Are SEP IRA Contributions Tax-Deductible? + FAQs

Yes, SEP IRA contributions are tax deductible, meaning the money you contribute to a Simplified Employee Pension (SEP) IRA can be subtracted from your taxable income.

According to a 2024 Fidelity analysis, a self-employed professional in a 32% tax bracket who maxes out a SEP IRA can save over $20,000 in income taxes in one year.

This immediate tax break makes the SEP IRA one of the most powerful retirement tools for small business owners and self-employed individuals looking to slash their tax bills while saving for the future.

💰 How SEP IRA deductions work: Discover exactly how contributing to a SEP IRA lowers your taxable income and puts money back in your pocket.
🏛️ Federal vs. state rules: Learn the key IRS rules on SEP IRA deductibility and surprising state-level differences (New Jersey, Pennsylvania, etc.) that could affect your tax savings.
⚠️ Mistakes to avoid: Find out about common SEP IRA pitfalls – from overcontributing to missing deadlines – and how to steer clear of costly tax errors and penalties.
🔄 Comparisons with other plans: See how SEP IRAs stack up against Solo 401(k)s, SIMPLE IRAs, and Traditional IRAs, so you can confidently choose the right plan for your needs.
🤔 Expert tips & FAQs: Get clear answers to frequently asked questions (from Reddit and beyond) about SEP IRAs – including real-life examples, new Roth SEP IRA rules, and strategies to maximize your benefits.

Yes, SEP IRA Contributions Are Tax Deductible – Here’s Why

Absolutely, SEP IRA contributions are 100% tax deductible under U.S. federal tax law. This means every dollar you put into a SEP IRA reduces your taxable income by the same amount. In other words, if you contribute $15,000 to your SEP IRA this year, you can subtract that $15,000 from your income on your tax return – potentially saving you thousands in taxes. It’s an immediate reward: you’re funding your retirement and cutting your current tax bill at the same time.

The IRS treats SEP IRA contributions much like contributions to a 401(k) or traditional IRA: they’re made with pre-tax dollars. For a self-employed person or small business owner, these contributions are typically deductible as a business expense or an “above-the-line” adjustment to income on your tax return.

If you have employees, any amounts you contribute into your employees’ SEP IRA accounts are also deductible for your business, and your employees don’t pay income tax on those contributions either. Essentially, Uncle Sam lets you invest in retirement first and pay taxes later, which is why SEP IRAs offer such a valuable tax break.

Federal Tax Law Favors SEP IRAs: Deduction Rules Unpacked

Generous contribution limits: Federal law sets generous limits on how much you can contribute (and deduct) with a SEP IRA. For the 2024 tax year, you can contribute up to 25% of an employee’s compensation or $69,000 – whichever is less. In 2025, this cap rises to $70,000 (indexed to inflation).

These high limits far exceed what you could put into a personal IRA. However, the IRS also caps the amount of annual compensation you can count for the 25% calculation (for example, $330,000 in 2023, $345,000 in 2024, and $350,000 in 2025). Any pay above those figures doesn’t increase your SEP contribution room.

Special rules for the self-employed: If you’re self-employed (including a single-member LLC or sole proprietor), your “compensation” is your net business profit. Calculating 25% of net profit gets tricky because you must account for the deduction itself.

Practically, a self-employed person can contribute roughly 20% of net self-employment income as a SEP IRA contribution. (For instance, on $100,000 of net profit, about $20,000 is the maximum deductible contribution, not $25,000.) The IRS provides worksheets in Publication 560 to help self-employed individuals compute their allowed contribution. The key point is that you still get a large deduction – just slightly less than 25% of your profit – due to the way the formula works.

Tax filing and deadlines: From a tax filing perspective, SEP IRA contributions are claimed differently depending on your business structure. Sole proprietors and partners deduct SEP contributions on their personal tax return (Form 1040, as an adjustment to income), while corporations deduct them as a business expense. Importantly, you have until the tax filing deadline (including extensions) to set up and fund a SEP IRA for the prior year.

That means if you file an extension, you could make a SEP contribution as late as October 15th and still have it count for the previous calendar year’s taxes. This flexibility is a huge advantage – you can decide on your deduction once you know your year-end financials.

No double-dipping on personal IRAs: Keep in mind that participating in a SEP IRA makes you an “active participant” in a retirement plan for that year. You can still contribute to a Traditional or Roth IRA personally, but if your income is high, the tax deductibility of a Traditional IRA contribution may be phased out because of your SEP coverage. (Roth IRA eligibility could also be affected by your higher adjusted income.) This doesn’t affect your SEP IRA deduction – it’s fully deductible regardless of income – but it’s a consideration if you’re trying to maximize all your retirement contributions.

Avoid excess contributions: Federal law won’t reward you for going over the limits. Contributions above the SEP IRA limit are not deductible and could trigger a 6% excise tax per year on the excess until removed. In short, stick to the annual dollar cap or 25% of pay – whichever is lower – to keep your entire contribution tax-favored.

Also note that unlike 401(k)s, SEP IRAs do not allow catch-up contributions for those over age 50. The employer contribution limit is the same for everyone, old or young. This is one reason some older business owners might consider a Solo 401(k) instead, since that plan allows extra “catch-up” contributions for age 50+.

The bottom line: The IRS gives SEP IRA contributors a significant tax break. You can claim a sizable deduction each year now, with the understanding that you’ll pay ordinary income tax on withdrawals later in retirement. In many cases, you’ll end up paying those taxes at a lower rate in retirement if your tax bracket is smaller. This win-win scenario is why SEP IRAs are so popular for entrepreneurs and small businesses aiming to minimize taxes today while building wealth for tomorrow.

State Tax Surprises: SEP IRA Deduction Rules in Different States

When it comes to state income taxes, the rules for SEP IRA contributions can differ from the federal treatment. In most states, you get to deduct your SEP IRA contribution on your state return just as you do on your federal return (because many states start with your federal adjusted gross income). However, a few states have quirky rules or don’t offer the same benefit. Here are some notable examples:

New Jersey: No State Deduction Upfront

New Jersey does not allow any deduction for contributions to IRAs or SEP plans on the state income tax return. In New Jersey, your SEP IRA contribution is treated as taxable income in the year you make it (no tax break at the state level). The good news is you won’t be taxed twice: when you eventually withdraw from the account, New Jersey lets you exclude the portion of the withdrawal that represents contributions you already paid state tax on. But still, for the contribution year, New Jersey business owners don’t get the immediate tax relief that federal law provides.

Pennsylvania: Taxed Now, Tax-Free Later

Pennsylvania also does not permit a state tax deduction for SEP IRA contributions – they’re considered part of your taxable income when contributed. However, Pennsylvania law provides a generous twist: retirement distributions after age 59½ (or upon retirement) are exempt from PA state tax.

In practical terms, if you wait until retirement to take money out of your SEP IRA, Pennsylvania won’t tax those withdrawals at all (because it views them as tax-free retirement income). So, Pennsylvania essentially taxes your contributions upfront but then lets all the growth come out tax-free later, provided you take distributions at retirement age. This is different from the federal government, which taxes SEP IRA withdrawals as income.

Massachusetts: After-Tax Contributions and Basis Tracking

Massachusetts follows a policy similar to New Jersey’s for IRAs and SEP contributions: no state deduction is allowed when you contribute. You must pay Massachusetts income tax on the SEP IRA contribution in the contribution year. Later on, Massachusetts will not double-tax that money – when you take distributions, the portion that was already taxed (your contributions) can be withdrawn state-tax-free.

Only the earnings portion of your withdrawal (the growth in the account) will be subject to Massachusetts income tax. Essentially, Massachusetts treats a SEP IRA a bit like a tax-deferred account (you don’t get an upfront break, but you defer state tax on the earnings until retirement).

States with No Income Tax: No Tax, No Deduction Needed

It’s worth noting that if you live in a state with no personal income tax – such as Florida, Texas, Tennessee, Washington, or Nevada – state deductibility is a moot point. There’s simply no state income tax on your earnings to begin with, so while you won’t get a “deduction” (there’s nothing to deduct against), you also won’t owe any state tax on your SEP IRA contributions or withdrawals. Residents of these states only need to focus on federal tax benefits, since the state won’t take a cut either way.

Bottom line: Always check your own state’s rules. Most states mirror the federal treatment (meaning your SEP IRA contribution lowers state taxable income), but a handful do not. Being aware of these differences can help you avoid unpleasant surprises, and even plan strategically. For example, knowing Pennsylvania’s rules might encourage someone to retire there to enjoy tax-free SEP IRA withdrawals at the state level.

Avoid These Costly SEP IRA Mistakes

Even savvy business owners can slip up with SEP IRAs. Here are some common mistakes to watch out for (and avoid):

⚠️ Not covering all eligible employees: A SEP IRA must include all employees who meet the eligibility criteria (age 21+, 3 years of service out of the last 5, and a minimal compensation threshold). One costly mistake is failing to include a part-timer or seasonal employee who actually qualifies – this can jeopardize your plan. Always apply the same contribution percentage to every eligible worker (not just yourself), as required by the IRS.
⚠️ Missing the setup or contribution deadline: Procrastination can cost you. If you don’t establish your SEP IRA plan (and make contributions) by your tax filing deadline (including extensions), you lose the chance to deduct those contributions for that tax year. Don’t wait until the last minute – give yourself time to set up the plan properly (e.g. execute the Form 5305-SEP or your provider’s SEP agreement) and fund the accounts before the deadline.
⚠️ Contributing above the allowed limit: Accidentally putting in too much is easier than you think, especially if you’re doing well financially. Remember that contributions for each person are capped at 25% of compensation or the annual dollar limit (e.g. $69,000 for 2024). Also, your business can only deduct up to 25% of the aggregate compensation of all participants. Over-contributing leads to penalties (a 6% excise tax on the excess each year until fixed). Keep track of all contributions and double-check the math to stay within limits.
⚠️ Miscalculating self-employed contributions: Many self-employed folks initially assume they can contribute a full 25% of their Schedule C profit to a SEP IRA. In reality, the formula nets out to about 20% of net earnings. If you calculate it wrong and contribute too much, you’ll have an excess contribution on your hands. Use the IRS worksheets or a tax advisor to compute your maximum self-employed contribution correctly – don’t just wing it with 25%.
⚠️ Assuming employees can contribute their own money: Unlike a 401(k), a SEP IRA does not allow employee salary deferrals. Sometimes employees (or employers) mistakenly think they can add their own contributions. Any money going into a SEP IRA must come from the employer. Employees cannot contribute to their SEP accounts via payroll deductions. Make sure everyone understands this to avoid confusion.
⚠️ Mishandling the tax reporting: Another frequent error is putting the deduction on the wrong part of the tax return or overlooking it entirely. If you’re self-employed, remember to take the SEP IRA deduction on your 1040 (it’s an above-the-line adjustment to income, not a business expense on Schedule C). If you run an S-corp or C-corp, the company should deduct the contributions on its corporate return as an employee benefit expense. Getting the reporting right ensures you actually receive the tax benefit you earned by contributing.

How Does a SEP IRA Stack Up Against Other Retirement Plans?

A SEP IRA isn’t the only way to save for retirement. Here’s a quick comparison of how SEP IRAs measure up versus some other popular small-business retirement arrangements:

SEP IRA vs. Solo 401(k)

Contribution Limits: Both plans allow a maximum annual contribution around the same high dollar amount (approximately $66k–$70k, depending on the year). However, a Solo 401(k) lets you reach that max with a combination of employee deferrals and employer contributions. For example, in 2025 a solo 401(k) owner under 50 could defer $23,500 as an “employee” and have the business contribute the rest as “employer” up to the $70k cap. A SEP IRA, by contrast, has no employee contribution option – it’s 100% employer-funded (so your only way to hit the max is having a high enough income for the 25% formula to reach the cap).
50+ Catch-Up Contributions: Solo 401(k) plans allow additional “catch-up” deferral contributions (over $7,000 extra if you’re age 50 or above). A SEP IRA has no catch-up provision, since participants can’t defer their own salary and the employer contribution limit is the same regardless of age.
Roth Option: Traditional SEP IRAs only allow pre-tax contributions. Solo 401(k)s often come with an option to contribute in Roth form (after-tax, for tax-free withdrawals later). Recent law changes in 2023 permit Roth SEP IRA contributions, but many financial institutions don’t yet offer a “Roth SEP” feature. Until that becomes common, the Solo 401(k) has the clear advantage if you want Roth savings.
Loans and Administration: Solo 401(k)s can permit loans to yourself from the plan (up to legal limits), while SEP IRAs do not allow loans at all (just like a regular IRA). In terms of paperwork, a SEP IRA is simpler – typically no annual filings. A Solo 401(k) involves a bit more administration: if plan assets exceed $250,000, you must file a Form 5500-EZ with the IRS each year. Still, both are designed for owner-only businesses; if you add full-time employees, a Solo 401(k) generally can’t continue (it would need to be converted to a regular 401k), whereas a SEP can cover employees (but then you must contribute for them).

SEP IRA vs. SIMPLE IRA

Contribution Structure: A SIMPLE IRA is another small-business retirement plan, but it works differently. Employees can defer a portion of their salary (up to $15,500 in 2023, plus a $3,500 catch-up if 50+) into a SIMPLE IRA, and the employer must provide a matching contribution (usually 3% of salary) or a 2% fixed contribution for all eligible employees. In a SEP IRA, only the employer contributes, but they can contribute a much higher percentage (up to 25% of compensation) and there’s no mandatory match each year.
Contribution Limits: SEP IRAs allow far higher total contributions for each person (tens of thousands of dollars) compared to SIMPLE IRAs. For instance, the maximum employer contribution to one person’s SIMPLE IRA is usually much lower (if an employee makes $50,000 and you match 3%, that’s $1,500 from the employer plus whatever the employee put in). The SIMPLE IRA’s employee deferral limit is also much lower than what a SEP allows an owner to contribute. Thus, a SEP is better for those who want the ability to contribute a large amount (and have the profits to do so), whereas a SIMPLE IRA is designed for more modest savings by employees and a limited employer outlay.
When Each Makes Sense: A SIMPLE IRA can be a good choice for small businesses that want employees to actively contribute to their own retirement (through payroll deferrals) and are okay with a required employer match. It’s somewhat like a “401(k) lite.” A SEP IRA is often better for a business with higher profits or one-person businesses – it gives the owner flexibility to contribute a lot in good years (or nothing in lean years) without being locked into a match formula. Note that a SIMPLE IRA has to be set up by October 1 of the year, while a SEP IRA can be established retroactively by the tax deadline.
Administrative Ease: Both plans are fairly easy to administer compared to a 401(k). However, a SIMPLE IRA does require sending out annual notices to employees and handling ongoing contributions each payday. SEP IRAs are extremely flexible – you can decide and fund contributions at year’s end. If you have no employees, a SEP is arguably simpler than maintaining a SIMPLE IRA, and it offers a higher ceiling on tax-deferred savings.

SEP IRA vs. Traditional IRA

Who Can Contribute: A Traditional IRA is an individual retirement account anyone with earned income (below certain age limits) can open on their own. It’s not tied to an employer. A SEP IRA, on the other hand, is a plan sponsored by an employer (even if that employer is just you as a self-employed person). If you don’t have self-employed income or an employer offering a SEP, you can’t contribute to a SEP IRA – you’d use a Traditional or Roth IRA instead.
Contribution Limits: Traditional IRAs have a much lower contribution limit (e.g. $6,500 per year in 2023, or $7,500 if age 50+). SEP IRAs allow contributions in the tens of thousands of dollars if you have the income to support it. This makes SEP IRAs a powerful tool for high earners, while Traditional IRAs are more limited for annual savings.
Deductibility: Both SEP IRA contributions and Traditional IRA contributions can be tax-deductible, but the rules differ. SEP contributions are always deductible to the business (and not counted as the individual’s income). Traditional IRA contributions are deductible on your personal return only if you meet certain conditions – if you or your spouse are covered by a workplace retirement plan (like a SEP or 401k), then income limits apply to whether you can deduct a Traditional IRA contribution. In short, a SEP IRA gives a business owner a big, straightforward deduction, whereas a Traditional IRA deduction might be phased out or unavailable at higher incomes if you’re already in a SEP.
Account Characteristics: Interestingly, a SEP IRA is actually a type of Traditional IRA under the hood. Money in a SEP IRA grows tax-deferred just like in a Traditional IRA. The withdrawal rules (such as early withdrawal penalties and required minimum distributions starting at age 73 under current law) are the same for SEP IRAs and Traditional IRAs. The key difference is just who contributes and how much. Think of a SEP IRA as a Traditional IRA with a supercharged contribution limit (funded by an employer). You could even have both: many business owners contribute to a SEP IRA for the big deduction and also max out a Roth IRA or Traditional IRA on the side for extra savings, if eligible.

Tax Savings in Action: Real SEP IRA Scenarios

Scenario 1: Solo Consultant Maximizes Her SEP IRA

Amy is a self-employed consultant with net business income of $100,000 for the year. She decides to contribute the maximum to a SEP IRA.

Item	Amount
Net self-employment income (after expenses)	$100,000
Max SEP contribution (~20% of net)	$20,000
Immediate tax savings (24% federal tax bracket)	~$4,800

Amy’s contribution of $20,000 to her SEP IRA will reduce her taxable income from $100,000 down to $80,000. In a 24% federal tax bracket, that saves her about $4,800 in federal income tax for the year (and possibly more when including state tax savings). Meanwhile, she has beefed up her retirement account by $20k in one go. This scenario shows how a high-earning solo professional can use a SEP IRA to significantly cut their tax bill while saving for the future.

Scenario 2: Small Business Owner Shares the Wealth

David owns a small company (an S-corporation) and pays himself a salary of $80,000. He has two full-time employees, each earning $40,000. David wants to contribute 10% of compensation to a SEP IRA for himself and his staff.

Contribution	Amount
David’s SEP contribution (10% of $80,000)	$8,000
Employee A SEP contribution (10% of $40,000)	$4,000
Employee B SEP contribution (10% of $40,000)	$4,000
Total deductible contribution by company	$16,000

In this scenario, David’s business will get to deduct the entire $16,000 as a business expense. David’s own $8,000 contribution does not count as personal income to him (it’s like an extra 10% of salary he gets to invest tax-free). Employees A and B also get $4,000 each deposited into their SEP accounts, and they owe no tax on those contributions. David has rewarded his employees and himself, and the company lowers its taxable profit by $16,000 – a win-win (plus potentially a happier workforce). Note that with a SEP, David couldn’t just contribute for himself without doing the same percentage for his eligible workers.

Scenario 3: Side Gig Savings on Top of a Day Job

Lisa works full-time for a company that offers a 401(k) plan, and she earns $100,000 in salary. She maxes out her 401(k) at work by contributing $22,500 (pre-tax). Lisa also has a side consulting business that brought in $50,000 of net profit this year. She decides to open a SEP IRA for her side business to shelter some of that self-employment income from taxes too.

Source of Income/Contribution	Amount
401(k) contribution at day job (pre-tax)	$22,500
SEP IRA contribution from side business (20% of $50k)	$10,000
Total tax-deferred retirement contributions	$32,500
Estimated federal tax saved (24% bracket)	~$7,800

Thanks to her side gig, Lisa is able to put away an additional $10,000 pre-tax into a SEP IRA, on top of her 401(k) savings from her main job. Her $10,000 SEP contribution will be deducted on her tax return, reducing the taxable income from her consulting business. Between the two plans, she’s deferred $32,500 of her money from taxation this year. That could save her roughly $7,800 in federal taxes (at a 24% rate), not to mention future investment growth in her retirement accounts. This scenario shows that having self-employment income on the side can unlock even more tax-saving retirement contributions, even if you’re already saving through a day-job 401(k).

SEP IRA Terms and Concepts Made Simple

SEP IRA (Simplified Employee Pension IRA): A retirement plan set up by an employer (often a small business or self-employed person) that contributes to Traditional IRA accounts for employees. SEP IRAs allow higher contributions than regular IRAs and are entirely funded by employer contributions (no employee deferrals). They’re easy to establish and have flexible, tax-deductible contributions.
Form 5305-SEP: A simple one-page IRS form that many businesses use to establish a SEP IRA plan. By signing Form 5305-SEP (or an equivalent document from a financial institution), the employer agrees to the SEP plan terms – such as eligibility rules and that contributions will be made equally for all eligible employees. This form essentially serves as the plan’s governing document and must be executed by the tax filing deadline of the first contribution year.
Self-Directed SEP IRA: A SEP IRA that is held with a custodian who allows a wide range of investments beyond the typical stocks, bonds, and mutual funds. “Self-directed” IRAs can invest in alternative assets like real estate, private businesses, precious metals, etc. Some self-directed SEP IRA holders even set up an LLC (Limited Liability Company) owned by the IRA to gain “checkbook control” over investments. (This requires careful compliance with IRS rules to avoid prohibited transactions.)
Compensation: The earnings that SEP IRA contribution limits are based on. For employees, “compensation” generally means W-2 wages or salary. For a self-employed person, it’s their net profit from self-employment (after expenses, and adjusted for the employer portion of self-employment tax). The IRS sets an annual cap on compensation that can be counted for SEP contributions (for example, $330,000 for 2023). Any income above that cap doesn’t increase the allowable contribution.
Active participant status: When you contribute to a SEP IRA (or have one set up for you by an employer), you are considered an active participant in an employer retirement plan for that year. This status matters only for determining if you can deduct contributions to a separate Traditional IRA – it has no effect on your SEP IRA itself. (If you’re an active participant, the tax deductibility of a Traditional IRA contribution is subject to income limits.)
Required Minimum Distributions (RMDs): Like other tax-deferred retirement accounts, SEP IRAs are subject to IRS required minimum distribution rules. Starting at a certain age (73 under current law for those born between 1951–1959, and 75 for younger individuals in the future), you must begin taking minimum withdrawals each year from your SEP IRA and pay taxes on those distributions. SEP IRAs follow the same RMD rules as Traditional IRAs. (Roth IRAs, by contrast, have no lifetime RMDs.)

Entities and IRS Rules You Need to Know

Internal Revenue Service (IRS): The U.S. tax authority that governs retirement plans like SEP IRAs. The IRS sets the contribution limits, defines the rules for eligibility and deductibility, and requires certain forms to be filed. For example, the IRS publishes Publication 560 (a guide on retirement plans for small businesses) and receives information on SEP IRA contributions each year from custodians (via Form 5498). It’s important to follow IRS rules closely – if a SEP plan is operated incorrectly, the IRS can disqualify it (making contributions taxable).
Financial Institution (Custodian/Trustee): A bank, brokerage, or financial company holds the SEP IRA assets. When you set up a SEP IRA, you do so through a custodian who provides the IRA account for each participant. The custodian invests the funds as directed and handles the paperwork (sending you and the IRS forms confirming contributions and the year-end value of the account). Choosing a reliable custodian is key – especially if you want a self-directed SEP that can handle alternative assets.
Written Plan Document: Every SEP IRA plan must be established with a written agreement. Most often this is done by signing IRS Form 5305-SEP or adopting a prototype SEP plan from a financial institution. This document spells out who is eligible and how contributions are allocated. It’s essentially the “contract” of the plan. Without a properly executed plan document, your SEP IRA might not be considered valid by the IRS.
Eligibility and Participation Rules: The IRS mandates that a SEP plan cover all employees who are at least 21 years old, have worked for you in at least 3 of the last 5 years, and earned at least a minimum amount ($750 in 2023–2024). You can use looser requirements (letting younger or newer employees in), but you can’t be more restrictive than these thresholds. All eligible employees must be allowed to participate – you cannot pick and choose individuals to exclude if they meet the criteria.
Uniform Contribution Percentage: An important IRS rule for SEPs is that the employer’s contribution must be the same percentage of compensation for every eligible employee. You as the owner can’t give yourself 25% and your employee 10% – it has to be uniform. (The only exception is if you integrate with Social Security, a complex option rarely used.) This uniformity rule ensures fairness and replaces the need for nondiscrimination testing that other plans (like 401(k)s) have.
Prohibited Transactions: SEP IRAs are subject to the same prohibited transaction rules as Traditional IRAs. This means you (and your related family or business interests) cannot borrow from your SEP IRA, use it as collateral, or invest its funds in your own company or other disallowed assets. If a prohibited transaction occurs, the IRS may treat the entire IRA as distributed (triggering taxes and penalties). Be cautious, especially if you self-direct your SEP investments.

Pros and Cons of SEP IRAs

Pros of SEP IRAs

✅ High contribution limits: You can contribute much more to a SEP IRA each year than to a Traditional or Roth IRA. Limits in the tens of thousands of dollars (up to $69k in 2024) let high earners really bulk up their retirement savings and snag big tax deductions.
✅ Simplicity and low cost: SEP IRAs are easy to set up and maintain. There are no annual IRS filings (unlike 401(k)s which require Form 5500 for larger plans), and administrative paperwork is minimal. Most banks or brokers don’t charge high fees for a SEP IRA, making it a hassle-free option for small businesses.
✅ Flexible contributions: As the employer, you have complete discretion to decide how much to contribute each year (from 0% up to 25% of compensation). You’re not locked into a fixed obligation. If business is good, you can contribute the max; if it’s a tight year, you can scale back or skip contributions entirely without penalties.
✅ Tax deductible for the business: Every dollar you put into a SEP IRA is a tax-deductible expense for the company (or for you if you’re self-employed). That reduces your taxable income dollar-for-dollar. Essentially, you’re paying yourself (and employees) instead of paying the IRS.
✅ Covers employees with immediate vesting: Contributions you make for your employees vest immediately – they own that money right away. This can be a pro from the employees’ perspective and helps with morale/retention. For the owner, offering a SEP can be a nice perk to attract and keep talent, with the benefit of deducting those contributions.
✅ Late contributions allowed: You have until your tax filing deadline, including extensions, to fund SEP IRA contributions for the prior year. This means you can decide on and make contributions after year-end, once you know your financials, and still get the deduction for last year. It offers more flexibility in tax planning.

Cons of SEP IRAs

❌ Must contribute for employees: If you have employees, you generally must contribute the same percentage for everyone. This can become expensive if you want to max out your own contribution – you’ll need to budget for contributing that percentage of each employee’s pay as well. There’s no option to favor the business owner; SEP IRAs are all-or-nothing across the board.
❌ No employee salary deferrals: Unlike a 401(k) or SIMPLE IRA, regular employees cannot contribute their own money to a SEP IRA. All contributions come from the employer. That means employees have no way to boost their retirement savings through the company plan, which could be seen as a downside (they could still use their own Traditional/Roth IRA, but not via payroll deduction).
❌ No catch-up for 50+: There’s no special increase in contribution limit for older participants in a SEP. A 55-year-old and a 35-year-old are capped by the exact same dollar limit. Other plans like 401(k)s and SIMPLE IRAs allow additional catch-up contributions for those aged 50 and above.
❌ Limited Roth availability: Historically, SEP IRAs have been tax-deferred only – no Roth option for after-tax contributions. Recent law changes now allow Roth-style SEP contributions, but many plan providers haven’t implemented this yet. Until Roth SEPs become common, anyone wanting tax-free Roth growth might find the SEP limiting.
❌ No loan feature: SEP IRAs don’t permit loans. In a 401(k), you might be able to borrow against your balance in a pinch, but with a SEP IRA, the money is essentially locked in until retirement (or until you take a taxable distribution).
❌ Self-employed calculations are a bit complex: If you’re self-employed, figuring out your maximum contribution involves an iterative calculation (since your contribution itself reduces your net income). It’s not a huge con – but it’s an extra step that sometimes requires a worksheet or tax software. You can’t just take 25% of your gross self-employment income. Some sole proprietors find this confusing at first.

Recent Updates and Legal Clarifications

Roth SEP IRAs (new in 2023): One of the biggest recent changes came from the SECURE Act 2.0 (enacted at the end of 2022). This law now allows SEP IRAs to accept Roth contributions. In practical terms, an employer can give participants the choice to treat SEP contributions as taxable income now (making them Roth contributions) so that the money grows tax-free and can be withdrawn tax-free later. This is optional – and as of 2024–2025, many financial institutions haven’t yet enabled Roth SEP IRAs.

The IRS issued guidance in late 2023 clarifying that any employer contributions designated as Roth must be included in the employee’s wages for tax purposes. If you’re interested in a Roth SEP IRA, check with your provider, as this feature becomes more available over time.

Higher retirement age and RMD changes: The same legislation raised the required minimum distribution (RMD) age for IRAs. If you were born in 1951 or later, your RMDs now start at age 73 (instead of 72). For those born in 1960 or later, RMDs will start at 75. This affects SEP IRA holders just like Traditional IRA holders. In short, the government is giving you more time before you must draw down your tax-deferred savings.

Bigger incentives for starting a plan: There are now significant tax credits available to small employers who establish a new retirement plan, including SEPs. For example, businesses with up to 50 employees can get a startup credit covering 100% of administrative costs (up to $5,000 per year) for setting up a SEP or other plan. SECURE Act 2.0 also added a credit for a portion of employer contributions made in the first few years of a new plan.

These changes, effective 2023, are meant to encourage more businesses to offer retirement benefits. If you’ve been on the fence about a SEP IRA, these credits could offset some costs of getting it going.

Staying informed: Tax laws and IRS rules around retirement plans continue to evolve. It’s wise to stay updated through IRS announcements or consult a tax professional annually. Recent years have brought many changes (like those above) that enhance the flexibility and benefits of SEP IRAs. By keeping up with new rulings, you can ensure you’re taking full advantage of opportunities (and remaining compliant with any new requirements).

FAQs: Common SEP IRA Questions Answered

Q: Are SEP IRA contributions tax deductible?
A: Yes. SEP IRA contributions are 100% tax deductible for the business or self-employed person, up to the annual IRS limits. They directly reduce your taxable income for the year.

Q: Can employees contribute their own money to a SEP IRA?
A: No. Only the employer can contribute to a SEP IRA. Employees cannot defer salary into a SEP IRA. (Employees can still contribute to separate Traditional or Roth IRAs on their own.)

Q: Do SEP IRA contributions reduce self-employment tax?
A: No. SEP contributions lower your income tax, but they do not reduce your self-employment (Social Security/Medicare) tax. They’re deducted on your 1040, not from your net self-employment earnings.

Q: Can I contribute to a SEP IRA and a Roth IRA in the same year?
A: Yes. You can contribute to a SEP IRA (through your business) and also contribute to a personal Roth IRA (if you meet the income requirements). One doesn’t stop you from doing the other.

Q: What is the deadline to contribute to a SEP IRA for a given year?
A: You have until the tax filing deadline of the following year (including extensions) to set up and fund a SEP IRA for the prior tax year.

Q: Does having a SEP IRA affect my Traditional IRA deduction?
A: Yes. If you (or your spouse) are covered by a SEP IRA, it counts as a retirement plan at work – which means a deductible Traditional IRA contribution may be disallowed at higher incomes.

Q: Can I use a SEP IRA if I already have a 401(k) at my job?
A: Yes. Having a 401(k) at one job doesn’t prevent you from opening a SEP IRA for self-employment income on the side. The contribution limits for each plan are considered separately.

Q: Are SEP IRA contributions subject to FICA or payroll taxes?
A: No. SEP IRA contributions are not counted as wages, so neither you nor your employees pay Social Security or Medicare taxes on those contributions.

Q: Are SEP IRA contributions deductible on state income taxes?
A: Yes in most states. Most states follow the federal rules, so your SEP contribution is state-deductible. A few states (like New Jersey and Pennsylvania) tax contributions now but give breaks later.