What Is a SEP IRA?

Daniel Penzing
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How Is a SEP IRA Different From a Roth or Traditional IRA?

There are many different types of IRA accounts. Some kinds of IRA accounts include SEP IRA, Roth IRA, Traditional IRA, and SIMPLE IRA. Each of these IRA accounts has its own unique advantages and disadvantages. Understanding these will help you decide which account is best for you.

As a general rule, you are able to open all of these accounts. The differences between them relate to the tax benefits that they offer, the requirements to qualify, and a few other technical details.

IRA accounts are retirement investment accounts that you set up with a bank or pension service company. The money you contribute to your IRA account is tax-deductible. As you save, you will build up your retirement savings. You must start taking your IRA distributions by the time that you reach age 70 and a half.

Here’s how the different kinds of IRA accounts compare:

  • Type
  • Key Features
  • Traditional IRA
  • Tax deductible
  • Penalty for early withdrawal

Contributions are fully tax deductible.

Penalty for early withdrawal.

Taxes are deferred until withdrawal.

You must start taking your IRA distributions by the time that you reach age 70 and a half.

Penalty for Early Withdrawal

Contributions are not tax deductible.

Penalty for early withdrawal.

Who Can Open a SEP IRA?

A SEP IRA is a self-employed retirement plan that is virtually identical to a traditional Individual Retirement Account. So, just like an IRA, it allows you to defer taxes on income that would otherwise be taxed in the year it’s earned, and contributions to the account are made with pre-tax dollars. A SEP IRA also offers favorable long-term growth potential, and there are no income restrictions or minimum required distributions upon retirement.

What Are the Contribution Rules?

Who Is Eligible?

One of the biggest benefits of having a SEP IRA is that it is available to people who are self-employed. There are very few retirement plans available to you if you do not make a salary and work for someone else. That’s why the SEP IRA comes in handy. It’s available to anyone who is self-employed.

At the same time, the SEP IRA has separate eligibility criteria for employers and employees. There are two sets of criteria to keep in mind. You can’t satisfy both sets because you’re both employer and employee. But if you satisfy the criteria for one, then you’re in!

Employee eligibility criteria:

  • Must be 18 or older
  • Thirty days of part-time employment with the employer
  • Employee can’t own more than 2 percent of the net value of the company
  • Employee can’t own more than 5 percent of the company’s stock

Tax-qualified retirement plan. A defined contribution or defined benefit plan like a 401(k) is eligible.

Employer eligibility criteria:

  • Employer must have a SEP-IRA plan
  • Employer must have eligible employees

Is a SEP IRA Right for Me?

One of the best things about a SEP IRA is that it’s easy to open and easy to use. You just need an employer identification number (EIN) and the number of eligible employees. In other words, if you actively participate in the business, you’re eligible to be an employee. That means if you own your own business or work for someone else, you can still open a SEP IRA, even if you’re married and file separate tax returns.

Consistency is also another great thing about SEP IRAs … and it’s also one of the reasons why SEP IRAs are so powerful in combination with our existing retirement plans. Because the money is withdrawn by you, you can usually take the money out as you need it. Once you reach age 59½, you must either start withdrawing money from your SEP IRA or roll it into an IRA or qualified retirement plan.

The Final Word

Some retirement designs get a lot of media attention as the purview of young, wealthy tech billionaires. But that doesn’t mean individual investors can’t benefit from these tax-savvy retirement designs. The most generous retirement plans are still tied to company employment with its major downsides of loss of flexibility and forced decisions. In a SEP IRA, you have all of that flexibility plus the tax-deferral that you get in a regular IRA.

A SEP IRA is largely one of the best retirement options for small business owners, self-employed people, and the self-employed. It is also quite easy to set up, maintain, and is an excellent lessor-risk investment.