What Is a SEP Contribution and How Does It Work?

A SEP contribution is money an employer deposits into a Simplified Employee Pension IRA for an eligible worker, or that a self-employed person deposits for themselves. For 2026, the maximum SEP contribution per participant is the lesser of 25% of compensation or $72,000.¹ Only the employer funds the account; employees do not defer their own salary into a SEP-IRA. Every dollar is 100% vested the moment it hits the account.²

How the Contribution Works

The employer decides each year whether to contribute and how much. There is no minimum funding requirement, so a business can skip contributions entirely in a lean year without penalty.³ When contributions are made, the money goes into a traditional IRA in each eligible employee’s name, and each employee controls how their own account is invested.²

The rate has to be uniform. If an owner puts 15% of their own pay into their SEP-IRA, every eligible employee gets 15% of theirs. Owners and managers cannot receive a higher percentage than the rest of the staff.⁴

Who Has to Be Included

An employee is eligible when they meet all three of the following:²

They are at least 21 years old.
They have worked for the employer in at least three of the last five years.
They earned at least $800 in compensation during the year. The threshold was $750 in prior years and rose to $800 for 2026.⁵

Compensation here means wages, salary, tips, overtime, bonuses, and commissions. It does not include severance pay, nontaxable fringe benefits, or workers’ compensation.³

Two categories of workers can be left out even if they meet those three tests: union employees whose retirement benefits were bargained through a collective bargaining agreement, and nonresident aliens with no U.S.-source income from the employer.⁶ Everyone else who clears the thresholds has to be covered.

The service rule catches more people than owners expect. A part-time worker who logs even a few hours in a year counts as having performed service that year. If they worked any amount in three of the past five calendar years, earned at least $800, and are 21 or older, they are in, whether or not they are still actively on the payroll. Accidentally leaving out an eligible employee is the most common SEP compliance error, and fixing it is expensive.

The 2026 Contribution Cap

The employer’s contribution for each eligible employee cannot exceed the lesser of 25% of the employee’s compensation or $72,000.¹ Only the first $360,000 of an employee’s annual compensation counts toward the 25% calculation.⁵ Both figures are adjusted periodically for inflation.

An employee earning $200,000 could receive up to $50,000, which is 25% of pay. An employee earning $400,000 would be capped at $90,000 based on the $360,000 compensation ceiling, but the flat dollar cap brings that down to $72,000. The arithmetic is simple for W-2 workers. It gets more involved when the participant is self-employed.

Calculating a Self-Employed SEP Contribution

Sole proprietors and partners do not draw a W-2, so their compensation for SEP purposes has to be built from business profit through a multi-step calculation. The effective ceiling works out to roughly 20% of net self-employment income rather than 25%, because the contribution itself reduces the earnings figure the formula is based on.⁷

The sequence:

Start with net profit from Schedule C (sole proprietors) or Schedule K-1 (partners).
Subtract the deduction for one-half of self-employment tax. That is 7.65% of earnings up to the $184,500 Social Security wage base for 2026, plus 1.45% of any earnings above it. The result is net earnings from self-employment.⁸
Multiply by the reduced contribution rate. For a plan targeting the full 25%, you multiply by 0.20, not 0.25, to account for the circular reduction. Publication 560 has a rate table for other percentages.⁷
Compare against the caps. The contribution cannot exceed $72,000 for 2026, and you cannot use more than $360,000 of adjusted earnings in the calculation.

Getting this wrong is costly in both directions. Overcontribute and there is a 6% excise tax on the excess for every year it stays in the account.⁹ Undercontribute and you lose tax-deferred growth. If the worksheet is unfamiliar territory, a tax professional pays for themselves on this one.

When the Contribution Has to Be Made

You can establish a SEP and fund it for a given tax year as late as the due date of the business’s return, including extensions.³ That flexibility is one of the plan’s biggest practical advantages. You can wait until you know your final profit numbers before deciding whether and how much to contribute.

The specific deadline follows the entity type:

S-corporations and partnerships: returns are due March 15, and a six-month extension pushes the contribution deadline to September 15.
C-corporations and sole proprietors: returns are due April 15, and an extension moves the deadline to October 15.

Filing for a tax extension gives you the extra time to contribute even if you file your actual return earlier. The deadline is tied to when the return is due, not when you happen to file it.³

Tax Treatment

The employer can deduct SEP contributions as a business expense, up to 25% of total compensation paid to all participants. Contributions must be deposited by the tax filing deadline (including extensions) to count in that tax year. Miss the deadline without an extension and the contribution can still be made, but the deduction moves to the following year’s return.³

For the employee, an employer’s contribution to a traditional SEP-IRA is not included in gross income for the year it is made. The money is taxed later, when the employee takes distributions in retirement. That deferral is the core of the tax benefit: the business reduces taxable income now, and the account grows without annual tax until withdrawal.

The Roth Option

Starting in 2023, the SECURE 2.0 Act gave employers the option to designate SEP contributions as Roth. A Roth SEP contribution is included in the employee’s taxable income for the year it is made, but qualified withdrawals in retirement are tax-free.¹⁰ Offering the Roth designation is not mandatory. Employers who do offer it must give employees the chance to elect it at least once per plan year, and Roth SEP contributions are reported to the employee on Form 1099-R rather than excluded from wages the way traditional SEP contributions are.

Setting Up the Plan

Most employers use IRS Form 5305-SEP, a model agreement that serves as the plan document. You do not file the form with the IRS; you keep it in your business records.¹¹ The form is where you set the contribution percentage and the participation criteria, though you cannot make the criteria stricter than the federal minimums.

Every eligible employee must get a copy of the completed form. If the plan is later amended, each participant must receive a copy of the amendment and a written explanation of how it affects them within 30 days of the change taking effect.¹¹

Each participating employee opens their own SEP-IRA at a bank, brokerage, or insurance company, and the employer transfers the contribution directly to that account. Employers who use Form 5305-SEP and meet the notice requirements are exempt from filing annual returns (Forms 5500 or 5500-EZ). The financial institution handling the IRA files Form 5498 to report the contribution.

Getting the Money Out

Every dollar in a SEP-IRA belongs to the employee from day one. There is no vesting schedule and no forfeiture risk.² Federal law prohibits the employer from conditioning contributions on the employee keeping the money in the account, so the employee can withdraw or roll over the funds at any time.⁴ That freedom comes with tax consequences.

Withdrawals taken before age 59½ face a 10% early distribution tax on top of ordinary income tax.¹² Several situations remove the 10% penalty:

Total and permanent disability.
Unreimbursed medical expenses exceeding 7.5% of adjusted gross income.
Qualified higher education expenses.
Substantially equal periodic payments taken over your life expectancy.
First-time homebuyer expenses up to $10,000.
Birth or adoption expenses up to $5,000 per child.
Federally declared disaster losses up to $22,000.

Even when an exception erases the penalty, the withdrawal is still taxed as ordinary income unless it comes from a Roth SEP-IRA and meets the qualified distribution rules.

Required minimum distributions begin by April 1 of the year after the account holder turns 73.¹³ Missing an RMD triggers a steep excise tax on the amount that should have come out. There is no still-working exception for SEP-IRAs, unlike some employer-sponsored plans.

SEP-IRA money can be invested in most standard assets, including stocks, bonds, mutual funds, ETFs, and precious metals that meet purity requirements. Collectibles and life insurance are off limits.¹⁴

Fixing a Contribution Mistake

The IRS offers a correction framework called the Employee Plans Compliance Resolution System. Minor operational errors, such as a small miscalculation, can often be self-corrected without contacting the IRS or paying a fee, provided you are using an IRS-approved plan document like Form 5305-SEP. More serious problems, such as leaving out an eligible employee entirely, generally require the Voluntary Correction Program or resolution under audit.

Correcting an exclusion means opening a SEP-IRA for the missed employee, contributing what they should have received for every year they were left out, and adding an adjustment for the earnings they lost during that time. You cannot reduce other employees’ accounts to offset the cost.⁶ If the problem went unnoticed for several years, the corrective contributions add up quickly. Reviewing eligibility once a year is the cheapest form of compliance.

1
Internal Revenue Service. SEP Contribution Limits (Including Grandfathered SARSEPs)
2
Internal Revenue Service. Simplified Employee Pension Plan (SEP)
3
Internal Revenue Service. Retirement Plans FAQs Regarding SEPs
4
Office of the Law Revision Counsel. 26 U.S. Code 408 – Individual Retirement Accounts
5
Internal Revenue Service. IRS Notice 25-67 – 2026 Amounts Relating to Retirement Plans and IRAs
6
Internal Revenue Service. SEP Plan Fix-It Guide – Eligible Employees Were Excluded From Participating
7
Internal Revenue Service. Publication 560 (2025) – Retirement Plans for Small Business
8
Social Security Administration. 2026 Cost-of-Living Adjustment (COLA) Fact Sheet
9
Office of the Law Revision Counsel. 26 U.S. Code 4973 – Tax on Excess Contributions to Certain Tax-Favored Accounts and Annuities
10
Internal Revenue Service. SECURE 2.0 Act Changes Affect How Businesses Complete Forms W-2
11
Internal Revenue Service. Form 5305-SEP – Simplified Employee Pension Individual Retirement Accounts Contribution Agreement
12
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
13
Internal Revenue Service. Retirement Topics – Required Minimum Distributions (RMDs)
14
Internal Revenue Service. Retirement Plan Investments FAQs