SEP IRA Explained

By Ryan O'Connell, CFA, FRM Published October 14, 2026

A SEP IRA lets an employer fund retirement savings through individual accounts, with simple administration and flexible annual contributions. Freelancers must determine how much business income supports a contribution; employers with staff must also fund eligible employees’ accounts. This guide explains both decisions using U.S. federal rules and 2026 limits. For the broader framework, see retirement planning and accounts.

What Is a SEP IRA?

SEP stands for Simplified Employee Pension. The SEP is the employer’s written retirement plan; the SEP IRA is the participant’s account receiving contributions. Each participant owns and controls their IRA.

Employers of any size, including self-employed people, can establish a SEP. A partnership establishes the plan for its partners; partners do not each establish a separate plan for the partnership’s earnings. A standard newly established SEP uses employer contributions, rather than employee salary deferrals. Older salary-reduction SEPs, called SARSEPs, are a separate legacy arrangement that cannot be newly established. A traditional SEP IRA otherwise follows many of the personal IRA rules outlined in our retirement account guide. [2]

Who Must Be Included in a SEP Plan?

The most restrictive permitted eligibility requirements generally include an employee who:

• Has reached age 21.
• Worked for the business in at least three of the preceding five years.
• Receives at least $800 of compensation in 2026.

The written plan can be more generous, but cannot impose stricter tests. Its requirements apply equally to owners and other employees. Even a small amount of part-time or seasonal work counts as service in a year under the three-of-five test. Eligible employees who quit before year-end or before the contribution deposit still share in the contribution. Limited exclusions exist for certain collectively bargained employees and nonresident aliens without U.S.-source compensation. [1] [2]

Contributions can vary or be zero each year. In a funded year, the employer must follow the written formula and cover every eligible participant. Most SEPs, including IRS Form 5305-SEP, require the same compensation percentage for everyone. The owner cannot fund only their own account while omitting eligible staff. [2]

SEP IRA Contribution Limits for 2026

For an employee, an annual SEP contribution generally cannot exceed the lesser of 25% of compensation or $72,000 in 2026. Compensation considered is capped at $360,000. The plan’s chosen percentage can produce a much lower contribution than either maximum. These limits must also be coordinated with other defined-contribution plans of the same employer. [1] [2]

Employer SEP contributions must be made in cash, not by contributing personally owned shares or other property. A standard SEP has no employer-contribution catch-up allowance at age 50. Being older does not increase its $72,000 ceiling. [2]

Why Self-Employed Owners Often Use a 20% Rate

A sole proprietor’s contribution is not 25% of revenue or unadjusted Schedule C profit. For the traditional SEP calculation, retirement-plan earnings account for both the deductible portion of self-employment tax and the owner’s contribution itself. The IRS reduced-rate method solves that circular calculation:

The 20% effective rate applies when the plan rate is 25%. A lower plan rate produces a different reduced rate. Do not subtract the contribution again after using the reduced-rate method. Use the IRS worksheet for the compensation cap, other plans, and your final deduction. An S-corporation shareholder instead bases contributions on employee compensation; shareholder distributions do not create retirement-plan earned income. [3]

How SEP IRA Taxes Work

Within applicable limits, traditional SEP contributions are deductible to the employer and excluded from the participant’s current gross income. Investment income and gains generally accumulate without current income tax inside the IRA. Taxable withdrawals later receive ordinary-income treatment, rather than the preferential long-term capital-gains rate. Any properly tracked nondeductible IRA basis requires separate treatment. [2] [9] Our personal tax strategy guide explains how deductions differ from tax credits.

Traditional employer SEP contributions use a different limit from your own regular IRA contributions. In 2026, the combined regular Traditional and Roth IRA limit is $7,500, plus a $1,100 catch-up at age 50 or older, for a total of $8,600, subject to compensation and other eligibility rules. [1] A traditional SEP IRA may also accept regular IRA contributions if the custodian permits them, but these share that individual limit with your other IRAs. SEP coverage can restrict the deduction for a regular Traditional IRA contribution; a separate ordinary Roth IRA contribution still requires Roth eligibility. For more on the separate Roth account, see our retirement account comparison. [5]

Can a SEP IRA Be Roth?

Federal law permits Roth SEP contributions for tax years after 2022, but an employer need not offer the option. If offered, the participant must affirmatively elect Roth treatment before the deposit. The plan and custodian must support the arrangement; opening an ordinary Roth IRA alone does not establish a Roth SEP contribution process.

An employer’s Roth SEP contribution is included in the participant’s income in the year actually deposited, even when made for the employer’s prior tax year. IRS guidance requires Form 1099-R reporting, and current Form 5498 instructions identify Roth SEP contributions separately from regular Roth contributions. These employer contributions are not wages subject to federal income-tax withholding, FICA, or FUTA; participants may nevertheless need additional withholding or estimated payments to cover income tax. Qualified Roth withdrawals are tax-free only when the applicable five-tax-year requirement and a qualifying event, such as reaching age 59½, are satisfied. The original Roth SEP IRA owner has no lifetime RMDs, although beneficiaries have distribution requirements. [9] [6]

Investments, Costs, and Choosing a SEP Custodian

A SEP IRA is a tax arrangement, not an investment. Depositing cash does not automatically choose a portfolio. Available securities and trading permissions depend on the custodian. Diversification, fund expenses, trading charges, and investment risk still matter; our personal investing fundamentals guide covers those decisions. An asset allocation strategy should reflect the participant’s time horizon and risk capacity.

Participant loans are prohibited, and self-dealing transactions can jeopardize IRA treatment. Immediate ownership of SEP deposits does not allow you to borrow from the account or use its assets as business operating cash without considering the IRA rules. [7] [5]

Questions to Resolve Before Opening an Account

• Plan and account support. Does the financial institution accept the written SEP arrangement you intend to use, and how will each eligible participant’s IRA be established?
• Roth implementation. If desired, can the employer and custodian support the Roth SEP election, contribution classification, and required reporting? Statutory permission alone does not establish a working deposit process.
• Investment access. Which holdings are available, and what approvals or restrictions apply? Do not treat a trading permission as a standard feature of every SEP IRA.
• Total costs. Compare account maintenance, trading, advisory, fund, and transfer charges where applicable. Our expense ratio guide explains a recurring investment cost that can remain even when an account has no maintenance fee.
• Funding and transfers. Confirm accepted cash-deposit methods, processing cutoffs, contribution coding, tax forms, and whether investments can move directly to another custodian.

These are comparison questions, not universal account requirements or a quoted fee schedule. For background on account permissions, see our investing fundamentals guide. The employer remains responsible for plan coverage and contributions; the participant remains responsible for investment choices within the account. Keep retirement funding separate from the business cash needs addressed in your financial plan.

How to Establish, Fund, and Report a SEP

1. Choose an appropriate written agreement. Options include IRS Form 5305-SEP, a provider prototype, or an individually designed plan. Form 5305-SEP has restrictions, including when the employer maintains another qualified plan.
2. Identify all eligible participants. Review service and compensation records, including seasonal workers. Related businesses and leased employees can require professional coverage analysis.
3. Provide employee information and establish participant IRAs. Keep the adopted agreement; Form 5305-SEP is not filed with the IRS.
4. Calculate and deposit contributions. Use the plan’s allocation formula, current limits, and the self-employed worksheet where applicable. Keep the intended contribution year clear in employer records.
5. Maintain annual records. Provide contribution statements and required plan information; review eligibility and document changes each year.

A SEP can generally be established and funded for a year by the due date of the employer’s federal income-tax return, including extensions. The business’s filing form determines the deadline; there is no universal April 15 SEP deadline. Ask the custodian about its processing cutoffs. Generally, the employer has no annual Form 5500 filing requirement, but still has notice, recordkeeping, and tax-return responsibilities. [8]

The custodian reports SEP deposits on Form 5498 for the calendar year actually deposited. A deposit made the following year for the prior business tax year can therefore appear on a later Form 5498. Reconcile employer records and the deduction instead of assuming the form’s year proves an error. Roth SEP contributions have the additional reporting described above. [6]

Withdrawals, Transfers, and Inheritance

An employer cannot require deposited SEP money to stay in the account. However, immediate ownership does not make withdrawals tax-free. A traditional SEP withdrawal generally includes taxable ordinary income and, before age 59½, a 10% additional tax on its taxable portion unless an exception applies. An exception to that additional tax does not necessarily remove ordinary income tax. [2] [9]

Traditional SEP IRAs also have required minimum distributions. An owner turning 73 in 2026 generally has a first lifetime RMD for 2026; the applicable age is 75 for those born in 1960 or later. The first RMD can generally be delayed until April 1 of the following year, but later annual RMDs are due December 31. Still working does not postpone an IRA owner’s RMDs. Delaying the first can put two taxable distributions in one calendar year. For people born in 1959, the saved final regulation reserves the age provision while the accompanying proposal specifies age 73; recheck finalized guidance before that cohort reaches 73 in 2032. [9]

To change custodians, arrange a direct trustee-to-trustee transfer and confirm the receiving account can accept the assets. Taking possession of money instead may trigger a generally 60-day rollover deadline and the IRA limit of one rollover in any 12-month period across your IRAs. Direct IRA transfers avoid those constraints. A traditional SEP-to-Roth conversion generally makes pre-tax amounts taxable. Required minimum distributions cannot be rolled over. For the broader distinction between rollovers and retirement accounts, see our retirement account overview. [5]

Keep beneficiaries current. After death, a traditional SEP IRA follows IRA beneficiary rules: spouses have special options, and many nonspouse designated beneficiaries face a ten-year payout requirement, sometimes with annual distributions as well. The beneficiary category and owner’s death timing matter. For further planning context, see our estate planning guide. [9]

Plan for incapacity as well as death. Discuss documented account authority with an attorney and ask the custodian what it will require from an authorized representative. Separately, a business owner should arrange for someone to locate the plan agreement, employee records, and contribution history if the owner cannot manage the business. These practical steps do not establish any particular person’s legal authority.

SEP IRA vs. Traditional IRA, SIMPLE IRA, and Solo 401(k)

A SIMPLE IRA offers employee salary deferrals. A Solo 401(k) generally covers an owner with no employees, or the owner and spouse; hiring eligible staff changes the analysis. Compare employee costs, desired deferrals, deadlines, and administration. For more on these employer-plan choices, see our retirement plan comparison. [2] [10]

Common SEP IRA Mistakes

• Multiplying sales by 25%. Employee compensation and self-employed adjusted earnings are different from gross revenue.
• Ignoring eligible workers. Part-time service counts, and quitting does not automatically eliminate entitlement.
• Confusing the two contribution limits. Employer SEP deposits and personal regular IRA contributions need separate classifications.
• Assuming every provider offers Roth SEP. Legal permission does not establish a supported deposit and reporting workflow.
• Treating the IRA as business cash. No participant loan is available; distributions can have tax consequences.
• Using only a broker’s tax summary. Check current IRS amounts, the plan document, and applicable correction procedures when an error occurs.

Limitations of a SEP IRA

Compare account charges, investment expenses, permitted holdings, and transfer procedures before choosing a custodian. Simplicity may be valuable, but it does not make a SEP the best retirement arrangement for every business.

Someone who wants employee salary deferrals, or whose staff-funding cost is high under a uniform SEP percentage, should compare the actual plan designs before adopting one. A Solo 401(k)’s employee deferral opportunity can increase savings capacity at lower earnings, but elective deferral limits must be coordinated with deferrals to another employer’s 401(k). More contribution flexibility may bring more administrative obligations. [10]

Sources and Rule Dates

Research checked October 13, 2026, using saved IRS primary evidence and selected fresh public retrievals. Dollar figures refer to tax year 2026. Publications 560 and 590-A/590-B are 2025 editions; their older dollar examples do not replace the 2026 limits. The cited eCFR evidence is the saved October 1, 2026 version; the 1959 RMD distinction is qualified above.

1. IRS: 2026 retirement-plan COLA tables and Notice 2025-67.
2. IRS Publication 560 (2025), chapters 2, 3, and 5 and SEP FAQs. The FAQ retains older numeric examples; use source [1] for 2026 figures.
3. IRS: S-corporation retirement contributions.
4. IRS Topic 554: Self-employment tax.
5. IRS Publication 590-A (2025): Contributions, transfers, and prohibited transactions.
6. IRS Notice 2024-2, section K, Q&A K-1 through K-8 and 2026 Forms 1099-R/5498 instructions.
7. IRS: Retirement-plan loans.
8. IRS: SEP plan operation and notices.
9. IRS Publication 590-B (2025): Distributions and beneficiaries, 2024 final RMD regulations and accompanying proposal, and 26 CFR 1.408-8: IRA distribution requirements.
10. IRS: One-participant 401(k) plans.