SEP IRA Eligibility Rules: What You Need to Know

A little more than half of America’s workers have access to some kind of an employer-sponsored retirement savings plan, such as a 401(k) plan. While these accounts can be an important part of any retirement savings strategy, they don’t do much for self-employed individuals.

For those who either operate as a sole proprietor or own a small business with employees, saving for retirement often means taking a different approach. That’s where a SEP IRA can come in.

“SEP IRAs are very popular with freelancers, gig workers, real estate brokers, and others who work as sole proprietors of their own business,” explains Titan retirement specialist Eddie Lopez. “They have the same rules and tax benefits as traditional IRAs, where contributions are tax deductible—but a higher contribution limit that makes them especially attractive".

What is a SEP IRA? 

A SEP IRA

—short for “simplified employee pension individual retirement account”—is a tax-advantaged retirement account designed for self-employed individuals and business owners. SEP IRAs give these individuals an easy way to save for their own retirement as well as contribute toward the retirement of their employees.

The essential characteristic of SEP IRAs is that they come with an obligation to others: They require business owners to contribute equally—by percentage—to every eligible employee’s account. So, if the owner contributes 15% of their salary to their own account, they must contribute 15% of every eligible employee’s salary to their accounts as well. 

What are the SEP IRA eligibility requirements?

SEP IRA plans are available to businesses of any size, whether it’s just one self-employed individual or a company with, say, 100 employees. Because SEPs don’t involve many of the same complex processes and costly management of traditional employer-sponsored retirement accounts, they can often be a viable solution for smaller businesses and individuals.

They do, however, have a few rules and restrictions, which businesses must adhere to in order to be eligible to maintain the plan.

• Only the employer can contribute.

  Unlike some other retirement plans, such as a 401(k), SEP IRAs only allow the employer to contribute to the account. The employee usually cannot elect to have a portion of their wages directed into the account, unless the plan allows it.

• All contributions must be equal.

  If a SEP IRA is offered to even a single employee, it has to be offered to every eligible employee, with equal terms. The contribution is measured as a percentage of the employee’s compensation; so if a small business owner wants to save 15% of his or her wages in a SEP IRA, they will need to offer a 15% contribution rate to every eligible employee in the company.

• Contributions have limits.

  For 2022, the SEP IRA maximum contribution limit is $61,000, or 25% of an employee’s compensation, whichever is less. If an employee makes $100,000, for example, contributions to their SEP IRA are limited to $25,000.

• Employees are fully vested, immediately.

  There are no waiting, or vesting, periods when it comes to SEP IRAs. Instead, employees are 100% vested from the moment the funds are contributed. 

• Employers don’t have to contribute each year.

  A company can choose to contribute to everyone’s SEP IRAs one year when revenue is high, but reduce or even eliminate those contributions the following year, if earnings dip. There is no requirement to contribute every year, as long as there is a standard across the board for all employees of the company.

Who is able to participate in a SEP IRA?

An employee who meets three minimum IRS requirements is considered eligible to participate in their employer’s SEP IRA plan, if one exists. 

• They must be 21 or older.
• They must earn at least $650 per year for 2022 and 2021, and more than $600 annually for the years 2020 and 2019 (if applicable).
• They must have worked for the employer for at least three of the last five years.

While an employer can have less restrictive requirements than these, they cannot have more restrictive ones. This means an employer can choose to forgo these altogether or require less from an employee in order to participate in the workplace’s SEP IRA plan. They cannot, however, require the employee to meet more stringent requirements, such as earning more than $650 per year or being with the company for longer than three years. 

With that said, there are some employees who may be exempt from the SEP IRA contribution requirement. Employees can be excluded from a company’s SEP IRA accounts if they are covered by a union contract, which already addresses their retirement benefits. Employees can also be excluded if they are non-resident foreign employees who do not earn U.S. wages.

When a business owner establishes an SEP plan, all eligible employees must be provided with a notice that it exists. They also need to receive a notification telling them what the requirements are for a SEP IRA plan allocation, and how much the employer intends to allocate on their behalf; this is often done with a Form 5305-SEP. 

If the employer makes any contributions into employees’ SEP accounts, they are also required to notify employees of those contributions by no later than that year’s tax filing date (the following spring).

How are SEP IRA eligibility requirements different from those from a traditional IRA and a Roth IRA?

A SEP plan utilizes a traditional IRA for each eligible employee. However, there are some important differences between the account used for a SEP IRA, and the typical traditional or Roth IRA that an employee could obtain on their own.

Both traditional IRAs and Roth IRAs are individual retirement accounts that allow employees to save and invest for retirement on their own. These accounts are not sponsored by employers, but are instead available through a variety of financial institutions, such as banks and brokerage firms. Both types of IRAs have an annual contribution limit of $6,000 (or $7,000 if the employee is age 50 or older), and penalty-free withdrawals can be taken beginning at age 59 ½ (for Roth IRAs, these are tax-free, too).

One of the biggest differences between a SEP IRA and a traditional or Roth IRA is that only employers can contribute to SEP IRAs. Elective salary deferrals are not allowed, and employers must offer equal contributions to all eligible employees in the company.

Another big difference is that SEP IRA limits are considerably higher. While a Roth and traditional IRA are limited to $6,000 a year, SEP IRAs have a limit of $61,000 (in 2022), or 25% of the employee’s wages, whichever is less.

The bottom line

For eligible employees and self-employed individuals, a SEP IRA can be a way to build retirement savings at an even faster rate than other accounts may offer. To be eligible for a SEP IRA plan, employers will need to offer equal contributions to all eligible employees, and cannot set more restrictive requirements than those outlined by the IRS.

Only employers can contribute to a SEP IRA, which may limit the retirement savings efforts of some employees. But because they have higher contribution limits than Roth and traditional IRA contributions, as well as 401(k)s, SEP plans can help boost retirement savings accounts for many eligible individuals.