Can an Employee Opt Out of a SEP IRA?

A Simplified Employee Pension (SEP) Individual Retirement Arrangement (IRA) is an employer-sponsored retirement plan designed to offer a straightforward way for employers to contribute to their own and their employees’ retirement savings. This type of plan is particularly common among small businesses and self-employed individuals due to its administrative simplicity. Funds contributed to a SEP IRA grow tax-deferred, meaning taxes are typically paid only upon withdrawal in retirement.

Employer Requirements for SEP IRA Contributions

Employers funding a SEP IRA are the sole contributors to the plan; employees cannot make their own contributions. If an employer chooses to contribute for a given year, contributions must be made for all eligible employees, including the owner if self-employed, on a non-discriminatory basis. This means that contributions must be an equal percentage of compensation for all eligible participants. For instance, if an employer contributes 10% of their own compensation, they must contribute 10% of each eligible employee’s compensation.

Employee eligibility for a SEP IRA is defined by specific criteria: an employee must be at least 21 years old, have worked for the employer for at least three of the last five years, and have received a minimum compensation amount from the employer during the year (for example, $750 in 2025). Employers do have the flexibility to set less restrictive eligibility requirements, but they cannot impose stricter ones. Contributions are tax-deductible for the employer and must be made by the business’s tax-filing deadline, including any extensions.

The amount an employer can contribute to each employee’s SEP IRA is substantial, limited to the lesser of 25% of the employee’s compensation or a specific dollar amount, which is $70,000 for 2025. This compensation limit applies to the first $350,000 of an employee’s earnings for 2025. Employers are not obligated to contribute every year, offering flexibility to adjust contributions based on business profitability.

Employee Eligibility and Participation

Once an employer establishes a SEP IRA and makes contributions, eligible employees cannot opt out of receiving these funds. The employer’s contribution to an eligible employee’s SEP IRA is a mandatory action under the plan’s non-discriminatory rules.

Upon contribution, the funds immediately become 100% vested, or owned, by the employee, regardless of their continued employment with the business. While employees cannot decline the employer’s contribution, they gain complete control over the funds once they are in their personal SEP IRA.

Employees are required to open their own individual SEP IRA account with a financial institution to receive these employer contributions. In situations where an employee is unable or unwilling to open an account, the employer may even establish the account on their behalf to ensure compliance with the plan’s terms.

Handling Funds in a SEP IRA

Once contributions are made to an individual SEP IRA, the employee assumes control over how the funds are invested. Similar to a traditional IRA, employees can choose from a wide range of investment options, including stocks, bonds, mutual funds, and exchange-traded funds (ETFs), allowing for personalized portfolio management. The employer has no further responsibility for investment decisions once the funds are deposited into the employee’s account.

Employees also have the flexibility to roll over their SEP IRA funds into other qualified retirement accounts. These rollovers can be made to a traditional IRA or, if the receiving plan permits, to an employer-sponsored 401(k) plan. Such rollovers allow individuals to consolidate their retirement savings or transfer funds to a plan that might better suit their long-term financial strategy.

Withdrawals from a SEP IRA are taxed as ordinary income. Distributions taken before age 59½ are subject to a 10% early withdrawal penalty, in addition to regular income taxes. However, certain exceptions exist that may waive this penalty, such as for qualified higher education expenses or a first-time home purchase. Account holders must begin taking Required Minimum Distributions (RMDs) from their SEP IRA at age 73. Failure to take these RMDs can result in a significant penalty.