Updated for the 2023 tax year.
So you work for yourself — either full time or part time — and you’re totally killing it. Being the boss of you lets you work how you want, when you want, on the projects you want. You’re a master planner. Now you’re ready to master-plan that retirement.
If you operate as a team of one, own a company with a small number of employees, or freelance (even if it’s just a side hustle), there’s a super special type of IRA (individual retirement account) that you should know about. It’s called a SEP IRA.
Remind me: What’s an IRA?
An IRA is a tax-advantaged investment account that lets you set aside up to $6,500 ($7,500 if you’re over 50) each year to save for your retirement. Anyone with an income is eligible to use one, and you can open an IRA with pretty much any investment advisor (including Ellevest, if you have an Ellevest Plus or Executive membership).
What’s a SEP IRA and why would I want one?
It stands for “simplified employee pension individual retirement account” — say that five times fast. A SEP IRA is pretty much like a personal IRA, but with a few edits. The biggie is that your employer (which can just be yourself, if you’re the business owner) makes all the contributions.
But here’s the best part (also a biggie): A SEP IRA comes with super-high contribution limits. For 2023, it’s up to 25% of earnings or $66,000, whichever is lower. That limit blows a typical IRA out of the water, and it’s way higher than an employer-sponsored 401(k), too (which limits you to $22,500, or $30,000 if you’re over 50).
Who can use a SEP IRA?
Any employer, from a sole proprietor up through a corporation, can establish a SEP plan for its employees. Those high annual contribution limits (and the fact that they’re easy to establish — more below) make them a really great choice for armies of one — freelancers, contractors, and other self-employed people — or those with very few employees.
They’re typically not as great a choice for companies with a bigger team. With a SEP, the employer has to make the same contribution to every single employee’s account. That means if a business owner wants to put in the full 25% of her earnings for herself, she also has to contribute 25% of each of her employees’ earnings for them. That can get expensive. So keep that in mind if, for example, you think your company will grow quickly. Unless a company’s looking to offer especially generous benefits in order to reduce turnover, it’s an uncommon choice.
But no matter how many employees a company has, anyone who’s 21 years old, earns at least $600 a year, and has worked for the company in three out of the previous five years is eligible to get SEP contributions. But you can make these requirements less restrictive if you want.
How do I open a SEP IRA?
Appropriately enough for a gang of mostly do-it-yourself types, it’s a pretty DIY process. First, the employer (you, if you’re the owner) establishes the SEP plan. That involves creating a formal written agreement, which is usually based on the government’s template because it’s straightforward and doesn’t require extra IRS approval. If your business can’t use the template because you have special circumstances, some financial institutions have pre-gov-approved prototypes you can use. And if you have really specific needs for your business that aren’t covered by an existing prototype, you can design your own custom agreement. Just know that the last option will require you to get special IRS approval.
Next, if you’re the company’s only employee, you can just open a SEP IRA with an investment advisor (shameless plug for Ellevest) and start making contributions. You get to pick the actual investments in your SEP IRA, just like you do for a personal IRA.
If you have other employees, your next steps will be to give all your team members a copy of the plan and make sure each of them opens a regular IRA for themself (and choose their own investments — that DIY thing again). Then your company makes SEP contributions into it. (In fact, this is the true definition of a “SEP IRA”: it’s just a traditional IRA that receives special SEP contributions.)
Give me the fine print.
A SEP IRA is structured like a traditional IRA, so the idea is that you can deduct your contributions (in other words, pay no taxes) today. Then you pay income taxes on that money and its earnings when it’s withdrawn when you’re retired.
If you’re self-employed, there’s a max to how much you can deduct from your personal taxes. Alas, finding your max requires some hefty math. (That’s because it depends on your net earnings from self-employment, which is a number that actually already takes your SEP contributions into account. So it’s … complicated. Why is it always complicated with you, Uncle Sam?) The IRS gives you some tables and forms to help you DIY the calculations, but really, we recommend asking your favorite tax pro to help you out.
Oh, and one more thing: There’s no Roth option on a SEP IRA. (But you can have a separate Roth IRA if you want — more on this below.)
The basic SEP contribution limit for any employee is up to 25% of their earnings or $66,000, whichever is lower. With just a few caveats.
First: If you own your own business, “earnings” means net earnings from self-employment. Which means you can contribute up to 25% of your Schedule C income, minus any allowable deductions (including the deductible part of your self-employment tax and the SEP contributions themselves). Yes, this involves some more fancy math.
Second: Only the first $330,000 of a person’s income can be used to calculate that 25%. If you’re thinking that seems kind of high (25% of $330,000 is more than $66,000, after all), it’s because of the fancy contribution limit calculations for business owners mentioned above. Once you do the math, 25% of the net earnings from self-employment on a gross $330,000 comes out to that $66,000 max.
Finally, with a SEP IRA, there are no catch-up contributions if you’re over 50, unlike with personal IRAs and 401(k)s.
Withdrawals and Required Minimum Distributions
SEP IRAs follow the same rules as traditional IRAs for withdrawals and required minimum distributions (RMDs).
You can’t withdraw money from your SEP IRA before age 59½ without paying a 10% early withdrawal penalty (plus income tax). There are some exceptions, like if you need the money for medical expenses, you’re buying a home for the first time, or you’re using the money for higher education. And, like other IRAs, you can’t take a loan out of your account like you can with most 401(k)s.
But you also can’t leave that money in your SEP IRA forever. The IRS makes you start taking RMDs at age 72. The amount of that RMD is determined based on your IRA’s account balance. If you don’t take your RMDs on time, you’ll get hit with a penalty equal to 50% of the RMD amount (whoa).
If you want to consolidate your retirement accounts, get different investment options, or move your SEP IRA to a different investment advisor for some other reason, you can roll it over tax-free into a different traditional IRA, just like you can with a personal IRA.
Combining SEP IRAs with personal IRAs and 401(k)s
If you’re a part-time freelancer (for example), and you also have an employer who offers a 401(k), a SEP IRA doesn’t prevent you from using that too.
Also, having a SEP IRA doesn’t interfere with your ability to contribute to a personal IRA, either traditional or Roth. In fact, you can generally put your traditional IRA contributions into that same SEP IRA.
Just one thing to know about that: If you have a SEP, it might affect how much of your personal IRA contributions you can deduct today. If you aren’t covered by a retirement plan at work (and you aren’t married to someone who is), then there’s no income limit on whether you can deduct your traditional IRA contributions on your taxes. If you’re not covered at work but you’re married to someone who is, the limit for a full deduction is $218,000. But if you are covered by a retirement plan at work (which includes a SEP IRA), the limit for the full deduction drops to $73,000 for singles and $116,000 for married couples filing jointly. That’s highly unlikely to affect whether a SEP IRA is right for you, but it’s good to keep in mind.
Things to know if you have employees
This is the big one: You have to give each employee the same contribution, including yourself. That can be a percentage of their income (up to the max) or a fixed dollar amount. There’s also a way to calculate employee contributions called “Social Security integration,” but you’ll probably want an accountant’s help if you choose to go that route.
Also, contributions are “discretionary.” For example, just because you put in 10% this year doesn’t mean you have to do 10% next year. You can even skip years altogether and not contribute anything to anyone. (Just as long as everyone gets the same contribution as everyone else in any given year.) This can be helpful if your business results are less predictable. It can also be a great way to inspire your employees — perhaps the more you exceed your sales targets, the more you’ll contribute to their SEP IRAs.
Also, while the contributions you make on employees’ behalf are deductible for your business, they aren’t deductible or considered gross income for your employees, and they’ll pay income taxes on that money when they withdraw it.
Are SEP IRAs are especially important for self-employed women?
Yep. In one study, 78% of self-employed women reported that they’re happier being their own boss, and nearly 100% of them plan to stay self-employed. (Maybe that’s because 70% of them said workplace discrimination and the corporate glass ceiling were part of why they left their job. Oof.)
But self-employed women face some gender-specific challenges, too. 20% of the women in that study reported that they need to charge less than their male peers do in order to get and keep clients. And 30% said they believe they have to work harder than men to get the same results. (Ugh.) And if that weren’t enough, research has also shown that self-employed women earn even less than salaried women.
So, unsurprisingly, self-employed women face a serious self-employment wage gap. (We’ll save you a click: It’s 28%.) And with the majority of freelancers in the US being women, we can’t say we’re very surprised that there’s a gig economy pay gap, too.
As it is, women retire with two-thirds the money and live six to eight years longer as compared to men. And self-employed women may be coming from even farther behind. If we don’t do as much as we possibly can to save, we’ll never catch up. But hey — it takes some serious grit to work for yourself. So if anyone can do it, it’s you.
How much should I contribute to my SEP IRA?
Good question, and we’re so glad you asked. You aren’t legally required to make a contribution at all — but contributing regularly is a huge step in order to get the retirement you want.
When you become an Ellevest member, you can open a retirement account at Ellevest (including a SEP IRA*). We’ll use your earning power, savings, age, education level, and gender to create a personalized plan for you. That includes a recommended target amount — one that will get you an annual income of 90% of whatever we project your salary will be just before you retire. Then we’ll suggest a monthly contribution to get you there and take care of automatically rebalancing your investment portfolio as you get closer to retirement age.
Regardless of where you put your SEP IRA, we recommend investing regularly in a low-cost, diversified investment portfolio. And freelancers: Check out this article for some tips on how to bake retirement savings into the rate you set for your services.
*Quick note: Right now, Ellevest SEP IRAs are only built for single-employee sole proprietorships. We can't support SEP IRA programs for companies with multiple employees just yet. Read more here.