How a SEP IRA Works for Self-Employed Retirement Savers

When you work for yourself, nobody sets up a 401(k) for you, and nobody nudges you to contribute. A SEP IRA is one of the simplest ways to fix that, letting a freelancer or small business owner put away far more than a regular IRA allows with almost no paperwork.

I write about retirement accounts for people with irregular income, and the SEP is the account I see most often opened in a hurry in April. That is fine, because the rules allow it. But understanding how the contribution math actually works will tell you whether it is the right account or whether something else would let you save more.

What a SEP IRA is

SEP stands for Simplified Employee Pension. Legally it is an employer plan, but each contribution lands in an ordinary traditional IRA in your name at a brokerage. You pick the investments, just like any IRA. There is no annual filing with the IRS for a basic SEP, and opening one usually takes about 15 minutes online with a one-page form, IRS Form 5305-SEP, that you keep in your records.

Contributions are made by the business, not by you as an employee. For a sole proprietor that distinction is mostly on paper, since you are both, but it matters for how the limit is calculated.

SEP IRA contribution limits for 2026

The business can contribute up to 25 percent of each eligible person's compensation, with a dollar cap of 72,000 dollars for 2026. Only the first 360,000 dollars of compensation counts toward the calculation.

For an owner who files Schedule C, the 25 percent turns into roughly 20 percent of net self-employment earnings. That is because your "compensation" is net profit minus half of your self-employment tax and minus the SEP contribution itself. The circular math works out to about 20 percent.

A worked example

Say your Schedule C shows 80,000 dollars of net profit.

1. Self-employment tax is about 80,000 times 0.9235 times 15.3 percent, or 11,303 dollars.
2. Half of that, 5,652 dollars, is deductible, leaving 74,348 dollars.
3. Twenty percent of 74,348 dollars is 14,870 dollars. That is your maximum SEP contribution.

A traditional or Roth IRA, by comparison, caps out at 7,500 dollars for 2026 for most people under 50. So the SEP lets this freelancer save roughly twice as much, all tax-deductible.

Deadlines, deductions and flexibility

This is where the SEP shines. You can open and fund it for the prior year right up to your tax filing deadline, including extensions. File an extension and you have until October 15 to decide how much to put in for last year.

One practical habit helps: move 15 to 20 percent of every client payment into a separate savings account as it arrives. By filing time the SEP money is already sitting there instead of competing with your tax bill.

Contributions are entirely optional year to year. A great year can mean a big deposit; a slow year can mean nothing at all. That suits people whose income jumps around, such as consultants, photographers and contractors.

The deduction reduces your income tax, though not your self-employment tax. Someone in the 22 percent federal bracket who contributes 14,870 dollars saves about 3,270 dollars in federal income tax that year, plus any state tax.

Under the SECURE 2.0 Act, providers may now offer Roth SEP contributions, which are taxed now and grow tax-free. Not every brokerage supports this yet, so ask before you open the account. If you are unsure which tax treatment fits your bracket, our comparison of Roth IRA vs traditional IRA walks through the same trade-off.

The employee rule most solo owners miss

If you have employees, a SEP must cover all eligible ones, and the business has to contribute the same percentage of pay for them as it does for you. Eligible generally means age 21 or older, worked for you in at least three of the last five years, and earned more than a small IRS-set minimum.

So if you contribute 20 percent for yourself, you also contribute 20 percent of your part-time assistant's 30,000 dollar salary, which is 6,000 dollars. That money vests immediately and belongs to them. For a growing business this can become expensive fast, and it is the main reason owners with staff look at other plans.

Why a SEP IRA is not always the best choice

The common advice is that a SEP IRA is the default retirement account for the self-employed. For high earners with no staff it is fine. For many freelancers earning under about 150,000 dollars, I think a solo 401(k) is usually better, and the reason is simple arithmetic.

A solo 401(k) allows an employee deferral of 24,500 dollars for 2026 on top of the same roughly 20 percent employer contribution. Back to the 80,000 dollar freelancer:

The SEP also offers no catch-up contribution for savers 50 and older, while a solo 401(k) adds 8,000 dollars more. If you are behind and trying to make up ground, as covered in catching up on retirement savings after a late start, that gap matters.

The trade-off is paperwork. A solo 401(k) must be opened by December 31 to accept employee deferrals for that year, and once the balance passes 250,000 dollars you file Form 5500-EZ annually. The SEP wins on convenience and on last-minute setup. It loses on capacity at moderate incomes.

How to open and fund one

1. Choose a brokerage with low-cost index funds and no account fees.
2. Complete the SEP application and Form 5305-SEP, which the brokerage usually provides.
3. Calculate your contribution after your Schedule C is final, using the 20 percent shortcut or the IRS worksheet in Publication 560.
4. Deposit the money and tell the brokerage which tax year it is for.
5. Report the deduction on Schedule 1 of Form 1040.

Withdrawals follow standard IRA rules: penalty-free after 59 and a half, and required distributions eventually begin, as explained in how required minimum distributions work.

Frequently asked questions

Can I have a SEP IRA and a Roth IRA at the same time?

Yes. A SEP is an employer plan, so it does not reduce your personal IRA limit. You can fund a Roth IRA up to 7,500 dollars in 2026 if your income is under the Roth limits, and still make a full SEP contribution.

Can I contribute to a SEP IRA if I also have a 401(k) at a day job?

Yes, a SEP based on your side business income is separate from your employer's 401(k). The 72,000 dollar cap applies per unrelated employer, so the two do not usually interfere. Your SEP contribution is still limited to about 20 percent of your self-employment profit.

What happens if I contribute too much to a SEP IRA?

Excess contributions are not deductible and face a 6 percent excise tax each year they stay in the account. Withdraw the excess and any earnings on it before your tax filing deadline to avoid the penalty. Recheck the math after your final Schedule C numbers are in.