What Is a Simplified Employee Pension Plan (SEP IRA)?

A Simplified Employee Pension plan, or SEP IRA, is an employer-funded retirement account that lets self-employed people and small business owners set aside up to $72,000 per participant in 2026 with almost no administrative overhead. The employer contributes directly into individual retirement accounts opened for each eligible worker, and there is no company-run trust fund, no annual IRS filing, and no employee deferrals to track. The governing statute is 26 U.S.C. § 408(k).¹

Who Can Open a SEP IRA

Any business structure qualifies: sole proprietorships, partnerships, LLCs, and both C and S corporations. A freelancer with no staff is on the same footing as a company with a dozen workers.

Once you have employees, though, you cannot pick and choose who gets covered. A worker must be included if they are at least 21 years old, have worked for you in at least three of the last five years, and earned at least $800 from you during the year (the 2026 threshold, adjusted for inflation from $750 in prior years).² You are free to loosen these rules (enrolling new hires immediately, for example), but you cannot tighten them.³

Two narrow groups can be left out: employees covered by a collective bargaining agreement where retirement benefits were bargained in good faith, and nonresident aliens with no U.S.-source compensation.⁴

How Contributions Work

Only the employer contributes. Employees cannot make elective deferrals or catch-up contributions into a SEP.⁴ That keeps the plan simple, but it also means workers have no say in how much goes in each year.

For 2026, the annual contribution for each participant cannot exceed the lesser of 25% of the employee’s compensation or $72,000.⁵ The most compensation that can be used in the calculation is $360,000 for 2026.² So an employee earning $400,000 has their share figured on $360,000.

The Uniform Percentage Rule

Whatever percentage you contribute for yourself, you must contribute the same percentage for every eligible employee. Contribute 15% of your own pay, and each qualifying worker gets 15% of theirs. You are not required to contribute every year, which helps in lean seasons. But in any year you do fund the plan, the percentage is the same across the board.

If You Are Self-Employed, the Math Loops

Your contribution is based on net earnings, but the contribution itself reduces those net earnings. The IRS handles this by dividing the plan contribution rate by one plus that rate. At the maximum 25% rate, the effective contribution works out to roughly 20% of net self-employment income after the deduction for one-half of self-employment tax.⁶ Publication 560 has worksheets that walk through the arithmetic. Skipping this adjustment is one of the more common mistakes self-employed filers make, and it can trigger excess-contribution penalties.

Tax Treatment

Contributions cut taxable income for the year and are exempt from Social Security, Medicare, and federal unemployment taxes.³ Employees pay no income tax on the money in the year it is contributed. Inside the account, interest, dividends, and capital gains grow tax-deferred. Tax is owed only on distributions.

Every dollar an employer puts into a SEP IRA belongs to the employee immediately. There is no vesting schedule and no forfeiture, so an employer cannot claw back a contribution if the worker leaves the next day.⁷

The Roth Option

Starting in 2023, Section 601 of the SECURE 2.0 Act let employers allow employees to designate SEP contributions as Roth. The contribution is made with after-tax dollars and included in the employee’s gross income for the year, and qualified withdrawals in retirement are tax-free. Employer nonelective or matching contributions designated as Roth must be reported on Form 1099-R in the year they are made.⁸ Not every custodian supports Roth SEP IRAs yet, so check before electing.

Setting Up the Plan

You need three things: a federal Employer Identification Number, a list of eligible employees with their Social Security numbers, and a signed plan document. Most small businesses use IRS Form 5305-SEP, a free model agreement. Financial institutions offer prototype documents for more complex situations.⁹

You do not file the form with the IRS. You give every eligible employee a copy along with the plan disclosures and open a SEP IRA for each participant at a financial institution. Employers generally have no annual filing obligations, including no Form 5500.³ That is one of the biggest reasons small businesses choose a SEP over a 401(k).

You have until the due date of your federal income tax return, including extensions, to deposit contributions for the prior year.⁴ For a sole proprietor on extension, that can be as late as October 15. Miss the deadline and you lose the deduction for that year.

Taking Money Out

Before Age 59½

Early withdrawals owe regular income tax plus a 10% additional tax.¹⁰ Several exceptions waive the 10%, though income tax still applies: total and permanent disability; substantially equal periodic payments taken over your life expectancy; unreimbursed medical expenses above 7.5% of adjusted gross income; health insurance premiums paid while unemployed; and a first-time home purchase up to a $10,000 lifetime cap.

Required Minimum Distributions

You cannot leave the money in forever. Beginning in the year you turn 73, you must take required minimum distributions each year, even if you are still working.¹¹ The penalty for missing an RMD is a 25% excise tax on the shortfall, dropping to 10% if corrected within two years. Missed-RMD penalties are reported on Form 5329.

Fixing Excess Contributions

Overshooting the limit happens often, especially for self-employed owners who miscalculate net earnings. Excess amounts left in the account past the tax-filing deadline (including extensions) trigger a 6% excise tax on the employee’s IRA each year the excess remains. The employer may also owe a separate 10% excise tax on nondeductible excess amounts.⁴

There are two ways to fix it. You can distribute the excess, adjusted for earnings, from the employee’s SEP IRA back to the employer, reporting it on Form 1099-R with a taxable amount of zero. Or you can keep the excess in the account through the Voluntary Correction Program, which requires an application to the IRS and a compliance fee of at least 10% of the excess amount (waived if the excess is under $100).¹² Under either method, the employer cannot deduct the excess.

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

A SEP is not the only small-business retirement option, and the wrong choice can leave money on the table.

A Solo 401(k) is available only to owners with no employees other than a spouse. It allows both employer and employee contributions, which produces a higher total contribution at lower income levels, and it permits Roth elective deferrals and plan loans. The trade-off is more paperwork and a Form 5500-EZ filing once assets exceed $250,000.

A SIMPLE IRA is designed for businesses with 100 or fewer employees. Employees can make salary-deferral contributions of up to $17,000 in 2026 for workers under 50, and the employer must either match up to 3% of compensation or contribute 2% for all eligible employees. The overall ceiling is well below the SEP’s $72,000, which makes the SIMPLE less attractive for high earners.

A SEP tends to fit best when the owner wants maximum contribution flexibility with essentially no filing burden, and either has no employees or is willing to contribute the same percentage for every eligible worker. If you want employees to fund their own retirement through deferrals, a SIMPLE IRA or a 401(k) is the better path.

1
Office of the Law Revision Counsel. 26 USC 408 – Individual Retirement Accounts
2
Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs
3
Internal Revenue Service. Simplified Employee Pension Plan (SEP)
4
Internal Revenue Service. Retirement Plans FAQs Regarding SEPs
5
Internal Revenue Service. SEP Contribution Limits (Including Grandfathered SARSEPs)
6
Internal Revenue Service. Self-Employed Individuals – Calculating Your Own Retirement Plan Contribution and Deduction
7
Internal Revenue Service. Retirement Topics – Vesting
8
Internal Revenue Service. SECURE 2.0 Act Impacts How Businesses Complete Forms W-2
9
U.S. Department of Labor. SEP Retirement Plans for Small Businesses
10
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
11
Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
12
Internal Revenue Service. SEP Plan Fix-It Guide – Contributions Exceeded Maximum Legal Limits