How It Works, Contribution Limits, and Pros and Cons
A SEP IRA can be an attractive retirement savings option for self-employed individuals and small-business owners who want to save for retirement without the administrative requirements of a traditional 401(k). Understanding how contributions work, who is eligible, and the advantages and disadvantages can help you determine whether a SEP IRA makes sense for your business.
What Is a SEP IRA, and How Does It Work?
Short Answer: A SEP IRA (Simplified Employee Pension) allows a business owner to make retirement contributions for themselves and any eligible employees. Contributions are made by the employer, and employees generally do not make salary-deferral contributions into a SEP IRA. Each eligible participant has their own SEP IRA account, and contributions are fully vested when made.
How Much Can I Contribute to a SEP IRA in 2026?
Contributions for each participant are generally limited to the lesser of:
- $70,000 for 2025 or $72,000 for 2026, or
- 25% of the participant's eligible compensation.
For self-employed individuals, the calculation is a little different. The allowable contribution is based on adjusted net earnings from self-employment and generally works out to approximately 20% of adjusted net self-employment income.
Who Is Eligible for a SEP IRA?
SEP IRAs are available to self-employed individuals and businesses with employees. An employer generally must include employees who meet the plan's eligibility requirements, which can include:
- Being at least age 21,
- Having worked for the employer during at least three of the previous five years, and
- Earning at least the minimum compensation amount established for that year.
An employer may choose less restrictive eligibility requirements if desired.
What Are the Advantages of a SEP IRA?
A SEP IRA offers several potential benefits for self-employed individuals and small-business owners:
- Easy to set up and administer. Very easy to set up and administer compared with many other employer retirement plans, making it a popular choice for self-employed individuals and small businesses.
- Minimal reporting requirements. There is generally no annual Form 5500 filing requirement.
- Flexible contributions. Contributions are flexible and discretionary, so the employer can contribute more in profitable years and reduce or skip contributions in years when cash flow is tighter.
- Significant retirement savings potential. The plan can allow for a significant retirement contribution without the administrative requirements of a traditional 401(k).
What Are the Disadvantages of a SEP IRA?
There are also some limitations to consider:
- Employees cannot generally make elective salary deferrals into a SEP IRA like they can with a 401(k).
- If the business has eligible employees, the employer generally must contribute the same percentage of compensation for those employees that it contributes for the owner.
- Because of this requirement, a SEP IRA can become expensive for a business owner who wants to make a large personal retirement contribution but also has several eligible employees.
How Do I Know If a SEP IRA Is the Right Retirement Plan for My Business?
There is no single retirement plan that works best for every self-employed individual or business owner. The right choice depends on factors such as your income, business structure, number of employees, cash flow, and long-term retirement goals. Because each option has different tax benefits, contribution limits, and employer requirements, choosing a retirement plan should be done with the help of a qualified tax professional who understands your business and your overall tax strategy.
If you are considering a retirement plan for yourself or your business, reach out to Barklee Financial Group. We can help you evaluate your options and determine which retirement plan best fits your business and financial goals.
