What Is a SEP IRA?

Employers often provide retirement savings benefits, such as a 401(k), and may even match a portion of what their employees contribute. As a business owner, you’ll need to plan for how you’ll save for retirement and whether you will help your employees.

If you work for yourself or own a small business, a financial tool called a SEP IRA can be a great way to help you and your employees save for retirement. It’s a special investment account that’s known for its high contribution limits and attractive tax benefits. That can go a long way if you’re self-employed and don’t have access to a 401(k).

Let’s look at how a SEP IRA works, including the pros and cons, so you can decide if it’s right for you.

What is a SEP IRA, and how does it work?

A Simplified Employee Pension (SEP) is a type of Individual Retirement Account (IRA). It can be a great option for businesses owned and operated by one person and business owners with a small team of employees.

The first step is consulting an expert about establishing a SEP plan. As the IRS explains, the next steps are:

• Executing a written agreement to provide benefits to eligible employees
• Sharing certain information about the agreement with employees
• Setting up an IRA for each employee

Eligible employees must be at least 21 years old, have worked for the company during three of the last five years and have earned at least $750 in compensation during the year.

Who can contribute?

As the owner of the SEP plan, you are responsible for funding your own SEP IRA. If you have employees, you must set up and fund a SEP IRA for each one who is eligible— employees themselves cannot contribute to their own SEP IRA. 

One important rule is that you must contribute the same percentage of compensation for everyone in your company who has a SEP IRA, including you. That means you can’t fund your account with 25 percent of your net earnings but contribute only 10 percent to your employees’ accounts.

What are SEP IRA contribution limits?

A SEP IRA follows the same investment, distribution and rollover rules as a traditional IRA. What’s different is the amount you can contribute to a SEP (versus that of a traditional IRA or Roth IRA). In 2024, you can contribute up to $69,000 or 25 percent of your pay to a SEP IRA — whichever is less. Meanwhile, total contributions to traditional and Roth IRAs cannot exceed $7,000 ($8,000 if you’re 50 or older). In all cases, you can contribute to an IRA until tax day, which is typically mid-April of the following year.

When it comes time to withdraw funds from a SEP IRA, your distributions will be taxed as ordinary income. It’s important to be strategic about how you’ll access your retirement savings, as there are many tax implications, including which tax bracket you may fall into. Planning could help you avoid a huge tax bill in retirement.

Pros and cons of a SEP IRA

Pros

• It allows those self-employed or small business owners to save for retirement.
• It’s easy to set up.
• You can still have other IRAs, so you can use multiple investment vehicles to build your retirement nest egg.
• Contributions are flexible as long as you keep the percentage of pay equal across employees.
• There’s no vesting schedule, so the money that’s in the account is available immediately. 

Cons

• There are no catch-up contributions, which would allow you to save more for retirement if you’re 50 or older.
• SEP IRAs cannot be Roth. Roth accounts allow you to make post-tax contributions and enjoy tax-free withdrawals.
• Required minimum distributions (RMDs), which is money you must take out or face a penalty, begin at age 73.
• You can expect a 10 percent early withdrawal penalty if you’re younger than 59½.

How is a SEP IRA different from a solo 401(k)?

A solo 401(k)s is another type of retirement plan for self-employed people, but you can contribute to one only if you have no employees. They’re structured like a traditional 401(k) in that:

• Contributions are tax-deductible.
• You’ll be taxed on the money when you take it out.
• You’ll likely face an early withdrawal penalty if you tap your funds before age 59½.
• RMDs begin at age 73.
• You can start making catch-up contributions at age 50.

But solo 401(k)s are unique because you can contribute as both the employer and the employee. In 2024, you can put in up to $23,000 as the employee—plus an extra $7,500 if you’re 50 or older. As the employer, you can also kick in up to 25 percent of your earned income.

How do you invest in a SEP IRA?

With a SEP IRA, you can invest in a wide array of securities. That typically includes stocks, bonds, mutual funds and more. Your age, financial goals and risk tolerance will determine the best asset allocation for you. One rule of thumb is to gradually make your portfolio more conservative as you get closer to retirement. (This is also the idea behind target-date funds.) Holding 60 percent stocks/40 percent bonds is another common split.

No matter what you invest in, staying diversified is crucial. The goal is to hold a variety of investments across different sectors and asset classes. That can help mitigate investment risk. If all your eggs are in one basket, you could suffer serious losses if things don’t go as planned. Rebalancing your portfolio annually can help you maintain your preferred allocation.

Retirement planning is highly individualized. If you’re self-employed or own a business, your needs may look very different from someone who contributes to a traditional 401(k). That’s where a Northwestern Mutual financial advisor can be especially helpful. They can use your timeline, risk tolerance and goals to craft a comprehensive financial plan that’s tailored to you.

Your advisor can also take a broad look at your money and help you identify blind spots and opportunities that might otherwise be overlooked. You can see how to leverage multiple financial options that work together to help you protect and grow your wealth as you look ahead toward retirement.

Frequently asked questions

What's the difference between a SEP IRA and a traditional IRA?

Both follow the same investment, distribution and rollover rules. The main difference is that a SEP IRA is designed for those who are self-employed or own their own business. You can also contribute much more to a SEP IRA.

Is a SEP IRA the same as a 401(k)?

No. A 401(k) is an employer-sponsored retirement account that’s offered as an employee benefit. Unlike a SEP IRA, it allows for employee contributions, which includes catch-up contributions.

Do I have to pay taxes on a SEP IRA?

SEP IRAs offer tax-deferred growth, but distributions are taxed as ordinary income.

At what age can I withdraw from my SEP IRA without penalty?

Withdrawals are always taxable, but you’ll likely incur an extra 10 percent penalty if you take money out before age 59½.

This publication is not intended as legal or tax advice. Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation. All investments carry some level of risk, including loss of principal invested. No investment strategy can assure a profit and does not protect against loss in declining markets.