This SEP IRA overview has been updated with information for the 2023 & 2024 tax years. Having become fully self-employed in recent years, I thought it would be a good time to revisit and update my research on the primary retirement accounts that those with self-employment and 1099 income can take advantage of: SEP IRAs, SIMPLE IRAs, and Solo 401Ks. If you have self-employment income (or plan/hope to at some point), or any side project or side hustle income, this should be of interest. I’ve previously opened and contributed to both an SEP IRA and Solo 401K, so I have personal experience with both. This article, an overview of SEP IRA basics, will be part 1 of a multi-part series. I’ll conclude with a comparison between retirement plans for self-employment income.
What is a SEP IRA?
SEP does not stand for “self-employed plan” or “self-employment plan” as one might expect. In fact, it stands for “Simplified Employee Pension”. The cool kids (are financial professionals “cool”?) pronounce it as one word – “sep”, versus “S-E-P”, by the way.
If you are looking into a SEP IRA for the purposes of directing self-employment income to retirement savings – don’t let the “employee” in the name deter you. Business owners can create a SEP IRA offering for employees (I won’t cover the particulars in this post, so you’ll want to consult other resources), but you can also create a SEP IRA for yourself.
At its core, SEP IRAs are very similar to Traditional IRAs. Both are pre-tax investment vehicles that allow you to deduct contributions from your taxable income to save for retirement. The main difference between the two is who can contribute and how much you can contribute.
What are the Qualifications to Create & Contribute to a SEP IRA?
If you have self-employment income (income reported on a 1099 form or similar sources), you can establish and contribute to a SEP IRA, with a few qualifications:
You must be age 21 or older
You must have worked for the employer (e.g. yourself) in at least 3 of the last 5 years (see note below)
You must have received at least $750 (2023/2024) per year in compensation from the employer (self-employment income)
Self-employment income for the purpose of this deduction means net profits from a Schedule C or Schedule F, self-employed income from a partnership, or wages as a shareholder-employee in an S-corporation. You do not have to have a registered LLC or maintain other incorporated status to be eligible for a SEP.
Note on the 3-of-5 year rule: this is the most restrictive eligibility requirement allowable. You can choose to use less restrictive participation rules in your plan, such as allowing employees to participate immediately after they start work or after a shorter period of employment (for example, after working for only 1 year). As a self-employed individual, you can basically eliminate this restriction in your plan.
Can you Contribute to Both a 401K and a SEP IRA?
Yes, if you have an employer-sponsored retirement plan, you can contribute to both your employer’s 401K (or 403B, 457B, or Government TSP) and make contributions to your own SEP IRA (as an “employer”) simultaneously. Pretty sweet.
Can SEP IRAs be Roth SEP IRAs?
No. At this time, SEP IRAs are only pre-tax in nature and “Roth SEP IRAs” do not exist. Given the recent popularity of Roths and the addition of Roth IRA and Roth 401K accounts as investment vehicles in recent years, I would speculate that might change. But at this time, SEP IRAs are pre-tax only.
Can you Roll SEP IRAs Into a Roth IRA?
Yes, you can roll a SEP IRA in to a Roth IRA, if you’d like. Be aware, as with all Traditional-to-Roth rollovers, that any amount you roll over is considered taxable income in the year that you roll it over.
SEP IRA Contribution Deadlines
As with standard IRAs, if a contribution comes between January 1st and the tax deadline, you can characterize it for the previous or the present calendar year. This (very conveniently) allows you to lower your tax liability for the prior calendar year at the time you are actually doing your taxes, when you know what kind of impact it may have. Note that contributions for a calendar year must be made prior to filing your taxes for that year, or you will have to submit an amended tax return.
SEP IRA Contribution Limits (for 2023 and 2024)
To recap, the maximum IRA contributions for Traditional and Roth IRAs are capped at $6,500 in 2023 and $7,000 in 2024 (with a catch-up contribution of an additional $1,000 if you are age 50 and above). There are also income phaseout restrictions for each, at which point your ability to contribute (or deduct your contribution) is phased out to $0.
Some SEP IRAs allow individual contributions towards those IRA totals. Where SEP IRAs deviate substantially from Traditional and Roth IRAs and can be vastly superior, if you have self-employment income, as you can contribute as an “employer”.
The 2023 maximum SEP IRA contribution as “employer” for each employee can go up to the lesser of:
- 25% of compensation, or
The 2024 maximum SEP IRA contribution as “employer” for each employee can go up to the lesser of:
- 25% of compensation, or
Note that these totals are the same as the maximum 401K employer contribution limit. Also note that catch-up contributions as “employer” for those age 50 and over are not permitted in SEP plans. Nor are elective salary deferrals.
However, special rules apply for self-employed individuals which limits the maximum deductible contribution that they can make.
Should you Contribute to a SEP IRA as an Employer or an Individual?
When you make a SEP IRA contribution, you may have the option of contributing to a SEP IRA as an employer or individual. If you have self-employment income, you can contribute as your own “employer” at the limits highlighted in the previous section, and should do that first. You may also be able to contribute as an “individual” up to the standard maximum IRA contribution levels with +$1,000 catch-up contributions for those age 50+. Note that Traditional IRA income limits apply for the contributions to be tax-deductible eligible (which is the whole point). The $6,500 (2023) or $7,000 (2024) IRA maximum applies to contributions across all types of IRAs, combined.
Calculating the Self-Employed Maximum Deductible SEP IRA Contribution:
The calculation for how much you can contribute to your own SEP IRA as an “employer” is not as easy as taking the percentage (up to a max of 25%) and multiplying by your net income. Why? Because your SEP contribution must first be deducted from your net earnings.
To figure out the maximum of how much you can deduct (the maximum you would want to contribute):
- Start with your net profit (income minus expenses)
- Subtract one-half of your self-employment tax (which is a deduction)
- Subtract your SEP contribution (also a deduction)
Wait, how can you calculate the SEP contribution if you don’t yet know the percentage rate you can contribute?
This is where the IRS SEP rate table for self-employed contributions can help. To calculate the rate yourself, here is an example, assuming a plan contribution rate of 25%:
- Put your plan contribution rate (as a decimal): 0.25
- Add 1: 1 + plan contribution rate (in this example, 0.25) = 1.25
- Take #1 and divide by #2: (0.25/1.25) = 0.2
To get the max deductible contribution, multiply the result in step #3 (the same as the percentages in the rate table) by your net self-employment income, before SEP deduction.
For example, the maximum deductible contribution for $100,000 in net self-employment income would equate to $100,000 x 0.2 = $20,000. This equates to 25% of the post-deduction income of $80,000.
Go ahead and re-read that a few times, if you’d like. ;-)
SEP IRA Contribution Calculators
If you want to double-check your math, here are a few SEP IRA contribution calculators that can lend a hand:
- Vanguard’s retirement plan contribution calculator
- Calculator.net retirement plan calculator
- CalcXML SEP IRA calculator
Where Can you Open a SEP IRA?
SEP IRAs are fairly popular and each of the discount brokers highlighted in my “how to start an online broker account” article have a SEP IRA option, including Vanguard, Schwab, and Fidelity. Make sure to research minimum balance requirements and any associated fees, including account maintenance or inactivity fees before creating your account.
SEP plans are incredibly easy to set up and require no more paperwork or filing requirements than other IRAs.
SEP IRA Resources:
If you have any questions, definitely consult with a tax professional and/or a brokerage firm.
Outside of the SEP IRA resources highlighted earlier, you should also check out the following IRS articles on the topic:
- IRS SEP IRA page
- SEP Plan FAQs
- IRS Publication 560, Retirement Plans for Small Business (this is the big one)
- IRS Publication 4333
- IRS Publication 4285, SEP Checklist