Magazine

What Is a SEP IRA? Here’s How the Simplified Employee Pension Plan Works

By Ellevest Team

So you work for yourself — either full-time or part-time — and you love 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 type of individual retirement account (IRA) that you should know about. It’s called a SEP IRA.

Remind me: What is an IRA?

An IRA is a tax-advantaged investment account that lets you set aside up to a certain amount of money each year to save for your retirement. 

  • IRA contribution limits for 2023:

  • $6,500 ($7,500 if you’re 50 or older)

  • IRA contribution limits for 2024:

  • $7,000 ($8,000 if you’re 50 or older)

Anyone with an income is eligible to use one, though it’s popular for self-employed retirement plans. You can open an IRA with pretty much any investment advisor (including Ellevest).

What is a SEP IRA and why would I want one?

“SEP” stands for “Simplified Employee Pension” plan — say that five times fast. It’s technically a type of traditional IRA, and it functions a lot like one, but with one big difference: A SEP IRA has a super-high contribution limit.  

  • SEP IRA contribution limits for 2023:

  • Up to 25% of earnings or $66,000, whichever is lower

  • SEP IRA contribution limits for 2024:

  • Up to 25% of earnings or $69,000, whichever is lower

This limit blows a traditional IRA out of the water, and it’s way higher than an employer-sponsored 401(k), too.

  • Employer-sponsored 401(k) contribution limits for 2023:

  • $22,500 ($30,000 if you’re 50 or older)

  • Employer-sponsored 401(k) contribution limits for 2024:

  • $23,000 ($30,500 if you’re 50 or older)

Who can use a SEP IRA?

Any employer, from a sole proprietor up through a corporation, can establish a SEP IRA for its employees. That said, they’re typically not as great a choice for companies with a bigger team. 

This comes down to the SEP IRA rules. One is that the employer (which may be you, if you’re the business owner) makes all the contributions. Two, the employer (maybe you again) 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. This 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 to reduce turnover, it’s an uncommon choice.

But no matter how many employees a company has, SEP IRA eligibility is open to anyone who’s 21 years old, earns at least $750 a year, and has worked for the company in three out of the previous five years. But you can make these requirements less restrictive if you want.

Are SEP IRAs especially important for self-employed women?

Retirement for women is just different, but especially for self-employed women. 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 jobs. 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 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. 

Add that to the very real fact that 4 in 10 people who work for themselves don't have a retirement account at all, and you’re looking at a serious self-employed gender retirement gap

Luckily, as its full name suggests, the process to open a SEP IRA is rather simple. 

How do I open a SEP IRA?

Appropriately enough for a do-it-yourself type, establishing a SEP IRA is pretty DIY. 

  1. The employer creates a formal written agreement. If you’re the business owner, this is your first step. You’ll base the agreement 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.

  2. The employer gives each employee a notice and details of the plan. If you’re the company’s only employee, simply read over your paperwork. If you have other employees, they must receive the company’s plan info before that written agreement is “considered adopted.”

  3. The employer (or employees) set up a SEP IRA. If you’re the company's only employee, you’ll set up the SEP IRA for yourself. If you have other employees, you can set it up for them or instruct them to open their own SEP IRAs. In both scenarios, the person responsible for opening the account would open a traditional IRA and choose their own investments. Then, the company will make SEP contributions into each traditional IRA. 

Any investment advisor, including Ellevest, can help an employer set up a SEP IRA.

How much should I contribute to my SEP IRA?

You aren’t legally required to make a contribution at all. But contributing regularly is a huge step to getting the dream retirement you want.

Generally, when we estimate how much you need to retire, we recommend saving at least 20% of your annual income for retirement (and other financial goals). If that’s not possible, we say shoot for at least 10% to 15% of your annual income in your retirement accounts. 

As the business owner, you’ll need to have W2 payroll set up for SEP participants, including yourself and your employees — or pay employees using 1099-NECs – and follow contribution limits prescribed by the IRS. For example, if you pay yourself as a business owner $15,000 in a year, you could contribute up to $3,750. The IRS limits the employee’s contributions to 25% of the participant's compensation (limited to $305,000 of the participant's compensation) or $20,500. As the employer, the most you can deduct for your contributions to your or your employee's SEP IRA is the lesser of the following amounts: your contributions or 25% of the compensation (limited to $305,000 per participant) not to exceed $61,000 per participant.

If you open a retirement account at Ellevest (including a SEP IRA*), we really personalize that target number. Here’s what to expect

  • We use your earning power, savings, age, education level, and gender identity to create a personalized plan for you. That includes a recommended target amount — one that'll get you an annual income of 90% of whatever we project your salary will be just before you retire. 

  • We 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. 

As it is, women retire with two-thirds the money and live 6–8 years longer as compared to men. And self-employed women may be coming from even further behind. If we don’t do what we‌ 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.

Want confirmation that opening a SEP IRA is right for your current situation? Book a free 15-minute call with an Ellevest financial planner to feel confident about your next steps.

*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.

Disclosures

© 2023 Ellevest, Inc. All Rights Reserved.

All opinions and views expressed by Ellevest are current as of the date of this writing, are for informational purposes only, and do not constitute or imply an endorsement of any third party’s products or services.

Information was obtained from third-party sources, which we believe to be reliable but are not guaranteed for accuracy or completeness.

The information provided should not be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities, and should not be considered specific legal, investment, or tax advice.

The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person.

Investing entails risk, including the possible loss of principal, and past performance is not predictive of future results.

Ellevest, Inc. is an SEC-registered investment adviser. Ellevest fees and additional information can be found at www.ellevest.com.

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Ellevest Team

Ellevest helps women build and manage their wealth through goal-based investing, financial planning, and wealth management. Our mission is to get more money in the hands of women.