IRA if you want more flexibility.
SEP IRA Withdrawal Rules
SEP IRA withdrawal rules are the same as Traditional IRAs:
- Age 59 1/2 or older: Withdraw without penalty, pay ordinary income tax
- Before age 59 1/2: 10% early withdrawal penalty plus income tax
- Required Minimum Distributions: Must begin at age 73
Early Withdrawal Penalty Exceptions
The 10% penalty is waived for:
- First-time home purchase (up to $10,000)
- Qualified education expenses
- Medical expenses exceeding 7.5% of income
- Disability or death
- Health insurance premiums while unemployed
SEP IRA vs Other Retirement Plans
SEP IRA vs Solo 401k
- Contribution limits: Similar maximum, but Solo 401k allows employee contributions plus employer contributions
- Roth option: Solo 401k offers Roth contributions, SEP IRA does not
- Loan option: Solo 401k may allow loans, SEP IRA does not
- Administration: SEP IRA is simpler with less paperwork
SEP IRA vs SIMPLE IRA
- Contribution limits: SEP IRA has much higher limits ($70,000 vs $16,500)
- Employee contributions: SIMPLE IRA allows employee deferrals, SEP does not
- Employer requirements: SIMPLE IRA requires employer contributions
Example: SEP IRA vs Solo 401k
Mark has $100,000 in net self-employment income and wants to maximize retirement savings.
- SEP IRA: Can contribute approximately $18,587 (20% of adjusted income)
- Solo 401k: Can contribute $23,500 as employee + $18,587 as employer = $42,087
For maximizing contributions, Solo 401k wins. For simplicity, SEP IRA wins.
How to Set Up a SEP IRA
- Choose a provider: Select a brokerage like Fidelity, Vanguard, or Schwab
- Complete IRS Form 5305-SEP: This one-page form establishes your SEP plan
- Open the SEP IRA account: Complete the brokerage application
- Fund the account: Transfer your contribution
- Select investments: Choose how to invest the funds
- Keep records: Maintain documentation of contributions
SEP IRA Strategies
1. Maximize in High-Income Years
Since SEP contributions are flexible, contribute the maximum in years when your income is high and you want to reduce taxes.
2. Combine with Traditional or Roth IRA
You can contribute to both a SEP IRA and a Traditional or Roth IRA in the same year, though Traditional IRA deductibility may be limited.
3. Make Quarterly Estimated Tax Adjustments
Since SEP contributions are tax-deductible, factor them into your estimated tax payments to avoid overpaying throughout the year.
4. Convert to Roth IRA
In lower-income years, consider converting some SEP IRA funds to a Roth IRA to create tax-free retirement income.
Track Your SEP IRA Investments
Pro Trader Dashboard helps you monitor your SEP IRA performance and track your self-employed retirement savings growth.
Summary
A SEP IRA is an excellent retirement savings option for self-employed individuals and small business owners. With contribution limits up to $70,000, easy setup, and minimal administrative requirements, it offers a powerful way to reduce taxes while building retirement wealth. Consider your specific situation, including whether you have employees and how much you want to contribute, when deciding between a SEP IRA and other options like a Solo 401k.
Explore more retirement options in our guides on SIMPLE IRAs and Traditional IRAs.