Business owners who want to help their employees save for retirement have several workplace retirement plan options to consider, each with its advantages and disadvantages. Employers who want to contribute toward their employees’ retirement as well as their own retirement savings might consider a simplified employee pension (SEP) individual retirement account (IRA). But these IRAs come with some limitations that might make them a less favorable option for employers and employees alike.
A SEP IRA is a type of IRA that business owners can use as a workplace retirement plan. Businesses of any size can open and fund a SEP IRA for their employees, including freelancers and self-employed individuals. SEP IRAs function similarly to traditional IRAs in terms of taxes and withdrawal rules, but they offer a higher contribution limit.
| Type of employer | Any size business |
| Who can contribute | Employers |
| Contribution limits | The lesser of $69,000 or 25% of the employee’s compensation for tax year 2024(1) |
| Eligibility requirements | Employees at least 21 years old who worked for your business in at least 3 of the last 5 years and who will receive at least $750 in compensation in 2024 must be included in the plan(2) Employers can use less restrictive requirements to determine eligibility |
| Tax status | Pre-tax |
| Deductible contributions | Employers can deduct the lesser of their contributions or 25% of the employee’s compensation(3) |
| Access to funds before age 59.5 | Employees are always 100% vested and can withdraw money at any time but will incur a 10% early withdrawal penalty if younger than 59.5 |
The easy setup and low-cost operation of a SEP IRA compared to other workplace retirement plans make these retirement accounts attractive for many employers. To put a SEP IRA in place, the employer must:
Once established, the employer contributes to the account, and the employee is responsible for investing that money. Available investment options depend on what the IRA custodian offers and can include everything from stocks and exchange-traded funds (ETFs) to bonds and mutual funds. Employees can also choose to roll over their SEP IRA assets tax-free to other IRAs and retirement plans.(4)
Unlike some other workplace retirement plans, only employers contribute to the account. However, employees can both receive employer contributions to a SEP IRA and contribute to their own traditional IRA or Roth IRA. An employer’s SEP IRA contributions do not affect the amount an employee can contribute to their own IRA. (3)
For 2024, the maximum an employer can contribute to a SEP IRA is the lesser of $69,000 or 25% of the employee’s compensation. The Internal Revenue Service limits the compensation you can use to calculate the 25% limit to $345,000 in 2024,(2) meaning only the first $345,000 of an individual’s compensation is considered for contribution calculations. However, the calculated contribution can not exceed the annual contribution limit set by the IRS, which is $69,000 in 2024.
A SEP IRA functions like a traditional IRA in terms of taxes. Earnings in the account grow tax-deferred, which means the money grows tax-free until the employee makes qualified withdrawals in retirement, at which time the money is taxed as regular income. While employees can access their money at any time, any distributions before the age of 59.5 will typically be subject to a 10% early withdrawal penalty in addition to regular taxes. At age 73, employees are required to start taking withdrawals from their accounts.
Employers can generally deduct their contributions on their business’s tax return.(3) If you’re self-employed and make contributions for yourself, you need to calculate your maximum deduction for these contributions using a special computation that considers your net earnings from self-employment. Your net earnings from self-employment takes into account the deduction for the deductible part of your self-employment tax and the deduction for contributions to your own SEP IRA.(5) Consider getting help from a financial advisor to ensure you’re properly calculating your allowable deduction.
As with all types of retirement plans, the IRS sets specific rules for SEP IRAs. Consider these rules as you decide whether a SEP IRA is right for your business.
SEP IRA assets held within depository accounts such as savings accounts or certificates of deposit (CDs) are generally insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC)(6). However, SEP IRA investments held in securities such as stocks, ETFs or mutual funds are not FDIC-insured.
Additionally, SEP IRAs held at brokerage firms that are members of the Securities Investor Protection Corporation are protected up to $500,00 against the loss of cash and securities if the broker goes under.(7)
Before putting a SEP IRA in place for your business, weigh the pros and cons of these accounts.
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SEP IRAs, savings incentive match plans for employees (SIMPLE) IRAs and Solo 401(k)s are all retirement plans designed for business owners and self-employed individuals. But there are some key differences.
| SEP IRA | SIMPLE IRA | Solo 401(k) | |
|---|---|---|---|
| Type of employer | Businesses of any size | Businesses with 100 or fewer employees(8) | Business owner with no employees, or that person and their spouse(9) |
| Who can contribute | Employers | Employers and employees | The business owner as both the employer and employee |
| Contribution limits | Lesser of $69,000 or 25% of the employee’s compensation | Either matching contribution up to 3% of compensation or 2% nonelective contribution for each eligible employee | Business owner can contribute both:
|
| Tax status | Pre-tax | Pre-tax | Pre-tax and Roth |
| Withdrawal age to avoid penalties | 59.5 | 59.5 | 59.5 |
| Investment options | Wide range of investments | Wide range of investments | Wide range of investments More flexible than company-sponsored 401(k)s |
SEP IRAs can serve as effective retirement savings vehicles for business owners and self-employed individuals. They allow for deductible contributions for employers and, like traditional IRAs, tax-deferred retirement savings growth for employees. If you think a SEP IRA is right for your business, check out the best IRAs of 2024 to get started.
What is the downside of a SEP IRA?
Some downsides to a SEP IRA include the lack of catch-up contributions if you’re age 50 or older and the lack of a Roth form, which allows for tax-free withdrawals in retirement.
What is the difference between an IRA and a SEP IRA?
The main difference between a traditional IRA and a SEP IRA is who establishes and contributes to the account. Individuals open traditional IRAs and contribute money toward their own retirement, whereas employers open and contribute to SEP IRAs for their employees.
When can you withdraw from a SEP IRA without penalty?
Withdraw from a SEP IRA without penalty at age 59.5.
When is the deadline for a SEP IRA contribution?
You have until the tax filing deadline to make contributions for the prior year.(3)
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