SEP IRA: Contribution Limits, Setup, and Employee Coverage

A SEP IRA is a Simplified Employee Pension plan that lets a business owner or self-employed person put up to $72,000 a year (for 2026) into tax-deferred retirement accounts for themselves and any eligible employees. It is funded entirely by employer contributions, requires no annual IRS filing, and can be opened and funded as late as your tax filing deadline. The trade-off for that simplicity is a rigid rule about employees: whatever percentage you put in for yourself, you owe every eligible worker at the same rate.

Who Can Open One

Any business structure qualifies. Sole proprietors, partnerships, LLCs, S-corps, C-corps, and nonprofits can all establish a SEP. A freelancer with no employees is eligible, and so is a company with 200 workers. There is no size restriction.

The plan is funded exclusively by the employer. Employees cannot make salary deferrals the way they would with a 401(k) or a SIMPLE IRA. If you are self-employed, you are treated as both employer and employee, so your contribution counts as an employer contribution.¹ That classification shapes everything else about the plan.

Contribution Limits

For 2026, the employer can contribute the lesser of 25% of an employee’s compensation or $72,000.² Only the first $360,000 of compensation counts toward the calculation.³ Both figures adjust annually for inflation.

Self-employed people face a circular calculation. Your compensation for SEP purposes is your net self-employment income, but you subtract the SEP contribution itself and the deductible half of self-employment tax before applying the 25%. The result is that the effective rate on your net profit before the SEP deduction works out to roughly 20%. IRS Publication 560 has a worksheet, and most tax software runs the math automatically.

There are no catch-up contributions for participants age 50 or older. Because the plan is employer-funded, the catch-up rules tied to employee elective deferrals do not apply.¹ If your custodian permits it, you can make a separate traditional IRA contribution into the same account (up to $7,500 for 2026, or $8,600 at age 50 or older), though whether that is deductible depends on your income.

Which Employees You Have to Cover

Once you have employees, you must include every worker who meets three conditions in 26 U.S.C. § 408(k):⁴

Age 21 or older.
Worked for you during at least three of the last five years.
Received at least $800 in compensation this year (the 2026 threshold, adjusted for inflation).³

The three-of-five-years test is deliberately lenient. A seasonal worker who puts in a few weeks each summer counts after three qualifying years. You can loosen these thresholds in your plan document, but you cannot make them stricter than the statutory defaults.

Two categories of workers can be excluded: employees covered by a collective bargaining agreement that includes retirement benefits, and nonresident aliens with no U.S.-source income.¹ Everyone else who meets the three conditions must be included.

The Uniform Percentage Rule

Whatever percentage of compensation you contribute for yourself, you must contribute the same percentage for every eligible employee. This is the nondiscrimination requirement in 26 U.S.C. § 408(k)(3)(C): contributions must bear a uniform relationship to each participant’s compensation.⁴ Put in 15% for yourself and you owe 15% for every eligible worker.

You do choose the percentage fresh each year. You can contribute the full 25% one year, drop to 5% the next, and skip a year entirely after that. The rule is only that whatever you pick applies across the board. This helps a business with uneven cash flow, but it makes the plan expensive once you add staff, because you cannot fund your own account without funding theirs at the same rate.

Setting Up the Plan

Most businesses use IRS Form 5305-SEP, a fill-in-the-blank agreement that serves as the plan document. You enter the business name, effective date, and eligibility terms, then keep the form in your records. You do not file it with the IRS.⁵

Form 5305-SEP has limits. You cannot use it if you maintain any other qualified retirement plan (even one you are no longer funding), if you use leased employees, if you want a non-calendar plan year, or if you want your allocation formula to integrate with Social Security.⁶ In any of those situations you will need a prototype plan document from a financial institution or a custom-drafted plan.

Next, pick a custodian. A bank, brokerage, mutual fund company, or insurance company can hold the accounts. Each eligible participant gets their own SEP-IRA. Your role is to send in contributions; the employee owns the account and chooses investments from what the custodian offers.

If you use Form 5305-SEP, give each eligible employee a copy of the completed form and its instructions.⁶ Employees also need to be told that IRAs from other providers may offer different terms and returns, and that you will explain any plan amendments in writing within 30 days.

The Deadline

You can establish a SEP and make contributions for a given tax year as late as your federal income tax filing deadline, including extensions.¹ For most calendar-year sole proprietors that is April 15, or October 15 with an extension. You can see your full-year income before deciding how much to contribute, or whether to open a plan at all.

What You Report

Employers have no annual filing obligation with the IRS for a SEP. There is no Form 5500. The custodian files Form 5498 each year, and it reports contributions for the year they are actually deposited, regardless of which tax year the contribution is designated for.¹ You must give each employee a written statement of the contributions made to their account by January 31 of the following year.⁶

Vesting, Rollovers, and Loans

Every dollar contributed is 100% vested immediately. The employee owns it the moment it hits the account.⁶ There is no vesting schedule and no forfeiture if a worker leaves. Contribute $10,000 to a new employee’s SEP-IRA in January, and if they quit in February, the money goes with them.

Because each SEP-IRA is an individually owned IRA, the participant controls rollovers. Funds can roll into a traditional IRA, another SEP-IRA, a 401(k), a 403(b), or a governmental 457(b). Rolling into a Roth IRA is allowed, but the transferred amount is taxable income in the year of conversion.⁷ Loans against a SEP-IRA are not permitted.

Withdrawals and Taxes

Distributions follow standard traditional IRA rules. The employer deducts contributions, the employee owes no tax until withdrawal, and withdrawals are taxed as ordinary income.⁸

Withdrawals before age 59½ trigger a 10% early distribution penalty on top of income tax unless an exception applies, such as disability, certain medical expenses, or up to $10,000 for a first-time home purchase. Required minimum distributions must begin by April 1 of the year after you turn 73. Under SECURE 2.0, that age rises to 75 starting in 2033.⁸

How a SEP Affects Your Other Retirement Accounts

Participating in a SEP counts as being covered by a workplace retirement plan, and that triggers income-based limits on deducting traditional IRA contributions. For 2026, a single filer with modified adjusted gross income above $91,000 loses the traditional IRA deduction entirely. For married couples filing jointly where the SEP participant is the one claiming the deduction, the phase-out runs from $129,000 to $149,000.³ Nondeductible traditional IRA or Roth IRA contributions remain available within their own income rules, but the upfront deduction disappears.

If you have a SEP from a side business and a 401(k) through a separate employer, total employer contributions across all your defined contribution plans cannot exceed $72,000 for 2026. Your 401(k) salary deferrals do not count against that cap, but employer profit-sharing or matching contributions do.⁹

SEP IRA vs. Solo 401(k)

For a self-employed person with no employees, the solo 401(k) is the usual alternative. The SEP wins on simplicity: less paperwork, no annual filing, and you can open it after the tax year ends. The solo 401(k) wins on almost everything else.

A solo 401(k) lets you make employee salary deferrals (up to $24,500 for 2026, plus catch-up amounts at age 50 or older) on top of employer contributions of up to 25% of compensation. That combination often shelters more income at moderate earning levels. A solo 401(k) also allows participant loans, Roth contributions, and the mega backdoor Roth strategy, none of which exist in a SEP. The trade-off: once plan assets pass $250,000, you file Form 5500-EZ annually, and the plan must be established by December 31 of the tax year you want it to cover, unlike a SEP.

Once you hire employees beyond a spouse, a solo 401(k) is no longer available, and the comparison becomes a SEP against a full 401(k) or SIMPLE IRA, both of which carry more administrative cost.

Fixing Excess Contributions

If you contribute more than the legal limit, there are two paths. The straightforward one is to pull the excess (plus any earnings it generated) out of the employee’s SEP-IRA and return it to the employer. The distribution is not taxable to the employee, and the employer loses the deduction on the excess.¹⁰

Alternatively, the excess can stay in the account if the employer files under the IRS Voluntary Correction Program. That route requires a sanction of at least 10% of the excess (waived if the excess is under $100) plus a submission fee. Either way, the excess is not deductible.¹⁰

Ending a SEP

Terminating a SEP is nearly as simple as starting one. You stop by not making further contributions. The IRS recommends telling your employees and your financial institution, but you do not notify the IRS itself.¹ The existing SEP-IRA accounts stay open, employees continue to own their balances, and the funds remain tax-deferred until they are withdrawn or rolled over.

1
Internal Revenue Service. Retirement Plans FAQs Regarding SEPs
2
Internal Revenue Service. SEP Contribution Limits Including Grandfathered SARSEPs
3
Internal Revenue Service. Notice 2025-67 – 2026 Amounts Relating to Retirement Plans and IRAs
4
Office of the Law Revision Counsel. 26 USC 408 – Individual Retirement Accounts – Section: Simplified Employee Pension Defined
5
Internal Revenue Service. Form 5305-SEP – Simplified Employee Pension Individual Retirement Accounts Contribution Agreement
6
Internal Revenue Service. Simplified Employee Pension Plan (SEP)
7
Internal Revenue Service. Rollover Chart
8
Internal Revenue Service. Retirement Plans FAQs Regarding IRAs Distributions and Withdrawals
9
Internal Revenue Service. How Much Can I Contribute to My Self-Employed SEP Plan if I Participate in My Employers SIMPLE IRA Plan
10
Internal Revenue Service. Contributions to the SEP-IRA Exceeded the Maximum Legal Limits