How to Calculate the SEP Contribution Limit

A Simplified Employee Pension, or SEP IRA, is a retirement savings plan for self-employed individuals and small business owners. It allows for flexible, tax-deductible contributions that can be significantly larger than those permitted in traditional IRAs. The plan is relatively easy to establish and maintain for businesses that may not have the resources to administer more complex retirement plans.

Understanding the Contribution Rules

Contributions to a SEP IRA are made exclusively by the employer; employees are not permitted to contribute. The funding comes directly from the business’s profits, and the employer has complete discretion over contributions. The business can decide whether to contribute in any given year, as there is no annual funding requirement.

A primary principle of SEP IRAs is the proportional contribution rule. If a business owner contributes to their own account, they must also contribute to the accounts of all eligible employees. The contribution must be the same percentage of compensation for everyone, including the owner. An employee is eligible if they are at least 21 years old, have worked for the business in three of the last five years, and have earned at least $750 in compensation for the year.

The Internal Revenue Service (IRS) sets annual limits on these contributions. For 2024, the maximum contribution is the lesser of 25% of compensation or $69,000; for 2025, this dollar limit increases to $70,000. The maximum compensation that can be considered for this calculation is $345,000 for 2024 and $350,000 for 2025. SEP IRAs do not allow for catch-up contributions for individuals age 50 or over.

Calculating the Maximum Contribution

For an employee, the employer multiplies the employee’s gross compensation for the year by the contribution percentage chosen for that year. For example, if the employer chooses a 10% contribution rate, an employee earning $50,000 would receive a $5,000 contribution to their SEP IRA.

The calculation for a self-employed individual begins with the net earnings from self-employment, which is the figure calculated on Schedule SE. From the net earnings, the individual must subtract one-half of their self-employment tax. The resulting figure is the adjusted income used for the SEP IRA calculation.

The maximum contribution is then determined by multiplying this adjusted income by the contribution rate. This rate is effectively limited to 20% for the self-employed, not 25%.

As an example, consider a self-employed individual with $100,000 in net earnings from their business. Assuming one-half of the self-employment tax is $7,065, their net adjusted self-employment income becomes $92,935 ($100,000 – $7,065). The maximum contribution they can make for themselves is 20% of this adjusted amount, which equals $18,587.

Contribution Deadlines

The deadline for making SEP IRA contributions is tied to the due date of the business’s federal income tax return for the year, including any extensions. This rule provides business owners with additional time to fund their retirement accounts, often well into the following calendar year.

For sole proprietorships and single-member LLCs that file using a Schedule C, the contribution deadline is the same as the individual tax filing deadline, typically April 15. If the individual files for an extension to file their personal tax return, the deadline to make the SEP IRA contribution is also extended to October 15.

For businesses structured as S-corporations or partnerships, the deadline is earlier. The tax return for these entities is due on March 15. If the business files for an extension, the deadline to both file the return and make the contribution is pushed to September 15.

Making and Reporting the Contribution

Once the contribution amount has been calculated, the employer can make the deposit via an electronic funds transfer or by writing a check directly to the financial institution holding the SEP IRA for each eligible employee.

The specific form used to report the deduction depends on the business structure. A sole proprietor or single-member LLC reports the deduction for their own contribution on Schedule 1 of Form 1040. Contributions made for employees are reported as a business expense on Schedule C.

For partnerships, employer contributions are reported on Form 1065, U.S. Return of Partnership Income. S-corporations report these contributions on Form 1120-S, U.S. Income Tax Return for an S Corporation. In both cases, the contributions are listed as a business deduction, reducing the entity’s taxable income.