SEP IRA: A Guide for the Self-Employed & Small Business Owners

If you’re self-employed and looking for one of the most generous retirement plans possible, you need to consider a SEP IRA. This type of plan is best for self-employed individuals or small business owners with no employees.

At its core, it’s an IRA, but it allows for much larger contributions and tax deductions than a traditional IRA. More formally known as the Simplified Employee Pension Plan IRA, it’s one of the best self-employment retirement plans available due to the bigger savings opportunities both in your retirement account and in tax savings.

What is a SEP IRA and how does it work?

SEP IRAs work much like traditional IRAs. Your contributions may be tax-deductible, and the money can be invested in a self-directed account. Investment earnings accumulate on a tax-deferred basis and can be withdrawn beginning at age 59 and a half. 

The biggest difference between the two plans is the contribution limit and catch-up contributions. With a traditional IRA, your contributions are limited to no more than $7,000 per year, or $8,000 if you’re 50 or older (for 2024).

However, a SEP IRA doesn’t allow an additional catch-up contribution for those 50 and older. SEP IRA contributions allow for the lesser of either 25% of your compensation or $69,000 for 2024 ($66,000 in 2023).

Who is eligible for a SEP IRA

Whether you’re self-employed or a small business owner, you may be wondering who can open a SEP IRA.

A SEP IRA can be established by any employer, including self-employed individuals. No matter your business size, you’re able to have a SEP IRA, but you must be 21 or older to open an account.

For your employees to qualify for this plan, they must meet the following SEP IRA eligibility requirements:

• Must be at least 21 years old
• Must have worked for your business for at least three of the past five years
• Must have earned at least $750* during the year that they’re making contributions for

*For tax year 2024 

Note that if you have a SEP IRA for yourself and you have employees who meet the requirements, you must contribute an equal percentage of compensation for the employees.

How to start a SEP IRA

One of the big advantages of a SEP IRA is that it’s simple to set up and manage, given there’s no complicated paperwork involved in the process. When implementing, consider these basic requirements:

1. Begin the process by choosing a trustee to manage the plan. That could be a bank, a mutual fund family, a brokerage firm, or a robo-advisor.
2. Create a written agreement spelling out the details of the benefits of the plan. The IRS provides Form 5305-SEP, Simplified Employee Pension-Individual Retirement Accounts Contribution Agreement which simplifies the process. Also, it’s likely the trustee will be able to provide any necessary paperwork, including a pro forma for the plan, to help you with the written set-up process.

Making contributions to your SEP IRA

Another major advantage of a SEP IRA – being that it’s an IRA account – is that you can open a fully self-directed account. That means you can invest in a full-service brokerage firm and trade in just about any investments you choose. You can also choose to hold the plan in a managed option, like a robo-advisor.

Another advantage is, unlike with traditional and Roth IRAs, you can make a contribution to your plan for the previous year as late as the extended tax deadline for that tax year. So, if you filed a 2023 tax extension and you still need to file by the tax year 2023 extended tax deadline of October 15 (unless your state has an extension), you can still contribute to your SEP IRA by the extended deadline and save on your 2023 taxes.

Roth SEP IRA. Remember we said that there is no catch-up contribution on a SEP IRA for taxpayers 50 and older? There’s also no catch-up contribution for Roth SEP IRAs. However, if you earn within the income limits to make a Roth IRA contribution, you can set up a separate Roth IRA. 

You can contribute to that plan as long as, when combined with your SEP contributions, you don’t exceed $69,000, the contribution will be permitted.

Rollover rules for SEP IRAs

The rollover rules for SEP IRAs vary based on the account you’re rolling over into. Generally speaking, you can roll a SEP IRA into a traditional or Roth IRA, but there are some rules to consider.

If you’re rolling a SEP IRA into a traditional IRA, the process is generally simple because both IRAs use pre-tax dollars. While you can roll a SEP IRA over into a traditional IRA, you can only do this once per 12-month period.

While you can technically roll a SEP IRA into a Roth IRA, there are tax implications. When you roll a SEP IRA into a Roth IRA, you have to include that contribution in your taxable income for that year.

SEP IRAs can also be rolled into other types of retirement accounts, including SIMPLE IRAs, SEP IRAs, Governmental 457(b) plans, qualified plans, and 403(b) plans. That said, keep in mind that there are different rules and requirements depending on the type of account you’re rolling to.

You may want to consider consulting a financial advisor before rolling a SEP IRA to another account. A financial expert can help you make sure you’re choosing the best solution based on your financial situation.

Investment options with SEP IRAs

The investments you choose with SEP IRAs can significantly impact your retirement savings. Each employee gets to decide how they want to invest the money you contribute to their SEP IRA. Options for investing include stocks, mutual funds, money market funds, savings accounts, and more.

Diversifying your SEP IRA investments can help you protect your retirement savings. If one investment performs poorly, it won’t impact your account as much. Here are a few simple tips for diversifying your investments within a SEP IRA:

• Mutual funds: Mutual funds pool money from several investors to invest in a diverse portfolio of stocks. A professional manages these funds to ensure they’re invested properly, making mutual funds a simple way to diversify.

• Exchange-traded funds (ETFs): ETFs are like mutual funds, but they track a particular index or type of asset. Since ETFs allow you to invest in a broader industry or market instead of a single company, they can help you diversify your portfolio.
• Other investments: While mutual funds and ETFs are simple ways to diversify, you might also want to invest in a mixture of individual stocks, bonds, CDs, and other investments.

What are the tax benefits of a SEP IRA?

There are several tax benefits for small business owners who establish a SEP IRA. For example, business owners who start a SEP IRA can receive a tax credit between $500 and $5,000, depending on the number of plan participants.

As an employer, you can also deduct the payments you’ve made to a SEP IRA for employees. You can deduct the lesser of your contributions or 25% compensation. This tax deduction helps you reduce your taxable income while helping employees save for retirement.

Unlike employers, employees can’t deduct contributions to a SEP IRA, and they don’t receive a tax credit for participating. If you’re self-employed, SEP IRA tax benefits can help you lower your tax bill.

Should you open a SEP IRA?

Obviously, the biggest advantage to a SEP IRA is the much higher contribution limit allowed compared to a traditional or Roth IRA. It will not only allow you to accumulate a much larger retirement plan more quickly, but it may also provide you with a very generous tax break.

Don’t worry about knowing these tax rules. TurboTax Self-Employed will ask simple questions about you and your business and give you the tax deductions and credits you’re eligible for based on your entries. If you have questions, you can connect live via one-way video to a TurboTax Live Self-Employed CPA or Enrolled Agent with an average 15 years experience to get your tax questions answered. TurboTax Live Self-Employed CPAs or Enrolled Agents are available in English and Spanish and can also review, sign, and file your tax return.