What Is a SEP IRA?
A SEP IRA (Simplified Employee Pension Individual Retirement Account) is an employer-funded retirement plan established under IRC Section 408(k). Business owners can make tax-deductible contributions of up to 25% of each eligible employee's compensation, with a maximum contribution of $70,000 per participant for 2025 under IRC Section 415(c).
The SEP IRA is the simplest retirement plan available for self-employed entrepreneurs, requiring minimal administrative overhead and no annual IRS filing requirements. As discussed in "Billionaire Wealth Strategies" (Jim Dew, 2024), Chapter 9, the SEP IRA falls under the "D" (Defer) component of the DEAPR framework.
How Does a SEP IRA Work?
The employer (the business or self-employed individual) makes contributions directly to individual SEP IRAs established for the owner and each eligible employee under IRC Section 408(k). The business establishes the plan using IRS Form 5305-SEP or an equivalent plan document. No annual IRS Form 5500 filing is required, unlike 401(k) plans, which significantly reduces administrative costs.
Contributions are tax-deductible to the business under IRC Section 404(h) and tax-deferred to the recipient under IRC Section 402(h). Funds grow tax-deferred until withdrawal. Withdrawals before age 59-1/2 are subject to ordinary income tax plus a 10% early withdrawal penalty under IRC Section 72(t), with limited exceptions for disability, first-time home purchase (up to $10,000), and substantially equal periodic payments (SEPP under IRS Revenue Ruling 2002-62).
The contribution amount is discretionary and can vary year to year, including zero in years when the business has lower income. For self-employed individuals, the effective contribution limit is approximately 20% of net self-employment income (after the self-employment tax deduction), not 25% of gross income. The maximum contribution cannot exceed $70,000 (2025) under IRC Section 415(c).
If the business has employees, contributions must be made at the same percentage of compensation for all eligible employees under the non-discrimination requirements of IRC Section 408(k)(2). Eligible employees under IRC Section 408(k)(3) are those who are age 21 or older, have worked for the employer in at least 3 of the last 5 years, and have earned at least $750 (2025) in compensation. This equal-percentage requirement can significantly increase the total plan cost for businesses with multiple employees.
The SEP IRA is exempt from most Employee Retirement Income Security Act (ERISA) requirements under the DOL simplified plan exemption, further reducing administrative burden. However, fiduciary responsibilities still apply to the selection of investment options and custodians.
Under SECURE 2.0 Act Section 601 (effective 2023), employers can now designate SEP IRA contributions as Roth. Roth SEP contributions are made with after-tax dollars (no current deduction) but grow tax-free and produce tax-free qualified withdrawals under IRC Section 408A. Not all custodians have implemented Roth SEP IRA functionality.
When Do Entrepreneurs Use a SEP IRA?
Solo entrepreneurs or small businesses with no employees choose SEP IRAs for their minimal paperwork and absence of annual IRS filings. Establishing the plan requires only IRS Form 5305-SEP and individual IRA accounts at a qualified custodian. Setup can be completed in a single day.
Variable income businesses benefit from the discretionary contribution feature. In strong revenue years, the owner can contribute the maximum $70,000 (2025) under IRC Section 415(c). In lean years, the contribution can be reduced or skipped entirely without penalty or plan amendment.
Late-year tax planning is a key advantage. Under IRC Section 404(h), a SEP IRA can be established and funded up to the business's tax filing deadline, including extensions (typically October 15 for calendar-year sole proprietors filing Schedule C). An entrepreneur who realizes in March that the prior year's tax bill is higher than expected can establish a SEP IRA and make a deductible contribution retroactively.
Stepping stone to higher-limit plans positions the SEP IRA as a starting point before transitioning to a solo 401(k) or a Cash Balance Plan as income grows. The $70,000 annual limit (2025) under IRC Section 415(c) is lower than the combined limits available through a solo 401(k) with employee deferrals ($23,500 employee plus employer profit-sharing for 2025, with an additional $7,500 catch-up for those age 50 and older under IRC Section 414(v)). Cash Balance Plans can allow contributions exceeding $200,000 annually for older participants.
How Does Dew Wealth Approach SEP IRA Planning?
The SEP IRA is a solid starting point, but most high-income entrepreneurs outgrow the SEP IRA quickly, as discussed in "Billionaire Wealth Strategies" (Chapter 9). The $70,000 annual limit (2025) under IRC Section 415(c) represents a meaningful tax deferral, but entrepreneurs earning $500,000 or more in net self-employment income may benefit from higher-limit vehicles.
The Cash Balance Plan offers dramatically higher deferral limits, with annual contributions potentially exceeding $200,000 depending on the participant's age and compensation history. A solo 401(k) provides employee deferral ($23,500 in 2025, plus $7,500 catch-up for age 50 and older under IRC Section 414(v)) and employer profit-sharing, and now allows Roth contributions under the SECURE 2.0 Act (2022).
The Fractional Family Office evaluates which retirement vehicle maximizes deferral for each client's specific income level and employee structure. For businesses with employees, the SEP IRA's equal-percentage contribution requirement under IRC Section 408(k)(2) may make a 401(k) with targeted profit-sharing more cost-effective, as the 401(k) allows the employer to allocate a larger share of total contributions toward the owner.
The SEP IRA carries limitations that must be weighed against its simplicity. All contributions are employer-funded; there is no employee deferral component (employees cannot make their own pre-tax or Roth deferrals). There are no catch-up contributions for participants age 50 and older, unlike 401(k) plans under IRC Section 414(v). Participant loans are not permitted. Funds are illiquid until age 59-1/2, and early withdrawals face the 10% penalty under IRC Section 72(t).
Frequently Asked Questions
Can I also have a 401(k) alongside a SEP IRA?
Can I make Roth contributions to a SEP IRA?
What is the deadline to establish and fund a SEP IRA?
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