Self-Employed SEP IRA: Contribution Rules and Deadlines

A Simplified Employee Pension (SEP) IRA is a retirement savings plan for self-employed individuals and small business owners. It allows for significant, tax-deductible contributions, and investment earnings grow tax-deferred until withdrawal. Plan participants must begin taking Required Minimum Distributions (RMDs) upon reaching age 73. The plan’s flexible contribution requirements can be adjusted annually based on business performance.

Eligibility Requirements for the Self-Employed

The primary requirement for establishing a SEP IRA is earning self-employment income. This plan is accessible to individuals operating as sole proprietors, freelancers, and independent contractors, as well as partners in a partnership. Owners of incorporated businesses, such as S corporations, C corporations, or limited liability companies (LLCs), can also utilize a SEP IRA. The defining factor is income generated from personal services, not passive sources like rent or investments.

For a self-employed individual, the business owner is treated as both the employer and the employee. This means you establish the plan for your business and make contributions for yourself. If you hire staff, you may be required to make contributions for eligible employees if you make one for yourself. An employee becomes eligible if they have reached age 21, have worked for the business in at least three of the last five years, and have received at least $750 in compensation for the year.

Calculating and Making Contributions

For 2024, contributions are limited to the lesser of 25% of compensation or $69,000, with the dollar limit increasing to $70,000 for 2025. For the self-employed, compensation is not your gross revenue or the net profit figure from Schedule C.

The calculation starts with your net earnings from self-employment. From this amount, you must subtract one-half of your self-employment taxes, which are calculated on Schedule SE. The result is your net adjusted self-employment income, and this is the compensation base used to determine your maximum contribution.

Although the contribution limit is stated as 25%, the effective rate for the self-employed is 20% of net adjusted self-employment income. This is because the contribution is a deductible business expense that lowers the income on which it is based, preventing a circular calculation.

For example, a sole proprietor has $100,000 in net profit on their Schedule C. Assuming one-half of their self-employment tax is $7,065, their net adjusted self-employment income becomes $92,935 ($100,000 – $7,065). The maximum SEP IRA contribution would be 20% of this amount, or $18,587. This contribution is then deducted on the owner’s personal tax return.

A recent development for these plans is the option for businesses to offer a Roth SEP IRA. Unlike traditional SEP contributions made with pre-tax dollars, contributions to a Roth SEP IRA are made with after-tax dollars. This means the contributions are included in the employee’s gross income for the year, but qualified withdrawals in retirement are completely tax-free.

Establishing the Plan and Funding Deadlines

Setting up a SEP IRA involves choosing a financial institution, such as a brokerage firm or bank, to act as the plan custodian and completing its account-opening paperwork. You will use IRS Form 5305-SEP, which serves as the plan’s legal document. This form is not filed with the IRS but must be retained in your records.

A SEP IRA can be established and funded for a specific tax year up until the business’s tax filing deadline for that year, including any extensions. For a sole proprietor, this deadline is April 15, or October 15 if an extension is filed. This flexibility means you can make a contribution for the 2024 tax year well into 2025, up until you file your return.