What Is a SEP IRA? How the Employer-Funded Plan Works

A SEP-IRA is a retirement plan funded by a business owner, in which only the employer (owner) contributes to the SEP and it does not take any portion of employees' salaries/paychecks. The amount contributed can range from zero percent up to 25% of compensation, depending on how much you want to contribute annually, and that same contribution percentage will be made into a Traditional IRA owned by each eligible employee.

It's often favored by self-employed owners because of low operating costs, in addition to allowing you to open and fund it as late as your tax filing deadline for the previous year.

What is a SEP IRA?

A SEP-IRA is a low maintenance type of retirement plan referred to as a Simplified Employee Pension. This allows an employer to create a retirement plan (IRAs) for themselves and their employees by funding the plan without the paperwork involved in creating a 401(k). To set up a SEP IRA, the employer will generally only need to complete the one-page IRS Form 5305-SEP and contribute funds directly into each eligible employee's Traditional IRA that they own. As provided under 26 U.S.C. 408(k), only the employer makes contributions to the SEP IRA, and employees are always 100% vested.^[1] There are no annual Form 5500 filing requirements and no nondiscrimination testing required.

In exchange for this ease of use, a SEP puts all of the funding, and all of the decision-making flexibility, in your control. We have placed the alternatives side-by-side in our guide to small business retirement plans.

What are the SEP IRA rules?

All of the rules stem from this one design element: A SEP is a set of promises on how much an employer will contribute, not a plan that employees put money into. Because of this, the IRS allows you to establish and fund a SEP until the due date for your company's tax return, extensions included, which is why accountants often wait until they're ready to file their clients' taxes before setting up a SEP with them.^[2] The mechanics can be summarized in a single table:

One thing many of those just starting out as plan sponsors get wrong about SEPs is that you cannot limit a SEP contribution in a given year to people who were eligible for the entire year. Even if they are gone by year end, you have to contribute to them because anyone who was ever qualified for the plan during that year had to be included.

Who is eligible for a SEP IRA?

Any business can establish a SEP-IRA account, whether that is a sole proprietor or an S-corporation or non-profit organization. However, coverage is required for contributions to be made in any given year. In order to make a contribution in any particular year, you must generally cover all employees who are at least age twenty-one (21), have worked for you in at least three of the last five years and earn at least the minimum compensation requirement amount as defined under the SEP rules.^[3] You may lower these requirements but can never raise them.

The liberal SEP rules are working in opposition to the owner. A SEP is required to include part-time and seasonal employees who meet the three-of-five years test, including individuals that a 401(k) could exclude. Therefore an owner of long tenured part time employees can provide more retirement account funding than anticipated. One major problem with SEP plans is for those owning multiple businesses: under the controlled group rules, employees of a second business owned can also count as "employees" of your first SEP plan.

Can employees contribute to a SEP IRA?

No. Employees cannot put in contributions through their paycheck into a SEP-IRA and this is probably the most misunderstood thing about SEP's by employers. Many owners believe that a SEP operates similar to a 401(k) or a SIMPLE IRA, which allows employees to set aside an amount of each paycheck. Only the employer contributes to a SEP. The one narrow exception for employee contribution, the salary reduction SARSEP, has not been available to establish since 1996. If you wish to allow employees to make contributions from their own payroll checks then use either a SIMPLE IRA or 401(k) instead.

How much can you contribute to a SEP IRA?

You may make contributions of up to 25% per year of each eligible employee's compensation. The total is capped for 2026 at a $72,000 annual addition under section 415(c). In turn, the amount of each employee's salary/compensation which you can count will be capped at $360,000 for 2026 under section 401(a)(17), in order to prevent compensation over and above that point from raising additional contribution amounts.^[2] With respect to a self-employed business owner who has no W-2 wage income, that 25% applies to net earnings only after deducting half of self-employment taxes paid during the taxable year as well as the SEP contribution made by the employer-owner, and therefore approximately 20% of net income is effectively sheltered, not the flat 25% many owners expect. An example of how much an owner might be able to shield with regard to their own compensation would look something like this:

Unlike a SIMPLE IRA, there is no catch-up contribution allowed in a SEP plan regardless of the owner's age, so an owner over 50 gets no extra room here. The calculation of these caps is explained in our article about SEP IRA contribution limits, as they are subject to indexing and should be checked against current year limits prior to funding.

How does a SEP IRA compare to a SIMPLE IRA?

A SEP-IRA and a SIMPLE IRA both use employee owned IRAs. However, they address opposite problems. A SEP-IRA is simply employer funded at a uniform percentage. Therefore, this plan is most beneficial for business owners who either have no employees or would like to make large, flexible contributions using only their own funds after the year ends. In contrast, a SIMPLE IRA is centered around the amount of an employee's salary that they are able to defer into the plan (with some limitations) and as such has a relatively low required employer match. Therefore, the cost of running a SIMPLE IRA will be more predictable than a SEP-IRA once you hire multiple employees that desire to save. There is a full comparison of these plans in SEP IRA vs. SIMPLE IRA and IRAPilot prepares the SIMPLE IRA paperwork and tracks its deadlines for free.

The Bottom Line

A SEP-IRA is a type of employer-funded retirement plan where contributions of up to 25% of pay are made by employers directly to IRAs owned by the employees themselves. Contributions can only be based on a percentage of salary, with no employee deferred contributions allowed. The benefits of a SEP-IRA include flexibility and late setup deadlines. However, because of the uniform-percentage rule, every dollar contributed to one's own account will generate additional costs for all other employees on the team. If there are employees who want to contribute some or all of their salary towards saving money in their accounts, then consider comparing this option with SIMPLE IRA plans before making your final decision.

This guide is educational and summarizes IRS rules for SEP IRA plans. It is not investment, legal, or tax advice. Your plan documents and current IRS limits control. Talk to your tax advisor about your business's circumstances.