How Does a Simplified Employee Pension (SEP) IRA Work?

Retirement savings accounts known as SEP IRAs have distinct advantages

A simplified employee pension (SEP) IRA is a retirement savings plan established by employers for the benefit of their employees and themselves. It can also be established by self-employed individuals. Employers may make tax-deductible contributions on behalf of eligible employees to their SEP IRAs.

SEPs are advantageous because they are easy to set up, have low administrative costs, and allow an employer to determine how much to contribute each year. SEP IRAs also have higher annual contribution limits than standard IRAs. What's more, employer contributions vest immediately.

Fundamentally, a SEP IRA can be considered a traditional IRA with the ability to receive employer contributions.

Key Takeaways

  • A SEP IRA is an employer-sponsored retirement plan that can be set up by sole proprietors, partnerships, and corporations.
  • You must have earned at least $650 in 2022 from an employer to qualify for a SEP ($750 in 2023).
  • SEP IRA annual contribution limits are significantly higher than those for traditional IRAs.
  • Employers, not employees, make contributions to SEP IRAs, and the decision about whether and how much to contribute each year can vary.
  • Employees manage the investment decisions of their SEP IRAs within the limits set up by the plan’s trustee.

SEP Account: Jessica Perez

How a SEP IRA Works

SEP IRAs are an attractive retirement plan option for many business owners because they're simple to set up and manage, low cost, and flexible. Plus, they have generous contribution limits and offer tax benefits.

For example, a SEP IRA does not come with many of the start-up and operating costs that most conventional employer-sponsored retirement plans have.

Many employers also set up a SEP plan so that they can contribute to their own retirement at higher levels than a traditional IRA allows. Workers can open a SEP for a separate self-employed business even if they participate in an employer's retirement plan at a second job.

SEP IRA accounts are treated like traditional IRAs for tax purposes and allow the same investment options. The same transfer and rollover rules that apply to traditional IRAs also apply to SEP IRAs.

Employers receive a tax deduction for the contributions they make to every employee's SEP IRA account. Additionally, the business is not locked into an annual contribution. Decisions about whether and how much to contribute can change each year.

Another advantage for business owners is that they're not responsible for making investment decisions. Instead, the IRA trustee determines eligible investments, and the individual employee account owners make specific investment decisions. The trustee also deposits contributions, sends annual statements, and files all required documents with the IRS.

Who Can Participate in a SEP IRA Plan?

According to IRS rules, an individual must be at least 21 years old, have worked for the employer in at least three of the previous five years, and have received a minimum of $650 in 2022 ($750 in 2023) in compensation from the employer during the current year to qualify for an employee SEP IRA.

Individual employers are allowed to be less restrictive in their qualification requirements for their specific SEP IRA plans but may not be more restrictive than IRS rules.

SEP IRAs are tax-deferred accounts and have the same investment options as traditional IRAs. Employers can take a tax deduction for contributions to employee accounts.

Employers may exclude certain types of employees from participating in a SEP IRA, even if they would otherwise be eligible based on the plan’s rules. For instance, workers who are covered in a union agreement that bargains for retirement benefits can be excluded. So can workers who are immigrants without papers as long as they do not receive U.S. wages or other service compensation from the employer.

SEP IRAs were primarily designed to encourage businesses that would otherwise not set up employer-sponsored plans to offer retirement benefits to their employees. Sole proprietors, partnerships, and corporations can establish SEPs.

SEP IRA Contributions

One big advantage of a SEP IRA is the amount that can be contributed annually. For 2022, contribution amounts can be up to the lesser of 25% of the employee’s compensation for the year or $61,000 ($66,000 for 2023). The limit on compensation used to calculate the contribution is $305,000 for 2022. For 2023, the limit is $330,000.

This contribution limit is significantly higher than the $6,000 ($6,500 in 2023) limit imposed on standard IRAs (even when including the extra $1,000 catch-up contribution allowed for anyone aged 50 or over).

The deadline for contributions is the tax filing deadline (plus extensions) of the company or self-employed individual who sets up the SEP IRA.

Frequently Asked Questions

Can Employers Contribute Different Amounts for Different Employees?

No. IRS regulations for SEP-IRAs call for employers to contribute equal amounts to every eligible employee's SEP-IRA account.

Does a SEP IRA Have Any Downsides?

While the SEP IRA plan has great advantages for employers, their employees, and sole proprietors with no employees, it has a few rules that could prove a disadvantage for some. For one, if employers want to make a contribution to their own accounts, they must make contributions to every eligible employee's account, as well. Assets in a plan can't be used as collateral for a loan.

Further, employees aren't allowed to make contributions to their SEP IRA account. Whatever the employer contributes is what they get.

Can I Withdraw Money From a SEP IRA Before I Retire?

Yes, you can; however, any amount that you withdraw before the age of 59½ will be considered taxable income at your current tax rate and may be subject to an additional 10% tax. There are some exceptions to this, so if you're considering it, be sure to speak with your financial advisor or tax consultant.

The Bottom Line

A SEP IRA is a good option for retirement planning. It can be offered by an employer but is also available to the self-employed. Contribution limits are high, particularly when compared to traditional or Roth IRAs, allowing savers to put away more money.

Article Sources
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  2. Internal Revenue Service. "Simplified Employee Pension Plan (SEP)."

  3. Internal Revenue Service. "2023 Limitations Adjusted as Provided in Section 415(d), Etc.," Page 2.

  4. Internal Revenue Service. "SEP Plan Fix-It Guide - Eligible Employees Were Excluded From Participating."

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  6. Internal Revenue Service. "Publication 560, Retirement Plans for Small Business."

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  9. Internal Revenue Service. "401(k) Limit Increases to $22,500 in 2023, IRA Limit Rises to $6,500."

  10. Internal Revenue Service. "Retirement Topics - Exceptions to Tax on Early Distributions."

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