How does a SEP IRA work?
Last updated August 2026
Short answer
The appeal is administrative rather than mathematical. There is no annual filing, no plan document to maintain, and the decision can be made after the year has ended.
How the money moves
The business makes the contribution and takes the deduction. The employee, including a self-employed owner, receives it into a traditional IRA in their own name.
Once there, it behaves exactly like any traditional IRA: tax-deferred growth, ordinary income on withdrawal, the 10% additional tax before 59.5, and required distributions from 73.
The employee owns and controls the account immediately, with no vesting schedule of any kind.
The 2026 limits
Up to 25% of compensation, capped at $72,000, and compensation itself is capped at $360,000 for the calculation.
For a self-employed person the arithmetic differs, because the contribution reduces the base it is calculated on. The effective figure is closer to 20% of net self-employment income after subtracting half of self-employment tax.
Publication 560 carries the worksheet, and getting it wrong in either direction is common enough that most accountants run it rather than estimating.
The uniform percentage rule
Every eligible employee must receive the same percentage of compensation as the owner.
Contributing 20% for yourself means 20% for each eligible employee, which for a business with several staff becomes expensive quickly.
This is the reason SEPs are common among solo practitioners and rare among small firms with employees, where a 401(k) or SIMPLE IRA usually costs less overall.
Try it in Walnut
Walnut connects to your brokerage, including a SEP IRA held at a mainstream custodian, and reads what is inside it alongside your other accounts.
Eligibility and flexibility
Employees are generally eligible at 21 with three of the last five years of service and minimum compensation for the year, and the plan may be more generous.
Contributions are discretionary each year. A business having a bad year can contribute nothing without penalty or amendment.
That flexibility is genuinely valuable for irregular income, and it is one of the strongest arguments for the plan type.
The deadline advantage
A SEP can be established and funded up to the business tax filing deadline including extensions.
A sole proprietor who extends can therefore set one up in October and deduct it against the prior year.
No other plan allows the decision to be made that far after the fact, which makes a SEP the standard answer for someone who realises in spring that they owe more tax than expected.
Where the money can be held
A SEP IRA is a traditional IRA, so it can sit at any mainstream custodian and hold whatever that custodian offers.
There is no plan menu, no recordkeeper and no restricted fund list, which is a genuine advantage over most workplace plans.
It also means the ordinary IRA rules apply on the way out, including required distributions from 73 and the pro-rata rule on conversions.
Sources
The 2026 $72,000 limit and the $360,000 compensation cap are from IRS Notice 2025-67. Eligibility, the uniform percentage requirement and the self-employed contribution worksheet are in Publication 560. Walnut is informational and is not an investment adviser. This guide is educational and not personalized tax advice.
FAQ
How does a SEP IRA work?
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The employer, which for a sole proprietor is you, contributes to a traditional IRA held in each eligible employee's name. Contributions are deductible to the business, grow tax-deferred, and are taxed as ordinary income on withdrawal.
How much can go in for 2026?
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Up to 25% of compensation, capped at $72,000. For a self-employed person the effective rate works out near 20% of net self-employment income after the deduction for half of self-employment tax, which the IRS worksheet calculates.
Can employees contribute their own money?
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No. A SEP is entirely employer-funded, which is the main structural difference from a 401(k) or SIMPLE IRA. Employees can still make separate personal IRA contributions to their own accounts.
What is the rule that catches people with staff?
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Contributions must be the same percentage of compensation for every eligible employee, including you. Putting 20% into your own account means 20% for each eligible employee, which is why SEPs suit businesses with no employees.
Who counts as an eligible employee?
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Generally anyone 21 or older who has worked for you in three of the last five years and earned at least a set minimum for the year. The plan can be more generous but not more restrictive.
When is the deadline?
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The business tax filing deadline including extensions, which is unusually late. A sole proprietor filing an extension can establish and fund a SEP for the prior year as late as October, which no other plan allows.
Is there a Roth SEP?
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SECURE 2.0 permits Roth SEP contributions, but adoption by providers has been uneven. Check whether your custodian actually supports it rather than assuming the option exists.
How does it compare to a solo 401(k)?
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A solo 401(k) usually allows a larger contribution at moderate income, because it adds an employee deferral on top of the employer percentage. A SEP is simpler to open and has a later deadline, which is why it is often the first plan a freelancer uses.
Where is a SEP IRA held?
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At any mainstream custodian, because it is a traditional IRA. There is no plan menu and no recordkeeper, so the investment choice is whatever that custodian offers, and the ordinary IRA distribution rules apply on the way out.