Navigating financial planning as someone who is self-employed can sometimes be an overwhelming maze of trying to pay taxes, find health insurance, and save for retirement.
Planning ahead for retirement is something that might get easily overlooked by many freelancers or contractors. In fact, less than half of all Americans have access to a 401(k), making alternative methods of saving for retirement that much more important.
A SEP IRA allows a self-employed individual or a small business owner to make retirement contributions into a traditional IRA. SEP IRA rules make it so that the account is established in the employee’s name, not the business’s.
Traditional IRA vs. SEP IRA
A traditional IRA is a tax-advantaged retirement account that individuals with earned income can contribute to. It offers tax deductions on account contributions, depending on the individual’s income and tax filing status. Taxes are paid on traditional IRA withdrawals in retirement.
A SEP IRA, or a Simplified Employee Pension IRA, is one kind of IRA geared toward people who are self-employed and small business owners. The IRS notes that an individual can still set up a SEP IRA for their self-employed business even if they participate in another employer’s retirement plan at a second job. So, a business owner with one or more employees, a self-employed individual, or a person with freelance income on the side, can open a SEP IRA.
Under a SEP IRA, employers generally must contribute a uniform percentage of pay for each employee, although they do not have to make contributions every year. This flexibility is why some small businesses and self-employed individuals might want a SEP IRA retirement plan, due to the volatility of their income year over year.
Contributions to a SEP IRA are held in the employee’s name, and are tax-deductible. Employees own their SEP IRA accounts but cannot contribute to them. Only an employer can maintain and contribute to a SEP plan for their employees.
Like other traditional IRAs, money in a SEP IRA is not taxed until withdrawn. A SEP IRA has a higher contribution limit than other IRA plans.
Who Can Open a SEP IRA?
Here is who qualifies to participate in a SEP IRA:
• Any employee who is at least 21 years old
• AND has worked at the company for at least 3 out of the last 5 years
• AND has received at least $750 in compensation in 2024 (for 2025, the minimum compensation remains the same at $750)
Employers do not have to fund contributions every year, but if they do choose to do so, must contribute to the SEP IRA of every eligible employee, including themselves. Those eligible employees have to receive contributions equal in percentage to what the business owner puts away for themselves.
For instance, if an employee worked for a small business in 2022, 2023, and 2024, was over 21, and made at least $750 in 2024, their employer would need to make a contribution for that person in the 2024 plan if they were contributing for other employees and themselves.
If the business owner puts away 15% of their own compensation in their SEP IRA, they must also contribute 15% of the employee’s compensation to that person’s plan.
Also, while the 3-of-5 year eligibility rule is the most restrictive requirement, employers can also choose to use less restrictive rules, such as allowing employees to participate immediately after they begin work, or after a shorter period of employment, such as after only working for one year.
If an employer does use the 3-of-5 rule, they must count any work, no matter how little, in each of the prior 5 years. This also means using plan years (often the calendar year), not years based on the date the employee started working.
For people who share joint ownership of a business, both people must meet the SEP IRA rules individually in order to participate. The eligibility requirements apply equally to both owners and employees, whether of a small business or self-employment. Owners can also choose to exclude certain employees, according to the IRS, including those covered by a union agreement — if retirement benefits were bargained for in good faith — or nonresident aliens who have no U.S.-sourced compensation from the employer.
What Can Someone Contribute to a SEP IRA?
Just like other IRAs, there are annual contribution limits for a SEP IRA. However, SEP IRA accounts have a much higher monetary limit than Roth or traditional IRA plans. The contribution limits to a SEP IRA are the lesser of either 25% of total compensation or $69,000 in 2024, and for 2025, the lesser of 25% of total compensation or $70,000 .
This limit also applies to the net profits of a business, and are also tax deductible from business income. Withdrawals in retirement are taxed as regular income.
Like with a traditional IRA, there is a 10% penalty for withdrawals before the age of 59 ½, unless one of the exceptions applies such as death, disability, or medical expenses.
An important difference between a SEP and other retirement plans for the self-employed is that a SEP is set up for small businesses as well. This ties back into having to contribute an equal percentage for each employee, meaning an owner of a business can not contribute more in percentage of their own compensation to their own retirement than that of an employee.
For self-employed individuals with no employees other than a spouse, a SEP IRA, however, is simpler to manage than a solo 401(k), in terms of paperwork and annual reporting.
Special SEP IRA rules also apply when determining the maximum deductible contribution as someone who is self-employed. If a person makes contributions for themselves, they must calculate their compensation based on net profit from self-employment.
For example, the maximum 25% contribution might actually end up being about 18% of someone’s income, because it is based on profits and self-employment tax. A tool like an IRA calculator can help give a quick estimate before tax time.
While an individual might only be able to add $7,000 in 2024 and 2025 with a traditional or Roth IRA, since a SEP IRA is income-based, the contributions can be higher depending on self-employed income.
Pros and Cons of a SEP IRA
A SEP IRA can be beneficial to individuals running a solo enterprise. And for a small business, a SEP IRA is often a fairly easy way to set up a retirement fund that is less expensive than other options.
Plus, contributions are tax deductible. The flexibility to not contribute annually, if the business had a hard year, or contribute more in a good year, is another reason a SEP IRA might be a good option for some.
For self-employed individuals with no employees, a SEP IRA may help them lower their taxable income and invest in retirement. After receiving 1099 income, the individual must pay the employer and employee sections of Social Security and Medicare taxes. Contributing to a SEP can help reduce these taxes, and potentially, federal and state taxes.
Having the flexibility to decide what they want to contribute, and offering the option to go above the $7,000 limit of a traditional or Roth IRA in 2024, makes a SEP a useful tool for some self-employed people.
Using a SEP with employees does mean, however, that the business owner must contribute that same percentage of income for each employee.
SEP IRA Pros
• High contribution limit of $69,000 in 2024 and $70,000 in 2025, or 25% of total compensation (whichever is less)
• Relatively easy to set up and make contributions
• Does not limit use of another account, like a traditional or Roth IRA
• Contributions are tax-deductible, including those made to employee accounts
SEP IRA Cons
• Individuals must pay taxes on contributions now
• If a business owner contributes for themselves, they must contribute the same percentage for all eligible employees
Opening a SEP IRA
There are three steps to opening a SEP, according to the IRS.
1. SEPs tend to have low start-up and operating costs, and can be established with just a short form. There must be a formal, written agreement using an IRS-approved document such as Form 5305-SEP, or an individually designed plan form.
2. Every eligible employee must be provided with information about the SEP.
3. Finally, the employer must establish a SEP IRA for each eligible employee with a bank, insurance company, or other financial institution. While the employer makes the contributions, the employee still owns and controls the SEP IRA.
SEP IRA plans must also be updated to match current IRS rules and contribution amounts. Make sure to calculate the initial allocations based on the SEP plan’s terms, and verify that all initial proposed contributions are based on that uniform percentage of all individual employee compensation amounts.
The forms do not have to be filed with the IRS, just kept and recorded for the individual or small business. It’s more of a formal way to establish the rules of the SEP IRA, in case of a tax audit. The law also does not require that every participant in the SEP IRA be at the same financial institution, though it might be easiest for business owners to do it that way.
What time of year a SEP IRA can be set up depends on the business’s or self-employed individual’s tax filing deadline. Self-employed, sole proprietors are likely already filing business returns as Schedule C of their personal income tax return. So, if someone filed for an extension of their 2024 return, they could still establish a SEP and make contributions for 2024 as late as October 2025. Filing by the tax deadline means the first SEP contributions would then be eligible for the 2024 tax year.
Invest in a SEP IRA
It is fairly straightforward to open a SEP IRA with most financial institutions, including with SoFi Invest. The self-employed individual, sole proprietor, or business owner can select from the investments that the account provider offers, which usually includes stocks, bonds, and mutual funds.
When you set up an IRA remember that contributions must be made by the federal income tax return filing due date, including extensions. By deducting contributions, individuals are typically able to exclude those contributions from their gross income, thus reducing their taxable income, which is another key benefit that many self-employed workers might want to take advantage of.
Getting money into a SEP IRA can be as simple as linking the IRA to a checking or savings account. Most accounts will also allow for the set up of a recurring deposit, or individuals may choose to make one-time deposits, so long as they remain under the annual contribution limits.Once the account is open, the IRA owner may choose investments based on their age, planned retirement age, goals, and risk tolerance.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
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