What Is a Simplified Employee Pension (SEP)?

What Is a Simplified Employee Pension (SEP)?

If you're a self-employed person or run a small business, you might want to consider a Simplified Employee Pension IRA, or SEP IRA. It's basically an individual retirement account that you as an employer can set up. You get a tax deduction for the contributions you make to each eligible employee's plan, and you decide on those contributions discretionarily.

Thanks to the SECURE Act from December 20, 2019, small employers like you can get a tax credit to cover costs of starting a 401(k) or SIMPLE IRA with auto-enrollment, plus the existing startup credit. SEP IRAs stand out with higher contribution limits than regular IRAs. Think of them as a mix between a traditional IRA and a 401(k)—they take employer contributions like a 401(k), but vest immediately like a traditional IRA.

How a Simplified Employee Pension (SEP) Works

As a business owner, you'll find a SEP IRA appealing because it skips the startup and operating costs of typical employer-sponsored plans. Many of us set one up to boost our own retirement savings beyond what a traditional IRA allows. Small outfits prefer them due to eligibility rules: employees must be at least 21, have worked for you at least three years, and earn at least $750 in 2024. You can even skip contributions in tough years.

SEP IRAs follow traditional IRA rules for taxes and investments, including transfers and rollovers. When you contribute, you deduct that amount from taxes, and you're not committed to annual contributions—the decision varies yearly, up to $69,000 in 2024. You don't handle investments; the IRA trustee sets options, and employees choose. The trustee manages deposits, statements, and IRS filings.

Immediate Vesting

Contributions vest 100% right away, and you as the IRA owner direct investments. If you're an eligible employee or owner in a SEP plan, you need a traditional IRA for deposits. Some institutions insist on labeling it as a SEP IRA, others don't. Remember, you pick investments from the trustee's list.

SEP IRA Contribution Limits

Your employer contributions can't exceed 25% of an employee's pay or $69,000 in 2024, whichever is less. Withdrawals in retirement get taxed as ordinary income, like traditional IRAs. For sole proprietors, you pay yourself wages and can add a SEP contribution up to 25% of profits minus the contribution itself—for a 25% rate, it reduces to 20%. Once deposited, SEP funds follow traditional IRA rules on distributions, investments, contributions, deductions, and documentation.

SEP IRA Rules

These plans encourage small businesses like yours to offer retirement benefits. Any small business—sole props, partnerships, corporations—can set them up. Income caps at $345,000 for 2024 eligibility, and unlike qualified plans, you can't borrow from them. Employers can exclude union workers or nonresidents without U.S. wages. You can withdraw anytime, but it's taxable, with a 10% penalty before 59½. Rollovers are tax-free, and minimum distributions follow IRA rules.

SEP IRA vs. Solo 401(k)

Both SEP IRAs and solo 401(k)s allow employer contributions up to $69,000 in 2024, but you hit the max in a solo 401(k) at lower income—like $154,000—versus $276,000 for SEP. Solo 401(k)s let you take loans, which SEP IRAs don't. If you have employees, you must match their SEP contributions equally to yours. SEP IRAs are simpler to set up and maintain, with fewer fees and admin hassles than solo 401(k)s.

SEP IRA vs. Traditional IRA vs. Roth IRA

Traditional IRAs let you contribute pre-tax, taxing withdrawals later—ideal if you expect a lower bracket in retirement, with RMDs at 73. Roth IRAs use after-tax contributions for tax-free withdrawals, no RMDs, better if you anticipate higher taxes later. SEP IRAs, open to employers including self-employed, allow employer contributions that are tax-deductible, with higher limits than the others; distributions are taxed, and they're designed for small businesses to provide plans.

The Bottom Line

If you're a small business owner or qualified employee, a SEP IRA offers higher contribution and income limits than other plans. To get started, pick a provider and make contributions—if you have staff, contribute equally to theirs.