SEP IRA Retirement Plan: How to Use It

This guide walks you through setting up and using a SEP IRA (Simplified Employee Pension Individual Retirement Account) to save for retirement as a self-employed individual or small business owner. You’ll learn the steps to establish the account, calculate contributions, and avoid common errors. First, you’ll need your business’s tax identification number (EIN) or your Social Security number if you’re a sole proprietor with no employees.

What You’ll Need

• Your Social Security number or business EIN
• Bank account information for funding the IRA
• Your net earnings from self-employment (from Schedule C or K-1) for the contribution year
• List of eligible employees (if any) and their compensation
• A financial institution that offers SEP IRAs (bank, brokerage, or mutual fund company)

Step-by-Step

1. Confirm eligibility. You can establish a SEP IRA if you’re a sole proprietor, independent contractor, partnership, LLC, or corporation. You must have earned income from self-employment or employ others. If you have employees, they must be at least 21 years old, have worked for you in at least 3 of the last 5 years, and have received at least $750 in compensation (2024 figure) to be eligible.
2. Choose a financial institution. Open a SEP IRA at a bank, brokerage, or mutual fund company. You can use their standard SEP IRA adoption agreement, which is often the same as their traditional IRA application but marked for SEP.
3. Complete IRS Form 5305-SEP (or use the institution’s version). This form is the written agreement between you and the plan. It names the employer and the employees who participate. You don’t file it with the IRS; you keep it in your records.
4. Provide employees with information. If you have eligible employees, you must give them a copy of the adoption agreement and a statement explaining the plan. This is a one-time requirement, not annual.
5. Calculate your contribution. The contribution is a percentage of each participant’s compensation, up to a limit. For 2024, the maximum contribution is the lesser of 25% of compensation or $69,000. For self-employed individuals, compensation is net earnings from self-employment (after deducting half of self-employment tax and the contribution itself). Use the worksheet in IRS Publication 560 to compute the exact amount.
6. Make the contribution. Transfer funds to each participant’s SEP IRA. Contributions must be made by the business’s tax filing deadline, including extensions. For a sole proprietor, that’s usually April 15 (or October 15 with extension).
7. Report the contribution. Deduct contributions on your business tax return (e.g., Schedule C, Form 1120-S, or Form 1065). Employees report contributions on their individual tax returns using Form 5498, which the financial institution issues.
8. Invest the funds. Within the SEP IRA, choose investments (stocks, bonds, mutual funds, CDs, etc.) that align with your retirement goals. There are no restrictions on investment choices beyond what the institution offers.

Common Mistakes

• Missing the deadline. Contributions must be made by the tax filing deadline (including extensions) for the year you’re contributing to. Forgetting to fund by then forfeits the deduction for that year.
• Incorrect contribution calculation. For self-employed individuals, the 25% limit applies to net earnings after adjustments, not gross income. Using gross income overstates the allowed contribution.
• Excluding eligible employees. All eligible employees must receive the same percentage contribution. Failing to include a part-time employee who meets the eligibility criteria can disqualify the plan.
• Using the wrong form. Some institutions use their own adoption agreement instead of Form 5305-SEP. That’s fine, but make sure you complete all required sections and keep it on file.
• Not updating the plan when employees are hired. You must cover new eligible employees in the year they become eligible. Review your employee list each year.

Tips

• Set a reminder for the contribution deadline, especially if you file for an extension. The deadline is the same as your tax filing deadline, not the end of the calendar year.
• Use the IRS worksheet in Publication 560 to calculate your self-employed contribution. It accounts for the deduction of self-employment tax and the contribution itself.
• Consider a solo 401(k) if you have no employees and want higher contribution limits. For 2024, a solo 401(k) allows up to $23,000 in employee deferrals plus employer contributions up to 25% of compensation.
• Keep records of contribution calculations and employee eligibility. The IRS may ask for them during an audit.
• You can set up a SEP IRA as late as the tax filing deadline and still make a contribution for that year. This gives you flexibility after year-end.

Troubleshooting

• Contribution exceeds the limit. If you accidentally contribute more than the allowed amount, withdraw the excess plus earnings before the tax filing deadline (including extensions) to avoid a 6% excise tax each year it remains.
• Employee not covered. If you discover you missed an eligible employee, you must make a corrective contribution for that employee for the missed year, plus earnings. File Form 5330 with the IRS and pay a penalty if the correction is late.
• Financial institution doesn’t offer SEP IRAs. Not all institutions do. Call ahead or search for “SEP IRA” on their website. If they don’t, choose another bank or brokerage that does.
• Contribution deadline missed. If you miss the tax filing deadline, you cannot make a contribution for that year. You can still make a contribution for the current year. Consider filing an extension next time to gain extra time.
• Confusion about the 25% limit. The 25% applies to the employee’s compensation, but for self-employed individuals, it’s effectively 20% of net earnings (because the contribution reduces net earnings). Use the worksheet to avoid the math error.

Frequently Asked Questions

Can I have a SEP IRA and a traditional IRA at the same time?

Yes, you can have both. SEP IRA contributions are separate from your annual IRA contribution limit ($7,000 for 2024, plus $1,000 catch-up if 50+). You can contribute to both, but your total traditional IRA contributions cannot exceed the annual limit.

How much can I contribute to a SEP IRA as a self-employed individual?

For 2024, the maximum is 25% of your net earnings from self-employment (after adjustments) or $69,000, whichever is less. For most self-employed people, this works out to about 20% of net business profit.

When is the deadline to open and fund a SEP IRA?

You can open a SEP IRA and make contributions for a tax year by the business’s tax filing deadline, including extensions. For a sole proprietor, that’s typically April 15 (or October 15 with an extension).

Do I have to contribute to my employees’ SEP IRAs every year?

No, contributions are discretionary. You can choose to contribute 0% in a given year. However, if you do contribute, you must contribute the same percentage for all eligible employees.

Can I take a loan from my SEP IRA?

No, SEP IRAs do not allow loans. Withdrawals before age 59½ are subject to a 10% early withdrawal penalty and income tax. You can withdraw contributions (but not earnings) without penalty if you meet certain exceptions, but it’s generally not advisable.

What happens to my SEP IRA when I sell my business?

The SEP IRA is an individual account in your name. You keep it when you sell the business. You can continue to manage it or roll it over to another IRA or employer plan. The plan itself is terminated when the business closes, but the funds remain in your IRA.

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