How Does a SEP IRA Work? A Simplified Employee Pension (SEP) IRA is a tax-deferred retirement plan designed for self-employed individuals and small business owners. It allows higher contribution limits than traditional or Roth IRAs—up to 25% of compensation or the annual maximum limit—while keeping setup and maintenance costs low. Employers make all contributions, and employees own their accounts 100% from day one.

SEP IRA Basics

• Who it’s for: Self-employed individuals, freelancers, and small business owners with one or more employees.
• Contributions: Employer-funded only. You can contribute up to 25% of compensation or the IRS annual maximum, whichever is less.
• Vesting: Immediate—employees own 100% of employer contributions.
• Tax treatment: Contributions are tax-deductible for the employer and grow tax-deferred until withdrawal.

Tax Advantages of a SEP IRA

One of the greatest benefits of a SEP IRA is its ability to reduce taxable income while accelerating retirement savings. Contributions are deductible for the business and excluded from the employee’s current taxable income. This dual tax advantage makes it especially valuable for sole proprietors or S-Corp owners. When rolled into an annuity, you can maintain tax deferral while converting savings into a guaranteed income stream.

Rolling Over a SEP IRA

When you retire or close your business, you can move your SEP IRA to a traditional IRA or directly into an annuity for income. The safest way is through a direct rollover to maintain tax-deferred status. Many business owners also consider lifetime income annuities to protect against market volatility in retirement.

Contribution Limits

For 2025, the maximum SEP IRA contribution is the lesser of 25% of compensation or $69,000. Contributions are flexible—businesses can decide annually how much to contribute or skip a year entirely without penalty. All eligible employees must receive the same percentage of pay.

Withdrawals and Distributions

Withdrawals before age 59½ are subject to ordinary income tax and may incur a 10% penalty unless an exception applies. Required Minimum Distributions (RMDs) begin at age 73. Some owners transition their funds into fixed indexed annuities to keep money tax-deferred while adding lifetime income guarantees.

Coordinating Your SEP IRA With Other Retirement Plans

SEP IRAs can coexist with other retirement vehicles like traditional IRAs, Roth IRAs, and 401(k)s—but overall limits and deductibility rules still apply. Many business owners use their SEP IRA for large pre-tax savings while building post-tax flexibility through a Roth IRA or tax-deferred annuity ladder.

Related Pages

• How Does an IRA Work?
• How Does a Roth IRA Work?
• What Is a Direct Rollover?
• Annuities