What is a Simplified Employee Pension (SEP) & How It Works?

Retirement is the endgame for many homeowners, entrepreneurs, and many of those in the workforce. But for those who are self-employed, what would that look like?

We are going to dive into that and hopefully answer all your questions about what a Simplified Employee Pension (SEP) IRA is, how it works, and if it is worth it for you.

Self-employment is the dream and reality for several people all around the globe. In neither dream or reality do self-employed individuals work forever; retirement comes after a long and diligent career.

Business owners who want to set up a pension plan for them and their employees may be wondering just where to start.

• What is the deadline?
• Where do I go to get it going?
• What benefits can I get set up for myself and my workers?

We will lay out the basics and ease away some of those unknowns. 

What is a SEP IRA?

To first get started let’s discuss what exactly a SEP IRA is. Simply put, a Self Employed Pension plan is a retirement plan more tailored for freelancers, small business owners, and self-employed workers who are looking for a way to create a pension plan for them and anyone eligible that is working for them.

It gives some helpful tax breaks for those who are looking to save some money for the future.  The steps are as easy as filling out an IRS Form 5205-SEP and giving them out to your own employees if need be.

The regulations associated with SEP IRA accounts are the same as those under investment, distribution and even rollovers as with other traditional IRAs.

One thing to note: employers who set up their SEP IRA carry no responsibility in assisting with investing plan contributions. Participants do have the freedom to select their own IRA provider and how they would like their investments to be planned.

The deadline for employers follows that of the tax-filing deadline of their business to fund their SEP, unlike those of company qualified plans that goes with their 401(k) plan.

How a Simplified Employee Pension Works

In order to create a retirement savings plan- you have to save!  Employers or the self-employed who complete the SEP IRA make tax-deductible employer contributions for themselves or on the behalves of their employees. 

Some benefits of SEP IRAs include:

• List Easy and quick to set up.
• Relatively low administrative costs.
• Gives the employer or employee freedom of choice as to what they will contribute per year. Although there is a higher contribution limit than the standard IRA.

Contributions Limits in 2025

Now that we have covered the ‘who’ and ‘what’ it is, let’s take a look at everything that legally entails and surrounds SEP IRAs - including SEP IRA contribution rules.

Qualifications and Requirements:

1. All applicants and participants must be 21 years or older.
2. Work history must show they have worked with that employer(if self-employed, have worked individually) at the least of three to five years.
3. Employers or employees must also have a record of receiving a minimum of $600 in monetary compensation from the employer(or business) during that current year they sign up to set up a SEP IRA.

When making contributions to your SEP IRA, here are some things to remember when putting all those saved dollars and coins away.

• With a traditional IRA, the limit you can put away is $6000. With SEP IRA it is a whopping $58,000 or 25% of your income in 2021! Nearly ten times the regular amount of a traditional IRA.
• These SEP IRA contribution limits also apply to eligible employees who are under the plan as well. The 25% limit caps at $290,000 when calculated.
• Unlike with a traditional IRA contributions, there is no catch-up contribution available for 50+ individuals. 

Withdrawals & Distributions

When an individual or employer is making withdrawals, keep these things in mind when doing so. Withdrawals that are taken out before the age of 59 can invoke a penalty of 10% of what is being taken out.

This penalty can be waived if the reasoning behind it falls under any of these situations or circumstances below:

• The death of the account holder.
• Disability.
• Specific higher education expenses.
• History of a consistently equally made payments.
• A maximum of $10,000 for new or first time home owners.
• IRS tax levy.
• Specifically qualified unreimbursed medical expenses.
• Health insurance premiums if not employed.
• Specifically qualified situations in which those under the military reserves are called into active duty status.

*Note even with these exceptions that individuals are still subject applicable income taxes.

As much as we would like to just keep saving money indefinitely, it has to come out sooner or later. In regards to distributions, here are how things will go for those who set up a SEP IRA.

• Money has to be withdrawn by the age of 70. *For birthdays that are after July 1st or later, the age is 72. You can withdraw more than the minimum required amount if needed or wanted.
• There are worksheets to help calculate the required amount that must be taken when reaching age 70 or later.
• Failure to withdraw the required amount can result in a 50% excise tax.

SEP IRA vs. Roth IRA

Now in this section, we are going to compare and contrast the SEP IRA and Roth IRA. We will lay out the polar differences and possible similarities that we will find between them.

SEP IRA

• Contributions are tax deducted from your gross income. *The employer or your business gets a tax deduction on the contributions, but the withdrawals that come later will be taxed in accordance to their income tax rate. You are seen as both employer and employee when funding the account.
• Tailored towards freelancers, small business owners, and the self employed.
• SEP IRA rules are the same for traditional IRA rules as we discussed earlier.
• Calculated RMD (Required Minimum Distribution)
• Eligibility is as stated above when we discussed Qualifications and Requirements.

Roth IRA

•  No deductions on contributions, but no incurred taxes on any withdrawals made in retirement *You are contributing post-tax money, no upfront tax breaks. Tax-free withdrawals come in your retirement.
• It is not mandatory to withdraw after 70 and you can continue to make contributions past that age.
• More suited towards individuals who see themselves in a higher tax bracket after they retire.
• No RMD (Required Minimum Distribution)
• Money can be passed down to potential heirs if not needed for living expenses.
• Eligibility is determined by filing status and their modified adjusted gross income.

How to Open a SEP IRA Account

Here’s what you need to do to open a SEP IRA account:

1. Choose a trustee to handle your account and retirement plan (bank, mutual fund company, or a brokerage firm.)
2. Write a executed a plan/agreement to provide benefits to all eligible employees involved who adopt the SEP IRA *Give all important information they may need.
3. Set up an IRA for each employee (Be sure to provide your employees with a copy of the completed Form 5305-SEP or any other written agreement or plan approved, as well as instructions for the form.)

Is a SEP IRA Right for You?

Together, we’ve discussed the ins and outs of what an SEP IRA is, ran the necessary numbers needed to get it started, the rules applied to opening one, and lastly how to do it.

Now that you are all hyped with getting a SEP IRA set up, looked at the rules and regulations, ran the calculations and made the decision that yes this is right for you, what comes next?

Find a trustworthy account holder.  It can be your favorite bank, a trusted investing firm, or a skilled accounting agency that can help get the ball moving on your retirement plan.

It is never too late or too early to get started on setting yourself up right for the future, now is the time!  Now is your chance to make a hefty savings plan for you and your business.

FAQ's

Let’s move on and go ahead answer some questions our readers may still have. The goal is to respond to any lingering inquiries you may still have.