SEP IRA: Possibly The Best Retirement Plan For The Self Employed

If you’re a sole proprietor or you only have a few employees, a SEP IRA could be a great retirement plan option.

SEP IRAs come with generous contribution limits and when compared to 401k plans, they tend to be more flexible in regards to the equities that you can trade.

But a SEP IRA plan isn’t the right choice for every business owner. Depending on your income level and the number of employees on your payroll, a different retirement plan may be a better choice.

Let’s take a look at how SEP IRAs work and the rules that govern them. Then you can decide if a SEP IRA is the right retirement plan for your small business.

How Does a SEP IRA Work?

SEP IRAs can be set up by any employer. But they’re most popular with self-employed business owners. SEP IRAs can be an attractive choice because of how easy they are to set up and how affordable they are to administer.

As far as the IRS is concerned, your SEP IRA will need to follow the same investment, distribution, and rollover rules as Traditional IRAs. And you’ll get the same tax advantages that are available with a Traditional IRA.

The key difference between a SEP and a Traditional IRA is that SEP IRAs have much higher contribution limits. This could make a SEP plan a great choice for solo business owners.

But SEP IRAs become less attractive as you grow your business. That’s because SEP IRAs are funded by employers only. And employers are required to make the same percentage of compensation to every eligible employee’s plan.

Now that you understand the basics of how they work, let’s dig into the nitty-gritty details of the SEP IRA rules and guidelines.


If you’re thinking about starting a SEP IRA, here are the rules that you’ll want to be aware of.

How a SEP IRA is Taxed

As mentioned earlier, SEP IRAs receive the same tax treatment from the IRS as Traditional IRAs.

Every dollar that you contribute to a SEP IRA is tax-deductible and your earnings will grow tax-free. However, your distributions will be taxed. And if you take distributions before age 59½, a 10% additional tax will generally apply.

Since a SEP IRA is considered to be a variation of a Traditional IRA, there are no Roth options. However, it’s important to note that you can contribute to an individual Roth IRA and a SEP IRA at the same time (more on that later).

SEP IRA Contribution Requirements and Limits

Here are the key SEP IRA contribution rules that you need to know about.

Contributing to Your Own Plan

For 2019, SEP IRA contributions are limited annually to the smaller of $56,000 for 2019 ($55,000 for 2018) or 25% of compensation.

This means you’d need to be making right around $225,000 a year in order to save the full $56,000. If you make $100,000 annually, the max you could contribute to your SEP IRA would be $25,000.

The average business owner shouldn’t find the 25% rule too restrictive. However, if you hope to retire early, you may want to save a higher percentage of your annual income. In that case, you may want to consider a Solo 401k plan instead.

One of the nice things about SEP IRA plans is you won’t ever be locked into a particular contribution percentage. The amount that you contribute can change year to year. That kind of flexibility is nice–especially for small business owners who may be dealing with profit levels that vary from year to year.

Unlike 401k plans and individual IRA accounts, catch-up contributions are not allowed with SEP IRAs.

Contributing To Your Employee Plans

Another thing to consider is that you’ll need to contribute the same percentage of income to all of your eligible employees that you make to your own plan. So if you choose to contribute 20% of your income to your SEP, you’ll need to do the same for all of your employees.

The SEP IRA employee contribution rule can be very expensive for employers. That’s why you may need to switch from a SEP to a different retirement plan once you have a few employees on the payroll.

Related: Low Cost Employee Benefits for Your Small Business

Which Employees Are Eligible To Be Included In The SEP IRA Plan?

According to the IRS, an eligible employee is anyone who meets all of the following requirements:

  • Has reached age 21
  • Worked for the employer in at least three of the last five years
  • Received at least $600 in compensation from the employer during the year (for 2018 and 2019)

Employers are welcome to set up less restrictive rules for their SEP plans than these (i.e. allow 18-year-olds to be included in the plan or require fewer years of service), but they cannot set up more restrictive rules.

Here’s more info from the IRS about SEP plan employee eligibility rules.

Deadline For Contributing To A SEP IRA

Since SEP IRA contributions are tax-deductible, you’ll need to include your contributions on your annual tax return. For this reason, the deadline to contribute to your SEP account will be the tax-filing deadline for that year.

Most years, this means that your deadline for any given year will be April 15th of the following year. However, if you receive a tax-filing extension, your contribution deadline will be the extension deadline date–typically October 15th.

Combining A SEP IRA With Other Retirement Plans

SEP IRAs can be combined with individual retirement accounts, both Traditional and Roth IRAs. For 2019, the annual contribution limit to a Traditional or Roth IRA is $6,000, or $7,000 if you’re age 50 or older.

It’s important to note that SEP and individual IRA contribution limits are not shared. In other words, contributing to a Traditional or Roth IRA does not reduce the $56,000 max that you can contribute to your SEP IRA. You can contribute to your IRA up to the $6,000 max ($7,000 if you’re 50 or older) AND $56,000 to your SEP in the same year–effectively raising your maximum contribution limit to $62,000.

Do you have a separate W-2 job in addition to your self-employment income? If so, you can contribute to your company’s 401k in addition to your SEP IRA.

And once again, your contributions to either plan will not reduce the amount that you can contribute to the other. This makes a SEP IRA a great option for people who have a day job and make money on the side.

Check out this article from PT Money for an in-depth look at how to combine retirement accounts.

Setting up a SEP IRA Inside A Business Partnership

If you’re a part-owner of an LLC or other business partnership, you may wonder if you can set up your own individual SEP plan. Unfortunately, the IRS SEP FAQ says that you can’t.

The way the IRS explains it is that only an employer can maintain and contribute to a SEP plan for its employees. And when it comes to retirement plans, each partner or member of an LLC taxed as a partnership is considered an employee of the partnership.

Borrowing Rules

Unlike 401k plans, current SEP IRA rules do not allow for borrowing. If you’re a sole proprietor and you’d like a retirement plan that allows loans, a Solo 401k is probably your best choice.

However, keep in mind that once you hire your first employee, your Solo 401k will convert to a Traditional 401k. And Traditional 401ks can be expensive.

If you’re certain that you plan to borrow against your retirement, you’ll have to stick with a 401k plan. Otherwise, most business owners with less than 10 employees would probably be better off choosing a SIMPLE IRA–despite the fact that they don’t allow loans either. Here’s an article from Forbes about the pros and cons of the Solo 401K Plans.


This may be the biggest advantage of SEP IRAs. They’re incredibly inexpensive to set up and manage. You don’t need to file your plan with the IRS or submit any additional paperwork.

There’s basically zero administrative cost with SEP IRAs. The only fee that you should need to worry about is a custodian fee charged by the financial institution that holds the accounts.

And custodian fees are usually very cheap. For example, Vanguard charges $20 for each SEP account that has a balance of less than $10,000. And they say that the $20 fee can even be waived in certain situations.

On the flip side, the typical Traditional 401k comes with a bevy of fees, including plan administration fees, custodian fees, advisor fees, and recordkeeping fees. And these fees are typically charged as a percentage of assets managed.

If you’re looking for a cost-effective retirement plan, it’s hard to beat the SEP IRA.

Rollover Rules

SEP IRA rollover rules are the same as Traditional IRAs. This means that you can consolidate a SEP IRA with any Traditional IRA or 401k very easily.

However, if you want to rollover your SEP IRA into a Roth IRA, things get a little more complicated. In that case, you’d need to follow the Roth conversion process and you’ll owe tax on the converted funds.

If you expect to have a higher tax bracket in retirement than you have now, a Roth conversion may be worth it. Otherwise, you’re probably better off keeping the two accounts separate.

Related: The 7 Best Small Business Retirement Plans

How To Establish Your SEP IRA

Ready to set up your SEP IRA? Here are the three steps that you’ll need to take.

1. Choose Your SEP IRA Provider

As discussed above, your SEP plan administrative cost should be minimal no matter which provider you choose. But that doesn’t mean that all providers are created equal.

Does one provider have an investing platform that’s easier to understand than the others? Does one provider do a better job of providing educational content and customer support? You’ll also want to consider which investment choices are available in the provider’s SEP plans.

Here are a few popular financial firms that offer SEP plans:

The financial institution that you choose will serve as the trustee of the SEP-IRAs that hold each employee’s retirement plan assets. If you call one of these companies they will be able to walk you through the steps to set up your plan. If these directions below seem overwhelming, don’t let that keep you from getting started. Just give them a call, tell them what you want to do, and follow their directions–which will go something like this:

2. Fill Out the Required Forms and Documents

Once you’ve decided which provider you plan to use, you’ll need to adopt a formal written agreement by signing one of the following three documents:

  • IRS model SEP using Form 5305-SEPSimplified Employee Pension–Individual Retirement Accounts Contribution :
  • IRS-approved prototype SEP, offered by banks, insurance companies, and other qualified financial institutions; or
  • Individually designed SEP plan document.

If you choose to create your own custom plan agreement, it must include the name of the employer, the requirements for employee participation, the signature of a responsible official and a definite allocation formula.

3. Send Employee Disclosures And Open Employee Accounts

Once you’ve chosen your provider and signed your plan agreement, you’ll need to provide each eligible employee with information about the SEP.

At the very least, the IRS requires that each employee be given:

  • Notice that you have adopted the SEP
  • Requirements for receiving an allocation
  • The basis on which the employer contribution will be allocated

Next, you’ll need to set up a SEP IRA for each employee. It’s important to point out that each employee will be given their own account. Therefore, they’ll be solely responsible for the investment choices made with their SEP IRA contributions.

Don’t think a SEP IRA is Right for You? Consider These Alternatives.

If you don’t think that a SEP IRA is the right retirement plan for you, here are a few other options to consider.

  • Simple IRA: If you’re self-employed and don’t make more than $100k a year, a SIMPLE IRA may be a better choice.
  • Roth 401k: Could be a good option if you want to contribute more than 25% of your annual income.
  • Traditional 401k: Although you’ll pay more in administrative fees, it could still be your best option if you have 10 or more employees.

SEP IRA: Possibly The Best Retirement Plan For The Self Employed

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