What's a SEP IRA?


It’s a retirement account only available to small businesses and the self-employed.

SEP stands for simplified employee pension plan. It’s a retirement account available to businesses and the self-employed, and it essentially serves as a more flexible counterpart to a 401(k) for employees, usually at smaller companies and businesses.

A SEP has got a lot of similarities with the traditional IRA, the most notable being that any contributions you make to a SEP qualify as pre-tax, meaning that you won’t have to pay income tax on your contributions. That way, you get a major break when April 15 rolls around. Also like a traditional IRA, the SEP is tax-deferred, which means that at 59 ½, the age at which you can begin accessing your funds without penalties, the government will treat anything you withdraw as taxable income.

Apart from appealing to the no-commute-class of pajama-clad freelancers, what makes the SEP different from other retirement accounts is the amount of tax-deferred money you’ll be able to contribute. Where traditional and Roth IRAs cap maximum contributions for individuals under 50 years old at $5,500 per year, SEPs allow a maximum contribution of $54,000 per year, or 25% of your income, whichever number is smaller. And if you work for a small business, your employer can also make contributions on your behalf — up to 25% of your compensation, again, if that number is lower than $54,000.

SEPs allow members of the gig economy to save amounts comparable to company 401(k)s, but without the inconvenience of having to suffer through coworker birthday parties, or put on pants. As with most retirement accounts, the big danger with SEPs is early withdrawal. Anyone who withdraws early without a qualified exception — like paying for education, or the a first home — will be assessed a painful 10% tax on the money above your his or her income tax rate. SEP contributors should be conservative with their contributions to avoid this scenario at all costs.

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