SEP IRA for Self-Employed: Complete Guide

How a SEP IRA Works

A SEP IRA is technically an employer-sponsored retirement plan where you are both the employer and the employee. The employer (your business) makes contributions to the employee's (your) IRA account. Unlike a traditional 401(k) where employees can choose to contribute from their paycheck, a SEP IRA only accepts employer contributions. This distinction matters for tax purposes: the contribution is a business expense that reduces your taxable business income, not a personal deduction on your individual tax return.

The contributions go into a traditional IRA account in your name at the brokerage of your choice. Once contributed, the money is invested in whatever funds, stocks, or bonds you select within the account. Earnings grow tax-deferred, meaning you pay no taxes on dividends, interest, or capital gains while the money remains in the account. When you withdraw the money in retirement (after age 59.5), the withdrawals are taxed as ordinary income at your then-current tax rate. Early withdrawals before age 59.5 incur a 10% penalty plus ordinary income tax, with exceptions for disability, certain medical expenses, and a few other circumstances.

One important note: SEP IRA contributions go into a traditional IRA, and this affects your ability to make deductible contributions to a separate traditional IRA. If you are covered by a SEP IRA (meaning any contribution was made for the year), the deductibility of additional traditional IRA contributions is limited based on your income. However, you can still contribute to a Roth IRA if your income is below the Roth limits, or use the backdoor Roth strategy (though the SEP IRA balance complicates the pro-rata calculation for Roth conversions).

Contribution Limits and Calculation

The maximum SEP IRA contribution for 2025 is the lesser of 25% of net self-employment income or $70,000. But the calculation for self-employed individuals is not as simple as multiplying your profit by 25%. The IRS requires you to first deduct half of your self-employment tax from your net profit, and then apply a reduced rate of 20% (not 25%) to that adjusted figure. Here is why: the 25% rate applies to W-2 compensation, but self-employed income must be adjusted because you are both employer and employee.

The formula for sole proprietors and single-member LLCs is: Net self-employment income minus half of self-employment tax, multiplied by 0.20 (the effective self-employed contribution rate). For example, if your Schedule C net profit is $100,000, your self-employment tax is approximately $14,130, half of which is $7,065. Your adjusted net self-employment income is $92,935. Your maximum SEP IRA contribution is $92,935 times 0.20, which equals $18,587. At higher income levels, the self-employment tax cap on Social Security (only the 12.4% portion applies to the first $168,600 of income in 2024) reduces the deduction, and the contribution percentage approaches the full 25%.

For S-corporations, the calculation is simpler. The contribution is up to 25% of your W-2 salary from the S-corp. If you pay yourself an $80,000 salary, your maximum SEP IRA contribution is $20,000. The S-corp can also establish a Solo 401(k) instead, which may allow higher contributions depending on the salary level. For C-corporations, the same 25% of W-2 salary applies.

You do not need to contribute the maximum every year. Contributions are completely discretionary, meaning you can contribute $5,000 one year, $30,000 the next, and nothing the year after that. This flexibility is particularly valuable for businesses with variable income. In a strong year, maximize contributions to reduce your tax bill. In a lean year, skip the contribution entirely without penalty or administrative consequence.

Who Should Choose a SEP IRA

The SEP IRA is the right choice for self-employed individuals who prioritize simplicity and want generous contribution limits without administrative burden. Specifically, a SEP IRA makes the most sense if you are a solo operator with no employees (or only a spouse who does not work in the business), you earn over $100,000 per year (where the SEP contribution limit approaches or exceeds the Solo 401(k) employee contribution limit), you do not need a Roth option for retirement contributions, and you want the flexibility to make contributions after the tax year ends.

The SEP IRA is not the best choice if you earn under $60,000 to $80,000 per year (a Solo 401(k) allows larger contributions at these income levels through the employee contribution), you want to make Roth contributions (SEP IRAs are pre-tax only), you have employees (you must contribute the same percentage for eligible employees as you contribute for yourself), or you plan to use the backdoor Roth IRA strategy (SEP IRA balances create a pro-rata tax issue on Roth conversions).

How to Open a SEP IRA

Opening a SEP IRA requires two steps: adopting a SEP plan and opening a SEP IRA account at a brokerage. Most brokerages handle both steps in a single online process.

To adopt the plan, you fill out IRS Form 5305-SEP or the brokerage's equivalent plan adoption agreement. This document establishes the SEP plan for your business. You do not file this form with the IRS; you keep it in your records. The brokerage then opens a SEP IRA account in your name, which functions like a traditional IRA with the additional ability to receive employer (SEP) contributions.

Vanguard, Fidelity, and Charles Schwab all offer SEP IRAs with no account fees and access to their full range of index funds and ETFs. The process takes about 15 minutes online. You need your business name, EIN (or Social Security number for sole proprietors without an EIN), and personal identification information. Once the account is open, you can contribute immediately by transferring funds from your business bank account.

You can open a SEP IRA and make contributions for a tax year up until your tax filing deadline, including extensions. This means you have until April 15th, or October 15th if you file an extension, to open a SEP IRA and make contributions for the previous year. No other retirement plan offers this kind of retroactive flexibility.

SEP IRA vs Solo 401(k): Which Is Better

The Solo 401(k) allows higher contributions at income levels below approximately $100,000 because it includes an employee contribution ($23,500) plus an employer contribution (25% of income). The SEP IRA only has the employer contribution (effectively 20% of net self-employment income). At $60,000 in net income, a Solo 401(k) allows roughly $35,500 in total contributions while a SEP IRA allows roughly $11,150. At $150,000 in net income, the gap narrows significantly, and at $280,000 both plans max out at $70,000.

The Solo 401(k) also offers a Roth option, the ability to take loans from the plan, and the potential for higher total contributions when you combine employee and employer portions. The SEP IRA counters with simpler administration (no plan documents, no annual filings), the ability to open and contribute after year-end with no advance setup, and easier management for business owners who prefer to spend zero time on retirement plan administration.

If you already have a SEP IRA and are considering switching to a Solo 401(k), you can roll your SEP IRA balance into the Solo 401(k) to consolidate. However, you cannot have both a SEP IRA and Solo 401(k) for the same business and contribute to both in the same year (technically you can have both, but the combined employer contributions share the same 25% of compensation limit). Our Solo 401(k) guide covers the comparison in more detail from the 401(k) perspective.

Tax Reporting for SEP IRA Contributions

SEP IRA contributions are reported on your personal tax return, not on a separate business return (unless your business files its own return, like an S-corp or C-corp). Sole proprietors and single-member LLC owners report SEP IRA contributions on Schedule 1 of Form 1040, line 16 (Self-employed SEP, SIMPLE, and qualified plans). This deduction reduces your adjusted gross income, which in turn can reduce your eligibility for various income phase-outs and potentially lower your tax bracket.

The brokerage reports your SEP IRA contribution to the IRS on Form 5498, which you receive in May following the tax year. You do not need to attach this form to your tax return, but keep it for your records. If you over-contribute (exceed the 25% limit), you must withdraw the excess before your tax filing deadline to avoid a 6% excise tax on the excess amount for each year it remains in the account.

SEP IRA contributions also reduce your qualified business income (QBI) for purposes of the Section 199A deduction. Since the SEP contribution reduces your net income, it reduces the income base used to calculate the potential 20% QBI deduction. Your tax planning strategy should consider the interaction between retirement contributions and the QBI deduction, as in some cases a slightly lower retirement contribution could result in a larger QBI deduction that saves more total tax.