How Does a SEP IRA Work?


A SEP IRA is an employer-funded retirement plan. Employer contributions are deposited into an IRA account, set up by the employer but owned by the employee. SEP IRAs are one of the easiest plans to administer, making them attractive to smaller employers. Plans follow a calendar year, whether or not this matches the companies fiscal year.

Establishing a SEP IRA

Employers can establish a SEP IRA at any time before the due date of the tax return for the year for which they are making contributions. The IRS provides a prototype plan which may be used as long as the employer is not maintaining any other retirement plan besides SEP IRAs. Having another plan does not preclude adding a SEP IRA, the employer must simply use a different prototype plan or have one designed for the business. An investment company, such as a bank, mutual fund company, or insurance company, is used to establish individual IRA accounts for each eligible employee.


Employers must contribute for each eligible employee. The IRS has established three minimum criteria for eligibility:

  • At least age 21
  • Worked for employer at least three of last five years
  • Made at least $600 in 2015, indexed for inflation

Employers may select less restrictive criteria. For example, the employer could establish a minimum age of at least 18. In no case can the employer make the criteria more restrictive.

Contribution Limits

Contributions into the SEP IRA are subject to annual limits. The employer must contribute the same percentage of income for each eligible employee. The contributions cannot exceed the lesser of 25 percent of an employees income or $53,000. Employers are not required to contribute every year.

Investment Options

Investment options for a SEP IRA are determined by the company which holds the accounts. This can be any type of investment firm, such as a bank, mutual fund company, or insurance company. Employees determine how best to invest their funds, subject to the investments the company holding the SEP IRA has made available. As the investment account is owned by the employee, the employee may rollover or transfer the account at any time.


SEP IRAs are subject to certain restrictions. As with other IRA accounts loans are not permitted, nor can the account be used as collateral for a loan. In-service withdrawals are permitted, but proceeds are subject to taxation and penalty if the employee is under age 59 1/2. SEP IRA accounts are traditional IRAs and subject to the same required minimum distribution rules as traditional IRAs.