A listener named Wasittha asked me the following question:

“I’ve been trying to max out my IRA and 401(k). However, I’ll be unemployed next year for a while–hopefully not for too long. Since I started my own business early this year, can I invest in a SEP-IRA instead of a 401(k), and how much? 

Please explain SEP-IRAs since I’m new to being my own boss and have only earned a few thousand dollars. Thank you very much, and keep doing what you are doing! I tell everyone about you, and we love hearing your voice on the podcast!”

Thanks for your question and kind words, Wasittha! This post will explain everything you need to know about using a SEP-IRA when you have a little or a lot of self-employment income.

What is a simplified employee pension (SEP)?

When you have business income, one retirement account option is a simplified employee pension or SEP. The investment vehicle it uses is an individual retirement account or IRA, therefore, it’s known as a SEP-IRA. 

You can use a SEP-IRA if you’re an employer or self-employed with no employees. You can have any business entity, such as a sole proprietor, partnership, LLC, or corporation. You can use the account to build a healthy retirement nest egg whether you’re a full or part-time entrepreneur. 

I use a SEP-IRA and am a fan because it’s easy to administer and inexpensive to set up and maintain. They’re treated like a traditional IRA for tax purposes because you make tax-deductible contributions. Your money grows tax-deferred until retirement and then gets taxed when you take distributions.

So, consider a SEP-IRA a supercharged traditional IRA designed for solopreneurs and business owners. But it comes with some special rules you should know.

READ ALSO: How do wealthy people invest money?

What are the SEP-IRA contribution rules for employers?

If you have a business with employees, a critical rule of a SEP-IRA is that employees can never contribute their own money. Contributions can only come from the employer. 

For 2024, you can make SEP-IRA contributions for each of your employees (including yourself) up to 25% of their compensation for a maximum of $69,000. You must offer a contribution rate that’s the same for all your employees, including yourself.

In other words, if you create a SEP-IRA for yourself, you must set one up for each eligible employee and contribute the same percentage to their accounts. 

For example, if you draw a salary of $100,000 from your business and put 10% ($10,000) of your pay in a SEP-IRA, you also have to contribute 10% of each employee’s pay to their account. 

Let’s say you employ David, who earns $40,000 and is eligible for a SEP-IRA. You’d have to contribute 10% or $4,000 to his account. If you increase your contributions to 12%, you must also increase all your eligible worker’s contributions to 12%.

However, employers with a SEP-IRA are not required to make contributions. If you have a terrible year, you can stop contributions and resume them later if you wish. But you get a nice tax break for your generosity because contributions to your and your employees’ SEP-IRAs are tax deductible.

SEP-IRA contributions are immediately 100% vested, so an employee can take them if they quit working for you. 

Have you ever wondered how you can get an affordable self-employment benefits package? Laura answers a listener’s question about how to get affordable benefits when they become a full-time solopreneur. Listen in the player below. 

What are the SEP-IRA contribution rules for the self-employed?

If you’re self-employed with no employees, you can make SEP-IRA contributions if you have net earnings from your business. For 2024, you can contribute an amount to your own account up to 20% or 25% (depending on your business entity) of your net earnings up to $69,000. But you can’t make any contributions if you have a net loss in your business.

There are special rules for determining how much of your SEP-IRA contributions are tax deductible when you’re self-employed. There’s a worksheet that you use to calculate your deduction in IRS Publication 560, Retirement Plans for Small Business. But I recommend getting help from a tax professional when you have self-employment income. 

Can you use a SEP-IRA and other retirement plans?

Wasittha mentioned trying to maximize a couple of retirement accounts. You can max out a SEP-IRA and a traditional IRA or Roth IRA any year.

However, when your income exceeds an annual threshold, your traditional IRA contributions may not be tax-deductible. But if you qualify for a Roth IRA, that’s not a problem because contributions get made on an after-tax basis.

You can also have a SEP-IRA and another workplace plan, like a 401(k) or 403(b). However, the total you can contribute to an employer plan plus your SEP-IRA is limited to 100% of your compensation, up to $69,000 for 2024.

So, even if you have a day job with a 401(k), you can contribute to a SEP-IRA when you have self-employment income.

RELATED: Is it better to have a traditional IRA or Roth IRA?

What are the SEP-IRA withdrawal rules?

When taking money out of a SEP-IRA, the rules are generally the same as for a traditional IRA. If you withdraw money before age 59.5, you’re typically subject to a 10% early withdrawal penalty plus income tax. 

You can roll over your SEP-IRA to a traditional IRA tax-free. But you must take required minimum distributions or RMDs from a SEP-IRA or traditional IRA once you reach 73. Withdrawals of contributions and account earnings are subject to ordinary income tax.

READ ALSO: Am I saving enough for retirement?

What’s the downside of a SEP-IRA?

While a SEP-IRA is the most straightforward retirement plan for solo business owners to administer, there may be better options if you hire employees or substantially scale your business. You may not like the requirement to contribute equally to all your employees’ accounts as your business grows.

Another con for a SEP-IRA is not allowing catch-up contributions for those over 50. Nor does it offer an after-tax Roth option or account loans, which are usually features of the solo 401(k). 

However, you can only have a solo 401(k) if you have no employees other than a spouse. Plus, it requires you to contribute through payroll deductions, so there’s a higher administrative burden compared to a SEP-IRA. So, be sure to research both options if you don’t plan on hiring employees in your business. 

Should you take a 401(k) loan? Laura answers a listener’s question about 401(k) loans and using them to pay off credit card debt. She covers 11 pros and cons of taking a loan from a workplace retirement plan, such as a 401(k) or 403(b). Listen in the player below. 

How can I set up a SEP-IRA?

It’s easy to set up a SEP-IRA by completing Form 5305-SEP once and opening the account with a financial institution, brokerage firm, or investing platform. You contribute, and each account owner decides how to invest the funds in their SEP-IRA. You can put the money into mainstream investments, like index, mutual, and exchange-traded funds. 

Using a SEP-IRA and other tax-advantaged accounts is a smart way to build wealth for your future.