Fundamentals of the SEP IRA

The Simplified Employee Pension (SEP) IRA is a specialized retirement plan designed primarily for self-employed individuals and small business owners. It functions similarly to a Traditional IRA, where contributions are typically tax-deductible and the investments grow tax-deferred until they are withdrawn during retirement. The hallmark of the SEP IRA is its simplicity, as it lacks the complex administrative requirements and annual government filings associated with more robust workplace plans like a 401(k).

One of the most defining characteristics of a SEP IRA is that only the employer can make contributions to the account. Unlike other plans where employees can defer a portion of their own salary, the responsibility for funding a SEP IRA rests entirely on the business owner. For 2026, the employer can contribute up to 25 percent of an employee’s compensation, capped at a maximum of $72,000 per participant. If the individual is self-employed, a specific calculation is used to determine the contribution based on net earnings after certain deductions.

Eligibility rules for employees are governed by federal guidelines but can be made less restrictive by the employer. Generally, an employee must be included in the plan if they are at least 21 years old, have worked for the business in at least three of the last five years, and received a minimum amount of compensation, which is set at $800 for the 2026 tax year. Crucially, if a business owner decides to contribute to their own SEP IRA, they must contribute the same percentage of compensation to every other eligible employee’s account as well.

SEP IRAs offer significant flexibility for business owners whose income may fluctuate from year to year. There is no requirement to make a contribution every year; an employer can choose to contribute 20 percent during a highly profitable year and zero percent during a leaner year. Additionally, all contributions are immediately 100 percent vested, meaning the employee takes full ownership of the funds as soon as they are deposited. The deadline for making these contributions is the employer’s tax filing deadline, including any extensions, providing ample time to assess the year’s finances.

While traditionally limited to pre-tax contributions, recent legislative changes under the SECURE 2.0 Act now allow for the possibility of Roth contributions within a SEP IRA framework. This means that if the plan is set up accordingly, contributions can be designated as after-tax, leading to tax-free growth and qualified withdrawals. However, because this is a newer provision, not all financial institutions have implemented the systems to support Roth SEP IRAs yet. Consequently, most SEP IRAs currently in use still follow the traditional tax-deferred model.

Source: Internal Revenue Service (IRS) News Release IR-2025-111 and Publication 560, Retirement Plans for Small Business.