How does a SEP-IRA work?
Generally available; employee costs vary
A SEP-IRA under IRC §408(k) lets an employer contribute to IRAs for itself and eligible employees. Contributions are limited to the lesser of 25% of compensation or $72,000 for 2026 under IRC §402(h) and §415(c). For a sole proprietor, the effective limit is about 20% of net self-employment earnings. Every eligible employee must receive the same percentage of pay, and the plan can be set up and funded by the return due date.
Reviewed by Ebot Mbi, CPA, EA · Last reviewed · Law and figures current as of September 17, 2026
Key takeaways
- 2026 limits: lesser of 25% of compensation or $72,000 per person; compensation counted up to $360,000.
- Sole proprietors contribute about 20% of net profit after the half-SE-tax deduction.
- Contribution rates must be uniform for all eligible employees.
- The plan can be established and funded by the return due date, including extensions.
- SEPs are employer contributions only; there are no employee salary deferrals in new SEPs.
What it is
A simplified employee pension is an employer-funded arrangement in which the business contributes to a traditional IRA, or a Roth SEP IRA if offered, for each eligible employee, including the owner. It is popular with owner-only businesses because it is simple to start, often with Form 5305-SEP, and generally has no annual Form 5500 filing.
Contributions are discretionary from year to year. You can decide how much to contribute after the year ends, but whatever percentage you choose must apply to every eligible employee.
What the law says
IRC §408(k) defines a simplified employee pension and requires contributions not to discriminate in favor of highly compensated employees. IRC §402(h)(2) limits excludable contributions to the lesser of 25% of compensation or the §415(c)(1)(A) dollar limit, and IRC §404(h) limits the employer's deduction. IRS Notice 2025-67 sets the 2026 §415(c) limit at $72,000, the compensation limit at $360,000, and the minimum compensation for eligibility at $800.
For self-employed individuals, compensation is earned income under IRC §401(c)(2), which is reduced by the deduction for one-half of self-employment tax and by the contribution itself.
Requirements and tests
A SEP must meet these requirements:
- Written plan, such as Form 5305-SEP, adopted by the return due date, including extensions, for the year.
- Coverage of every employee who is at least 21, has worked for the employer in at least 3 of the last 5 years, and received at least $800 in 2026; the employer may use less restrictive terms.
- The same contribution percentage of compensation for every eligible employee, including the owner.
- Contributions made by the return due date, including extensions.
- If Form 5305-SEP is used, no other retirement plan except another SEP.
- Contributions are fully vested immediately.
How it works
An owner with no employees chooses a contribution up to the limit and deposits it to their SEP-IRA. A sole proprietor computes the maximum as 20% of net profit after subtracting one-half of self-employment tax. An S corporation owner uses 25% of W-2 wages, not of company profit.
With employees, the percentage you give yourself applies to each eligible employee's compensation. The employer deducts all contributions, including those for employees, so the net cost of covering staff is reduced by the deduction. Sole proprietors deduct their own contribution on Form 1040, which reduces income tax but not self-employment tax.
Compared with a solo 401(k), a SEP usually allows a smaller contribution at the same income for self-employed owners because it has no employee deferral component. The simplicity and flexible deadline are the main advantages.
Owners with more than one business must consider the controlled group rules. Employees of related businesses you control may count as eligible employees of the SEP, and leaving them out can cause the plan to fail its coverage requirements. If you also participate in another employer's 401(k), SEP contributions from your own business generally have a separate §415(c) limit, but the rules on related employers still apply. A SEP can also be combined with a later plan change: some owners start with a SEP and move to a solo 401(k) or a defined benefit plan as income grows.
Employees own their SEP-IRAs and can move or withdraw the money under the normal IRA rules, including income tax and a possible 10% additional tax on distributions before age 59½. Because contributions are fully vested at once, a SEP rewards short-tenure employees as much as long-tenure ones once they meet the eligibility requirements.
Assumptions: Tax year 2026; sole proprietor with $200,000 of Schedule C net profit and no other wages.; Self-employment tax: 12.4% on 92.35% of profit up to the $184,500 wage base plus 2.9% Medicare.; Plan contribution rate of 25%, which equals 20% of the owner's net earnings after the half-SE-tax deduction.; Alternative case: five eligible employees each paid $50,000.; Income tax savings are not shown because they depend on the owner's full return and graduated brackets.
| Self-employment tax | $28,234 |
|---|---|
| Deduction for one-half of self-employment tax | $14,117 |
| Net earnings after that deduction | $185,883 |
| Owner's maximum contribution (20% × $185,883) | $37,177 |
| Contributions for five employees (25% × $50,000 × 5) | $62,500 |
| Total deductible contributions with employees | $99,677 |
The owner can contribute about $37,177, and covering five eligible employees at the same 25% rate adds $62,500 of deductible cost.
Illustration only; not a projection of your results.
Risks and IRS scrutiny
Common problems include leaving out an eligible employee, using different percentages for different people, contributing on profit instead of W-2 wages for S corporation owners, exceeding the limits, and maintaining another plan while using Form 5305-SEP. Corrections may require additional contributions for missed employees under the IRS correction programs.
Excess contributions are included in the employee's income and can be subject to a 6% excise tax each year they remain in the IRA unless corrected.
Who it is not for
A SEP often does not fit a business with several long-tenured employees, because the owner's percentage must be given to each of them. It does not fit owners who want employees to fund their own retirement through salary deferrals, or owners who want the largest possible contribution at modest income, where a solo 401(k) often allows more.
How ebotCPA helps
We calculate the maximum contribution from your actual earnings, test the cost of covering eligible employees, compare the SEP with a solo 401(k), SIMPLE IRA, or defined benefit plan, and confirm the contribution is made on time.
Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.
Frequently asked questions
How much can I contribute to a SEP-IRA in 2026?
Up to the lesser of 25% of compensation or $72,000. For a sole proprietor, that works out to about 20% of net profit after the half-SE-tax deduction.
Do I have to contribute to a SEP for my employees?
Yes, if they meet the eligibility requirements. Each eligible employee must receive the same percentage of compensation that you contribute for yourself.
What is the deadline to open and fund a SEP-IRA?
The business's tax return due date, including extensions, for the year the contribution is for.
Is a SEP-IRA or solo 401(k) better for a self-employed person?
At the same income, a solo 401(k) often allows a larger contribution because of the employee deferral, while a SEP is simpler to run. The right choice depends on your income, employees, and administration preferences.
Have facts like these?
Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.