Self-Employed Retirement Planning: The SEP-IRA

By Ronald Kimmons. May 7th 2016

The IRS provides a number of ways for U.S. citizens to save for retirement in tax-advantaged accounts. Some of these retirement savings methods are designed specifically for self-employed individuals. For those who are self-employed, one of the most common retirement savings choices is the Simplified Employee Pension Individual Retirement Arrangement – or SEP-IRA. Read on to find out if the SEP-IRA is the right retirement vehicle for you.

SEP-IRA Vs. Solo 401(k)

When choosing between tax-advantaged retirement savings arrangements, self-employed people often have to choose between the SEP-IRA and the Solo 401(k) option. The Solo 401(k) has a number of advantages over the SEP-IRA such as a greater amount of flexibility when it comes to the specific things in which you can invest through the arrangement. However, a Solo 401(k) plan has strict limitations when it comes to employees. If you are a self-employed person with no normal, full-time employees, the Solo 401(k) option may be the best. However, if you have employees, the SEP-IRA option is probably the one for you. The SEP-IRA model is specifically made to simultaneously provide for the retirement of both self-employed individuals and their employees. (To learn more about the Solo 401(k) plan, see A Guide On Individual 401(k) Plans For The Self-Employed.)

Tax Benefits

As with various other tax-advantaged retirement plans, the SEP-IRA framework allows working people to save for retirement without having to worry about taxes until later. Whatever money goes into the SEP-IRA plan is tax-deferred. That is, if an employee takes $5,000 of her wages and puts it into a SEP-IRA, that employee's taxable income for that year is reduced by $5,000. The funds in a SEP-IRA then grow from year to year without being taxed. Once the employee reaches retirement, she may finally start taking distributions from the SEP-IRA, and these distributions are finally taxed. When it comes to someone who is self-employed, all of the same tax advantages apply: the SEP-IRA presents self-employed people with a way to save for retirement by deferring taxation on part of their income until when they actually take distributions from their retirement accounts upon retirement.

Advantages Of The SEP-IRA

As an investment instrument, the SEP-IRA has a number of advantages for self-employed people:

  • Neither contributions to employees nor to oneself are set in stone. The values of such contributions are entirely up to the discretion of the self-employed person.
  • The legal paperwork associated with setting up and managing a SEP-IRA is minimal. You usually do not have to report it directly to the government.
  • Because of the lack of paperwork, the administrative costs associated with operating a SEP-IRA are usually low compared to other investment options such as 401(k) accounts.
  • There are no annual fees.

Disadvantages Of The SEP-IRA

Despite the advantages of the SEP-IRA framework, there are a few disadvantages for self-employed people:

  • While employees may contribute to a normal IRA on their own, they may not do so with a SEP-IRA. All contributions are made by the employer.
  • Some people prefer the tax advantages of the Roth IRA framework over those of the SEP-IRA. In a Roth IRA, investors do pay taxes on their contributions but not on the distributions they receive upon retirement. This preference results from an assumption of a high level of growth in the IRA. (To learn more about Roth IRAs, see Differences Between Roth And Traditional IRAs.)
  • Unlike a 401(k), a SEP-IRA does not allow you to borrow funds from it.
  • Growth in a SEP-IRA is often lower than what could be realized in a 401(k).

Contribution Limitations

As it does with other tax-advantaged investment instruments, the IRS limits the total amount of money that investors are allowed to contribute into their SEP-IRA accounts every year. When employers make contributions for employees, contributions are limited to 25 percent of total compensation for the year, not to exceed the total amount stipulated by the IRS for that year. (The maximum contribution amount for 2012 is $50,000.) The contribution percentage must be the same for all eligible employees. As a self-employed person, if you receive your pay from the company in the form of corporate salary, you are limited by the same standards. If your company is unincorporated, your contributions are limited to the lesser of 20 percent of business profits or the maximum contribution amount for the given year.

Setting Up A SEP-IRA

Setting up a SEP-IRA is relatively simple. According to, to set up a SEP-IRA for your company, you must do the following:

  1. Contact an IRS-approved financial institution that handles SEP-IRAs. This institution may be a bank, mutual fund, insurance company or other financial firm. This institution acts as a trustee in providing and managing the SEP-IRA.
  2. Fill out the 5305-SEP form. It is not necessary that you turn this in to the IRS; its purpose is primarily to serve as a guide for the SEP-IRA.
  3. Give each employee a copy of the 5305-SEP form, along with a written statement outlining the specifics of SEP-IRA contributions for your firm, such as the contribution percentage.


In setting up your retirement arrangements for yourself and for your employees, remember that you are not locked into the framework that you pick forever. For example, if you later decide that a Roth IRA or a 401(k) is a better fit for you, you can convert your SEP-IRA into one of these other types of arrangements. Due to the simplicity and low costs of the SEP-IRA framework, many small business owners start with this arrangement and convert to other arrangements later if they see fit.

Now that you know the basics of a SEP-IRA, you can decide whether or not it is the best retirement vehicle for you and your employees. If you are still unsure, it’s always a good idea to speak with a financial advisor for additional guidance.


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