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How to Open a SEP IRA

June 4, 2022

Understanding how to open a SEP IRA is pretty simple, and the process can be done through many financial institutions including a brokerage or insurance company.

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Available to small-business owners and sole proprietors alike, a Simplified Employee Pension Plan, or SEP IRA, offers a workplace retirement savings option without the complexity and cost of a traditional 401(k) plan. SEP IRAs are managed by a custodian, funded exclusively by the employer, and invested however the employed individual sees fit.

Unlike other individual retirement accounts (IRAs), which have lower annual contribution limits, SEP plans allow for up to $61,000 per year to be saved on the employee’s behalf. These higher limits—along with low management fees and investment flexibility—make them a popular option for business owners looking to open and fund a retirement savings account.

How to open a SEP IRA in 4 steps

Opening a SEP IRA is a very simple process that can be completed without much confusion. 

1. Choose a custodian

First, the business owner (or self-employed individual) will need to choose a custodian. This custodian is responsible for actually holding the assets of each IRA for the employer and any eligible employees. Custodians can be a brokerage, insurance company, or other type of financial institution that offers SEP IRAs.

2. Apply

Then, the employer will need to fill out an application for that custodial account. This application generally involves providing:

  • Personal identification information including name, address, Social Security number, date of birth, and phone number
  • Trusted contacts for the SEP account and their contact information (this is optional)
  • Employer information including the company name, address, phone number, and tax identification number
  • Beneficiaries for the account
  • How account will be funded

This application may also require the business owner to note how they want future deposits to be invested. This includes directing their funds into selected investments, and in what percentage those investments should be distributed.

3. Complete paperwork

Depending on the custodian, an adoption form may also be required at this time. This form is used to outline the plan’s established date as well as the specific criteria that employees will need to meet in order to be eligible for SEP IRA participation with the company. 

4. Notify employees

Once the fund has been established, the small-business owner is required to offer a written agreement to all eligible employees, such as a Form 5305, explaining the plan and what employer contributions are involved. A personal IRA account will also be opened for each individual employee, which will also be held by the custodian.

Fees and commissions for SEP IRAs

While exceptions are possible, there generally aren’t any fees involved with establishing, maintaining, or even closing a SEP IRA account with a custodian. Certain types of investments may also be excluded from commission-based fees. 

The costs involved with this type of account are similar to traditional or Roth IRAs: many investment choices, such as mutual funds, incur annual fees expressed as a percentage of assets under management. These fees, known as expense ratios, are automatically factored into the returns of the account each year, so investors don’t have to pay them out of pocket.

Can you set up an account before making contributions?

A SEP IRA can be set up as far in advance of the first contribution as the employer would like. That’s because there is no annual contribution requirement for SEP IRAs, as long as all eligible employed individuals are given equal contributions (employers can contribute up to 25% of the employee’s compensation or as low as $0, as long as it’s equal).

However, a SEP IRA plan can be established too late. Employers have up to their tax filing date (either April 15 or, if an extension was granted, October 15) of that tax year to establish the account in order for SEP IRA contributions to be counted toward that year.

Can an individual contribute to both a SEP and traditional IRA?

Both self-employed individuals and employees can also choose to contribute to a traditional IRA in addition to any business contributions made into a SEP IRA on their behalf. Employer SEP IRA contributions do not count against the maximum traditional IRA contribution for the year.

Note that an individual can only invest in their own SEP IRA account if they are also the business owner or self-employed individual—but they must do so through their business. Employees cannot contribute to the SEP IRAs, even through elective deferrals. When it comes to self-employed business owners, SEP IRA contributions can be made into the account from the business, but not “from the individual.”

SEP IRA contributions are tax deductible for a self-employed business owner, meaning they lower their taxable pass-through income.

Can funds be rolled over from a previous employer's retirement account into a SEP IRA?

Funds from a previous employer’s retirement account, such as a 401(k), can be rolled over into an IRA that the employee already owns. In many cases, this includes their SEP IRA.

While the IRS allows for previous retirement savings to be rolled into a current SEP IRA, though, the custodian may not. 

The bottom line

SEP IRA plans are available to self-employed individuals and business owners with employees, offering them one more investment opportunity for retirement savings. These accounts are very flexible, but have one very important rule: any contributions made must be equal (by percentage) to the contributions made for all other eligible employees.

Understanding how to open a SEP IRA is pretty simple, and the process can be done through many financial institutions including a brokerage or insurance company. While most custodians don’t charge a fee for maintaining the account, there are costs involved (like expense ratios) depending on how those contributions are invested.

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