What Is a SEP IRA?

A Simplified Employee Pension IRA is a retirement plan similar to a traditional IRA. They’re designed to provide tax advantages for small business owners and self-employed workers who want to save for retirement.

Each employee owns their own SEP IRA, meaning they have control over all the money in it.

If you have employees, you must contribute to plans on their behalf so long as they are eligible for SEP IRA participation.

The amount of money a business owner is required to contribute to employees’ SEP IRA has to be equal to the percentage of compensation the business owner contributes to his or her own SEP IRA.

So, if you are the business owner and contribute 15% of your compensation to your own SEP, you have to contribute 15% of each employee’s pay to his or her SEP IRA.

Employers can exclude some workers from participating in a SEP IRA, including nonresidents who don’t receive U.S. wages or other compensation, or union members covered by other retirement benefits.

SEP IRAs work much the same way as traditional IRAs when it comes to tax advantages. The money you contribute to your account is not treated as income for tax purposes. But you are also allowed to contribute more to a SEP than to a traditional IRA.

The same withdrawal and rollover rules apply to traditional and SEP IRAs.

If you participate in a SEP IRA, you choose where you want to invest your contributions from a list of options the account provider offers. Your investment options are free from the control of your employer.

If your SEP IRA is set up through a brokerage account, you can invest in stocks, bonds and mutual funds. But if it is set up through a bank you’ll be limited to certificates of deposit, which generally have a low rate of return.

Your retirement savings grows based on your continued contributions and the growth of your choice of investments.

You can contribute almost 10 times as much money to a SEP IRA as you can to a traditional IRA. In 2023, the maximum amount you can contribute to a SEP IRA is $66,000 per year, while the limit is $6,500 for a traditional IRA.

But unlike traditional IRAs in which participants can contribute an additional $1,000 contribution over the limit each year after they turn 50, SEP IRAs do not allow such “catch-up” contributions.

Your employer can also contribute to your SEP IRA — up to 25% of your annual compensation or $66,000, whichever is less.

To withdraw money from your SEP IRA, you should contact the financial institution that administers the account rather than your employer. You will also need to complete and submit IRS Form 5329 to the Internal Revenue Service.

You can withdraw money from your SEP IRA at any time. You do not need to show a hardship to make a withdrawal.

But if you take money out of your SEP IRA before six months after your 59th birthday, you will have to pay a 10% penalty on top of paying income tax on the withdrawal.

One of the biggest advantages of a SEP IRA is that it allows self-employed individuals and their employees to receive tax advantages while saving for retirement. But there are also disadvantages when compared to a traditional IRA.