If you are self-employed or own a small business, a Simplified Employee Pension IRA (SEP IRA) is one of the best ways to save for retirement. With contribution limits much higher than traditional IRAs, a SEP IRA lets you put away substantial amounts while reducing your tax bill. This guide covers everything you need to know.
What is a SEP IRA?
A SEP IRA is a retirement account designed for self-employed individuals and small business owners. It works similarly to a Traditional IRA but allows for much larger contributions. The employer (which is you, if self-employed) makes all contributions, and they are tax-deductible.
Key advantage: While a Traditional IRA limits you to $7,000 per year, a SEP IRA allows contributions up to $70,000 in 2025. This makes it one of the most powerful tax-advantaged retirement vehicles available.
SEP IRA Contribution Limits for 2025
The contribution limit for a SEP IRA is the lesser of:
- 25% of net self-employment income (after the self-employment tax deduction)
- $70,000 maximum
SEP IRA Contribution Example
You are a freelance consultant with $150,000 in net self-employment income.
- After self-employment tax adjustment, your eligible compensation is approximately $139,000
- 25% of $139,000 = $34,750
- You can contribute up to $34,750 to your SEP IRA
- This reduces your taxable income by $34,750
Who Can Open a SEP IRA?
SEP IRAs work for various self-employment situations:
- Sole proprietors: Freelancers, consultants, gig workers
- Small business owners: LLCs, partnerships, S-corps, C-corps
- Side business income: Even if you have a day job with a 401(k)
- 1099 contractors: Independent contractors with self-employment income
SEP IRA vs Other Retirement Plans
SEP IRA vs Traditional IRA
| Feature | SEP IRA | Traditional IRA |
|---|---|---|
| 2025 Contribution Limit | $70,000 (or 25% of income) | $7,000 ($8,000 if 50+) |
| Who Contributes | Employer only | Individual |
| Tax Treatment | Tax-deductible, tax-deferred growth | Same |
| Setup Complexity | Simple one-page form | Very simple |
SEP IRA vs Solo 401(k)
Both are excellent for self-employed individuals. Key differences:
- Contribution flexibility: Solo 401(k) allows both employee and employer contributions; SEP IRA is employer-only
- Loan provisions: Solo 401(k) may allow loans; SEP IRA does not
- Roth option: Solo 401(k) can have Roth contributions; SEP IRA cannot
- Administration: SEP IRA is simpler; Solo 401(k) requires more paperwork once assets exceed $250,000
Tax Benefits of a SEP IRA
A SEP IRA provides powerful tax advantages:
1. Tax-Deductible Contributions
Every dollar you contribute reduces your taxable income. In the 32% tax bracket, a $30,000 contribution saves you $9,600 in federal taxes.
2. Tax-Deferred Growth
Your investments grow without annual taxation on dividends, interest, or capital gains. This allows for faster compounding.
3. Reduces Self-Employment Tax Calculation
While SEP contributions do not directly reduce self-employment tax, the contribution itself is calculated after the SE tax deduction, maximizing efficiency.
Tax planning tip: In high-income years, maximize your SEP IRA contribution. In lower-income years, you can contribute less or skip contributions entirely. This flexibility is a major advantage over other retirement plans.
How to Set Up a SEP IRA
Setting up a SEP IRA is straightforward:
Step 1: Choose a Provider
Open a SEP IRA at a brokerage firm like Fidelity, Schwab, or Vanguard. Most charge no fees for the account itself.
Step 2: Complete IRS Form 5305-SEP
This simple one-page form establishes your SEP plan. You keep it for your records; it is not filed with the IRS.
Step 3: Fund the Account
Transfer money from your business bank account. You have until your tax filing deadline (including extensions) to make contributions for the prior year.
Step 4: Invest the Funds
Choose your investments from stocks, bonds, ETFs, mutual funds, and other options available at your brokerage.
SEP IRA Withdrawal Rules
SEP IRAs follow the same withdrawal rules as Traditional IRAs:
Standard Withdrawals
- Withdrawals after age 59.5 are taxed as ordinary income
- No 10% penalty applies after 59.5
Early Withdrawals
- Withdrawals before 59.5 incur ordinary income tax plus 10% penalty
- Exceptions exist for disability, medical expenses, first-time home purchase, and others
Required Minimum Distributions
RMDs begin at age 73. You must withdraw a minimum amount each year based on your account balance and life expectancy.
SEP IRA Investment Strategies
1. Focus on Growth
Since withdrawals will be taxed as ordinary income regardless of investment type, focus on total return rather than tax-efficient investments.
2. Diversify Appropriately
A mix of US stocks, international stocks, and bonds based on your age and risk tolerance provides a solid foundation.
3. Consider Your Other Accounts
If you also have a Roth IRA, place higher-growth investments there (where gains are tax-free) and more conservative investments in your SEP IRA.
4. Rebalance Regularly
Without tax consequences for selling within the account, rebalance annually to maintain your target allocation.
SEP IRA Considerations for Employers
If you have employees, SEP IRAs have specific requirements:
- You must contribute the same percentage for all eligible employees as you do for yourself
- Employees must be included if they are 21+, worked for you in 3 of the last 5 years, and earned at least $750
- This can make SEP IRAs expensive if you have employees
If you have employees, a SIMPLE IRA or 401(k) may be more cost-effective since employees can make their own contributions.
Track Your Self-Employment Investments
Pro Trader Dashboard helps self-employed traders and investors track their SEP IRA and other accounts, providing a complete picture of your financial progress.
Common SEP IRA Mistakes to Avoid
- Missing contribution deadlines: Contribute by your tax filing deadline including extensions
- Over-contributing: Exceeding the 25% limit results in penalties
- Forgetting about employees: If you have eligible employees, you must include them
- Not contributing in good years: Variable income makes tax planning essential
- Early withdrawals: The 10% penalty plus taxes makes this costly
Summary
A SEP IRA is an excellent retirement savings tool for self-employed individuals and small business owners. With contribution limits up to $70,000 and simple administration, it offers significant tax benefits and flexibility. Whether you are a freelancer, consultant, or business owner, a SEP IRA can help you build substantial retirement savings while reducing your current tax bill.
Compare your options with our Solo 401(k) guide or learn about trading in retirement accounts.