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Retirement Planning > Saving for Retirement > IRAs

What the Self-Employed Need to Know About SEP-IRAs

By Roger Wohlner

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What You Need to Know

  • A SEP-IRA is a type of IRA with higher contribution limits geared toward the self-employed and business owners.
  • The contribution limits are based on a percentage of the self-employed individual’s compensation.
  • All contributions are made by the employer; there are no employee salary deferrals.

A SEP-IRA (SEP stands for “simplified employee pension”) is a retirement plan option open to the self-employed and to small-business owners. SEP-IRAs allow only employer contributions to the plan. As a type of IRA, a SEP-IRA gives small-business owners access to a wide variety of investments.

Benefits of a SEP-IRA for Self-Employed Individuals

A SEP-IRA has a number of benefits for the self-employed.

A SEP-IRA can be established and funded up to the tax filing date for your clients for the prior year, including any extensions. For those whose self-employed business is set up as a sole proprietorship and who file Schedule C as part of their personal tax return, these dates will coincide with the due dates for their individual return.

For clients whose business is set up as a separate entity, the key filing dates are those for their business tax returns, including extensions.

Contributions to a SEP-IRA are flexible. Your self-employed clients can skip contributions altogether for a given year or contribute any amount their income allows, up to the annual maximum.

SEP-IRAs are easy to establish, and the administrative requirements are fairly minimal. Each participant in the SEP-IRA has their own account, and unlike a plan like a 401(k), there are no testing requirements or similar administrative requirements.

SEP-IRA Eligibility Requirements

The IRS says, “Any employer, including self-employed individuals, can establish a SEP.”

If your self-employed business has employees, the IRS says that employees who have met these requirements must be eligible to participate in the SEP-IRA:

  • They are at least 21.
  • They have worked for the business in at least three out of the past five years.
  • They have received at least $750 in compensation for the past year or expect to receive at least that much in 2023.

An employer can use less restrictive eligibility requirements, but they cannot impose requirements more restrictive than these.

How a SEP-IRA Works for Self-Employed Individuals

Contributions to a SEP-IRA are made 100% with employer contributions — no employee contributions are allowed. This differs from other self-employed retirement plans like a solo 401(k) or a SIMPLE IRA that are funded with employee salary deferral contributions as well as employer contributions.

After opening a SEP-IRA account in their name, the self-employed individual is able to direct their own investments as they see fit. As with other types of IRA accounts, they can generally invest in any type of investment offered by the account custodian. This includes individual stocks and bonds, ETFs, mutual funds, cash accounts and a host of others. If they want to directly invest in gold, rental property or a number of other alternatives, they can consider opening a self-directed SEP-IRA.

SEP-IRA Contribution Limits

The contribution limit for a SEP-IRA is 25% of compensation. There is a dollar limit cap on this percentage. For the 2022 tax year, it is $61,000. For 2023, the dollar limit increases to $66,000. Unlike with a regular IRA or a workplace retirement plan like a 401(k), there are no additional catch-up contributions for those 50 or older.

For those who are self-employed and whose business is structured as a sole proprietorship,  contributions may be limited to 20% of net Schedule C income.

Tax Advantages of SEP-IRAs for the Self-Employed

Contributions to a SEP-IRA are made by the self-employed individual’s business. Whether they operate through a separate entity like an LLC or S corporation or as a sole proprietor filing a Schedule C as part of their personal tax return, these contributions are considered a business expense and serve to reduce their business income.

In the case where they are set up as a separate business entity, this will reduce the net income of the business, which passes through to their personal return. Overall, these contributions will reduce their personal income and the amount of taxes due. For those who are sole proprietors, the contributions work in a similar fashion. As a business expense, the contributions will reduce their Schedule C net business income, lowering the amount of business income reflected on their personal tax return. It is always best to consult with the client’s tax professional in determining the full tax impact of a SEP-IRA.

Comparing SEP-IRAs to Other Self-Employed Retirement Plan Options

A SEP-IRA is one of several self-employed retirement plan options your clients can consider.

Solo 401(k)

A solo 401(k) is an individual 401(k) plan that only allows business owners, their spouse who is involved in the business or their business partners to participate. A solo 401(k) allows for both employee deferral contributions and employer profit sharing contributions.

Here is a comparison of a solo 401(k) to a SEP-IRA.

Solo 401(k)  SEP-IRA
Eligibility Business owners, spouses who are involved in the business and business partners. Other employees are not eligible. Business owners and employees
Employee contributions Yes No
Roth option Yes No for tax years prior to 2023. The Secure 2.0 Act allows a Roth option beginning in 2023.
Loans allowed Yes No
Maximum contributions Annual employee deferral contributions plus profit sharing. Maximum contributions:
  • For 2022, $61,000 and $67,500 for those who are 50 or over.
  • For 2023, these limits are $66,000 and $73,500.
 The lesser of 25% of compensation up to a maximum of:
  • $61,000 for 2022
  • $66,000 for 2023

Regardless of age
Deadline to open End of the calendar year Up to the tax filing date, including extensions

Note that if your client opens and funds a SEP-IRA plan, they will need to contribute the same percentage of their compensation for any employees as they do for themselves.

SEP-IRA contributions are exclusively based on a percentage of their compensation. If your self-employed client’s compensation is variable or tends to be on the low side, a solo 401(k) might be the better option since they can make an employee deferral contribution up to 100% of their compensation as long as this amount is within the annual 401(k) employee contribution limit.

SIMPLE IRA

A SIMPLE IRA (Savings Incentive Match Plan for Employees) is a small-business retirement plan for companies with 100 or fewer employees. This includes self-employed individuals with no employees as well.

Like a SEP-IRA, a SIMPLE IRA is easy to set up. The employer must contribute either a flat 3% of compensation or a 2% match to each employee’s account. The employee contribution limit is $15,500, with a catch-up contribution of up to $3,500 for those 50 or over.

One caution: A participant cannot roll their money over to any type of account other than another SIMPLE IRA for two years after terminating their participation in the plan.

Here is a comparison of a SIMPLE IRA and a SEP-IRA.

SIMPLE IRA SEP-IRA
Eligibility Employees and the self-employed Business owners and employees
Employee contributions Yes, plus mandatory employer contributions Employer contributions only
Roth option No if prior to 2023. Under the Secure 2.0  Act, a Roth is allowed beginning in 2023. No if prior to 2023. Under the Secure 2.0  Act, a Roth is allowed beginning in 2023.
Maximum contributions — 2023 $15,500 plus a $3,500 catch-up contribution for those 50 or over The lesser of $66,000 or 25% of compensation

The ability to make salary deferral contributions can be a plus for the SIMPLE IRA if your self-employed client’s income is low or variable. A SIMPLE IRA may also be a better option if there are employees involved since the business owner must contribute the same percentage of salary for the employees as they do for themselves.

How to Set Up a SEP-IRA for the Self-Employed

SEP-IRAs are easy to establish at most custodians. Like any type of retirement plan account, there will be some paperwork required.

The IRS requires:

  • That the self-employed individual adopts a written agreement in one of their approved formats.
  • They provide each eligible employee with information about the plan, if applicable.
  • They establish an account for themselves and any eligible employee at a qualified financial institution.

Frequently Asked Questions About SEP-IRAs for the Self-Employed

Can I Contribute to Both a SEP-IRA and My Employer’s 401(k)?

In some cases, your client might have self-employment income in addition to being an employee at a full-time or part-time job. If that employer offers a 401(k) plan, your client can contribute to both that plan and to a SEP-IRA based on their self-employment venture. Since they are offered by different employers, participation in both plans is permitted by the IRS.

Can I Contribute to an IRA in Addition to My SEP-IRA?

Contributing to a SEP-IRA does not preclude a self-employed client from contributing to either a Roth IRA or to a traditional IRA. They will still be subject to any income-related restrictions that apply to their situation. In some cases, a SEP-IRA may allow traditional IRA contributions to the plan in addition to the normal employer contributions out of convenience.

(Image: Adobe Stock)

Roger Wohlner

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