Simplified Employee Pension IRA: Eligibility, Contributions, and Setup

A SEP IRA is an employer-funded retirement plan that lets a business contribute up to 25% of each eligible employee’s compensation, capped at $72,000 per person for the 2026 tax year, with every dollar deductible from business income.¹ The Simplified Employee Pension, to give it its full name, funnels those contributions into an individual retirement account opened in each worker’s name. Setup runs on a single IRS form, most employers file nothing with the government each year, and you can raise, lower, or skip contributions from one year to the next as the business allows. Those features are why the SEP remains a common choice for sole proprietors, freelancers, and small firms.

Who Can Open a SEP

Any employer can establish a SEP. Sole proprietors, partnerships, LLCs, C-corporations, S-corporations, tax-exempt organizations, and government entities all qualify.² A self-employed person working alone can open one, and so can a business with dozens of employees. There is no size limit.

You can run a SEP alongside another retirement plan, such as a 401(k), but the combined contributions across plans have to stay within federal limits. If you already sponsor another plan, check the interaction before contributing.

Which Employees You Have to Include

Once the plan exists, you generally must cover every employee who is at least 21 years old, has worked for you in three of the last five years, and earned at least $800 from you during the year the contribution covers.² The $800 figure applies starting in 2026, up from $750.³

You can loosen those requirements by lowering the age, shortening the service period, or dropping the compensation threshold. You cannot tighten them. If a worker meets the statutory tests, they get a contribution.

Two groups can be excluded even when they otherwise qualify: employees covered by a collective bargaining agreement where retirement benefits were part of good-faith negotiations, and nonresident aliens with no U.S.-source income from you.⁴

How Much You Can Contribute for 2026

Only the employer contributes to a SEP IRA. Employees cannot make salary deferrals, and catch-up contributions do not apply.⁵ That is the fundamental structural difference from a 401(k). If you want workers to defer their own pretax pay, a SEP won’t do it.

For 2026, the maximum contribution per employee is the lesser of 25% of that employee’s compensation or $72,000.⁶ Compensation counted in the calculation is capped at $360,000, so any earnings above that figure are ignored.¹

The percentage you choose has to be uniform. Contribute 15% of pay for one eligible employee and every other eligible employee gets 15% too.² For a solo operator this is a non-issue. For a business with staff, an owner who wants to max out their own contribution is committing to the same percentage for the whole payroll.

Timing is flexible. Fund the plan generously in a good year and skip it entirely in a lean one. Contributions for a given tax year have to be deposited by the due date of the business’s federal income tax return, including extensions.⁵ Miss that deadline without a filed extension and you lose the deduction for that year.

Figuring Your Own Contribution When Self-Employed

If you’re self-employed, you cannot just multiply net profit by 25%. Your plan compensation and your contribution depend on each other, so the IRS requires a reduced rate.⁷ Divide the percentage you want to contribute by one plus that percentage. A 25% target becomes 0.25 divided by 1.25, or an effective 20% rate. Before applying it, reduce your net self-employment earnings by the deductible portion of your self-employment tax from Schedule 1 of Form 1040. Publication 560 walks through the math with a rate table and worksheet.⁶

The Roth SEP Option

Starting in 2023, the SECURE 2.0 Act gave employers the option to let employees receive SEP contributions on a Roth basis, meaning the money is taxed now and grows tax-free.⁸ Offering it is optional, and each employee has to affirmatively elect Roth treatment before the contribution goes in.

Roth SEP contributions are included in the employee’s gross income for the year they’re made, but they are not subject to FICA or FUTA withholding. The employer reports them on Form 1099-R rather than Form W-2.

Setting Up a SEP

The process has three parts: adopt a written plan, notify employees, and open the accounts.²

The simplest plan document is IRS Form 5305-SEP, a fill-in-the-blank agreement covering eligibility and contribution formulas. Complete it, sign it, and keep it in your business records. Do not file it with the IRS. You can instead use a prototype document from a financial institution or a custom plan drafted by an attorney, but Form 5305-SEP handles most small businesses.

Give every eligible employee a copy of the completed form along with a statement explaining how contributions will be determined each year. Keep records showing when and how you delivered those notices.

Each eligible employee needs a SEP-IRA account at a bank, brokerage, insurance company, or mutual fund provider. The accounts must be open before you deposit anything. You can establish the plan for a given tax year as late as the filing deadline for that year’s business return, including approved extensions. That timing lets you see the year’s profit before deciding how much to contribute.

Ongoing Filings

One of the main administrative reasons employers pick a SEP is that there are generally no annual filings, including no Form 5500 for most plans.² Compared to a 401(k), that alone can save hundreds or thousands of dollars a year in compliance costs.

You should still keep the signed plan agreement, proof of employee notices, contribution amounts per participant, and the compensation figures you used. The IRS recommends an annual self-check, and if you find a problem, its voluntary correction programs are far cheaper than fixing it during an audit.

What Happens to the Money

Vesting

Every dollar you contribute to an employee’s SEP-IRA belongs to that employee immediately. There is no vesting schedule.² You cannot claw back contributions if the employee leaves the next day, and you cannot block withdrawals. Employees also control the investment decisions inside their own SEP-IRA.

Early Withdrawals

A SEP-IRA is legally a traditional IRA, so distributions before age 59½ are subject to ordinary income tax plus a 10% early withdrawal penalty.⁹ The 10% penalty is waived in specific situations, including total and permanent disability, up to $10,000 for a first home purchase, qualified higher education expenses, unreimbursed medical costs above 7.5% of adjusted gross income, health insurance premiums after 12 weeks of unemployment, up to $5,000 per child for birth or adoption expenses, substantially equal periodic payments, up to $22,000 for federally declared disaster losses, and one emergency distribution per year up to $1,000 for distributions after December 31, 2023.

Required Minimum Distributions

SEP-IRA owners must begin required minimum distributions at age 73, whether or not they are still working.¹⁰ Missing an RMD triggers an excise tax of 25% of the shortfall, which drops to 10% if you correct the miss within two years.

Rollovers

A SEP-IRA can be rolled to a traditional IRA or to a qualified plan such as a 401(k).¹¹ The standard one-rollover-per-12-month rule applies to IRA-to-IRA transfers. Rolling into a 401(k) requires the receiving plan to accept the transfer and to hold the funds in a separate account.

Employees can also make regular traditional or Roth IRA contributions on their own, separate from the SEP, up to the standard IRA limit of $7,500 for 2026. A SEP contribution does not reduce that personal IRA allowance.⁵

How the SEP Compares to a Solo 401(k) and a SIMPLE IRA

The SEP’s strengths, high ceiling and light paperwork, come with real trade-offs once you set it beside the alternatives.

A solo 401(k), sometimes called an individual 401(k), allows both employer and employee contributions, which lets a self-employed person shelter more income at lower revenue levels. The 2026 total limit is also $72,000, but you reach it by combining a $24,500 employee deferral with the 25% employer contribution. The paperwork is heavier, and once plan assets exceed $250,000 you have to file Form 5500-EZ each year.

A SIMPLE IRA works for businesses with 100 or fewer employees and allows employee salary deferrals up to $17,000 in 2026, plus a required employer match or fixed contribution. The ceiling is lower than a SEP’s, but employees can put in their own money, which some owners find useful for recruiting.

The SEP’s biggest constraint appears when you have staff. Because the contribution percentage has to be uniform, an owner aiming for the $72,000 cap is also funding every eligible employee at the same rate. A business owner earning $360,000 who contributes 20% is contributing 20% for every qualifying worker too. For a solo freelancer, that is irrelevant. For a growing payroll, it is often the reason employers eventually move to a 401(k) with a more targeted matching formula.

1
Internal Revenue Service. COLA Increases for Dollar Limitations on Benefits and Contributions
2
Internal Revenue Service. Simplified Employee Pension Plan (SEP)
3
Internal Revenue Service. Notice 2025-67 – 2026 Amounts Relating to Retirement Plans and IRAs
4
Internal Revenue Service. SEP Plan Fix-It Guide – Eligible Employees Were Excluded From Participating
5
Internal Revenue Service. Retirement Plans FAQs Regarding SEPs
6
Internal Revenue Service. Publication 560 – Retirement Plans for Small Business
7
Internal Revenue Service. Self-Employed Individuals – Calculating Your Own Retirement Plan Contribution and Deduction
8
Internal Revenue Service. SECURE 2.0 Act Changes Affect How Businesses Complete Forms W-2
9
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
10
Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
11
Internal Revenue Service. Rollover Chart