SEP IRA: rules, costs and examples

Overview

A Simplified Employee Pension, or SEP, is an employer retirement arrangement that funds employees’ IRA accounts. It can serve a sole proprietor, but having eligible employees changes the decision. The employer’s administrative obligations and contribution formula matter as much as the advertised maximum.

Who is this for?

A business owner should compare a SEP with a SIMPLE IRA and, where suitable, an individual or conventional 401(k). List eligible employees, compensation, cash flow, and the contribution the business can afford for everyone. A SEP that looks inexpensive for an owner alone may cost much more after employee coverage is included.

Tax treatment

Employer contributions can generally be deducted within the applicable limits. Conventional pre-tax SEP balances grow tax-deferred and distributions are generally taxable. Roth SEP treatment is permitted under newer legislation, but provider support and reporting need checking. Confirm the type of contribution your provider actually accepts instead of assuming every SEP offers the same tax options.

Contribution rules

For 2026, employer contributions generally cannot exceed the lesser of 25% of an employee’s compensation or $72,000. The compensation cap and plan terms also matter. Self-employed owners use an adjusted net-earnings calculation; simply multiplying Schedule C profit by 25% is incorrect. SEP employer contributions are distinct from the individual’s regular IRA limit.

Investments and costs

Employees generally control investments in their SEP IRA. Compare custody charges, fund expenses, transfer options, and whether the provider handles your contribution type. A provider’s willingness to open the account does not establish that your business calculated the correct employer contribution.

Withdrawals and restrictions

Pre-tax SEP IRA distributions generally follow Traditional IRA income-tax, early-distribution, and RMD rules. A distribution to cover business expenses is not automatically an exception to the early-distribution additional tax. Money inside the account is retirement money, rather than a business operating reserve.

Worked example and decision checklist

Hypothetical employee-cost example: if the plan contributes 10% of eligible compensation, an employee earning $50,000 receives $5,000. Budgeting only the owner contribution omits that cost. Before funding, document eligibility, the plan’s allocation percentage, eligible compensation, and the total for all covered workers. For self-employment income, use the IRS self-employed contribution worksheet or a tax preparer rather than this employee illustration.

Sources and scope

• SEP plan questions — IRS
• Retirement plan limits by year — IRS
• Publication 590-A: IRA contributions — IRS

Updated October 21, 2026. Prepared with AI assistance; no independent professional review is claimed. Examples are hypothetical. Editorial policy and corrections.