How Much Can You Put in a SEP IRA? Contribution Limits Explained
Understand SEP IRA contribution limits, how they vary for employers and the self-employed, and key factors that impact your maximum allowable contributions.
A Simplified Employee Pension (SEP) IRA is a retirement savings plan for self-employed individuals and small business owners. It allows employers to contribute toward their own and their employees’ retirement savings with higher limits than traditional IRAs. Understanding annual contribution limits is key to maximizing tax advantages and long-term growth.
Eligibility Factors
A SEP IRA is available to businesses of any size, but not all employees qualify. The IRS requires employers to include employees who are at least 21 years old, have worked for the company in at least three of the last five years, and have earned at least $750 in compensation during the current year (as of 2024). These rules ensure long-term employees receive retirement benefits.
Employers can set more lenient eligibility rules, such as lowering the age or service requirements, but cannot impose stricter conditions. All eligible employees must receive the same percentage of compensation—an employer cannot contribute more for some while excluding others.
Certain workers are exempt, including those covered by a union agreement with retirement benefits and nonresident aliens without U.S. income. Independent contractors and freelancers are not considered employees under SEP IRA rules but can establish their own plans.
Employer Contribution Calculations
Employers can contribute up to the lesser of 25% of an employee’s eligible compensation or $69,000 for 2024. This cap applies separately to each participant, meaning contributions must be calculated individually while ensuring the same percentage is applied to all eligible employees.
Eligible compensation includes wages, salaries, and bonuses but excludes stock options and certain fringe benefits. If an employee earns $100,000, the maximum employer contribution is $25,000. For an employee earning $50,000, the cap is $12,500, assuming the same percentage is applied.
IRS nondiscrimination rules require uniform treatment of all eligible employees. An employer cannot contribute 20% of one worker’s salary while contributing 10% for another. Any deviation could result in penalties or plan disqualification. Employers should maintain detailed records to ensure compliance.
Self-Employed Contribution Calculations
For self-employed individuals, SEP IRA contributions are based on net earnings after deducting business expenses and the deductible portion of self-employment tax. The IRS defines compensation for these contributions as net earnings reduced by the SEP contribution itself, creating a circular calculation.
Because contributions lower taxable income, the effective contribution rate is approximately 20% rather than the 25% limit applied to employees. If a sole proprietor reports $100,000 in net earnings before the SEP deduction, the maximum contribution is around $20,000. The IRS provides worksheets in Publication 560 to assist with these calculations, and tax software can automate them for accuracy.
Compensation Considerations
SEP IRA contributions must be based on eligible compensation as defined by IRS rules. For employees, this includes wages, salaries, commissions, and bonuses but excludes employer-paid health insurance and reimbursements.
For incorporated business owners receiving a W-2 salary, only that salary—not overall business profits—counts as compensation for SEP IRA purposes. This is especially important for S corporation owners, who often take both wages and shareholder distributions. Since distributions are not considered earned income, SEP IRA contributions can only be based on the W-2 portion. Misclassifying distributions as eligible compensation can lead to excess contributions and penalties.
Partners and sole proprietors do not receive W-2 wages, so their compensation is based on net self-employment income, adjusted for self-employment tax deductions. Accurate income tracking is necessary to avoid overfunding or underfunding contributions.
Tax Treatment and Reporting
SEP IRA contributions are tax-deductible, but proper reporting is required. Employers can deduct contributions as a business expense on their tax return. Corporations report deductions on Form 1120 (C corporations) or Form 1120S (S corporations), while sole proprietors and partnerships deduct contributions on Schedule C or Schedule K-1.
Unlike employee deferrals in a 401(k), SEP IRA contributions are entirely employer-funded and do not reduce an employee’s taxable wages on their W-2. Employees do not pay taxes on these contributions until they withdraw funds in retirement, at which point distributions are taxed as ordinary income.
Self-employed individuals report their SEP IRA deduction on Schedule 1 of Form 1040, reducing adjusted gross income. While SEP IRAs do not require annual filings like a 401(k) plan’s Form 5500, account holders must track contributions to avoid exceeding limits. Excess contributions must be withdrawn by the tax filing deadline to prevent a 10% excise tax under IRS rules. Keeping detailed records ensures compliance and simplifies reporting in case of an audit.