SEP IRA

Also called Simplified Employee Pension

A simplified retirement plan for self-employed people and small businesses, funded by employer contributions set as a percentage of each worker’s pay.

What it means

A Simplified Employee Pension (SEP) IRA lets a business owner, including a sole proprietor or freelancer, make tax-deductible contributions to IRAs for themselves and their employees. Contributions are made by the employer, not through employee salary deferrals, and are capped at a percentage of compensation up to a dollar limit the IRS sets each year.

The owner can change the contribution percentage each year or skip a year entirely, which suits businesses with uneven income. The catch is fairness rules: whatever percentage the owner contributes for themselves must also be contributed for every eligible employee. Withdrawals follow traditional IRA rules.

Example

Suppose a small business has a good year and decides to contribute 10% of pay. An eligible employee earning $50,000 receives a $5,000 contribution, and the owner must use the same 10% for their own compensation.

How it’s used

Freelancers and sole proprietors with variable income
Very small businesses wanting a low-paperwork plan
Saving more than a traditional IRA allows

Strengths and weaknesses

Strengths

Easy to set up with minimal paperwork
Flexible contributions that can change or stop year to year
Contributions are tax-deductible for the business
Potentially much higher limits than a regular IRA

Weaknesses

Owner must contribute the same percentage for all eligible employees
Employees generally cannot add their own salary deferrals
For lower self-employment income, a solo 401(k) may allow more savings

Good to know

Self-employed people calculate contributions using net earnings after certain adjustments, so tax software or a professional can help.

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.