What Is a SEP Plan?

A Simplified Employee Pension (SEP) is an employee’s individual retirement account or annuity (IRA) which may receive an increased rate of contributions from the IRA holder’s employer. To operate properly, each eligible employee must have an IRA to accept the employer’s contributions. Any employer — whether a corporation, partnership, or even a one-person sole proprietorship with no other employees — may establish a SEP.

SEPs are particularly useful for persons regularly employed by a company but who “moonlight” for themselves as independent contractors. That is why SEPs are sometimes referred to as a “moonlighter’s retirement plan.” While originally designed for small business employers, there is no limit on the size of employer that may establish a SEP.

Generally, an employer who establishes a SEP must cover each and every employee who has:

• Reached age 21
• Worked for the employer during the year in which the contribution is made
• Worked for the employer for at least three of the previous five years
• Received at least $800 in compensation (2026, adjusted for inflation) for the year in which the contribution is made

An employer is not required to make contributions to a SEP. However, if an employer makes contributions, they must be made under a written formula that indicates how the employer will calculate each employee’s share. Annual contributions are limited to the lesser of:

• 25% of the employee’s compensation (capped at $360,000 of compensation in 2026), or
• $72,000 (2026, adjusted annually for inflation)

SEP contributions need not be made every year — the decision to contribute or not is left solely to the employer.

A SEP plan must be in writing and must include a formula for the allocation of contributions and provisions governing participation, vesting, and nondiscrimination. The plan must be established no later than the business’s income tax filing date (including extensions) for the year for which it is contributing. A SEP is the only type of employer-sponsored retirement plan that can be established after the employer’s tax year has ended — making SEPs extremely attractive for businesses that do not know their financial condition until tax time.

For tax and legal purposes, the SEP plan is officially adopted when:

• Traditional IRAs have been established for all eligible employees
• The agreement form has been completed without modification
• Employees receive disclosure statements indicating the existence of the plan, that IRAs involve a degree of investment risk, and that the plan administrator will notify employees of any contributions to the SEP no later than January 31st of the following year

The final two steps are usually accomplished by signing and distributing IRS Form 5305-SEP to all eligible employees.

The IRS has developed a one-page form, Form 5305-SEP, that meets all the requirements of a Simplified Employee Pension plan and does not require any special document preparation. By using the IRS model, the employer need not develop an individual plan. (View IRS Form 5305-SEP →)

An employer may set up a Model SEP using Form 5305-SEP under the following conditions:

• The employer does not currently maintain any other retirement plan and has not maintained a defined benefit plan at any time in the past
• An IRA has been established for each eligible employee
• The employer does not use the services of leased employees
• All eligible employees of all members of an affiliated service group, a controlled group of corporations, or a trade or business under common control participate in the SEP

Since Form 5305-SEP is a “pre-approved” plan, no favorable ruling from the IRS is required, nor is the form filed with the IRS. The employer simply retains a signed, dated copy with its business records.

Employers who establish a Model SEP and furnish each eligible employee with a copy of the completed form need not file annual reports with the IRS. However, this exception is not available if the employer selects, recommends, or influences employees to choose IRAs that are subject to special provisions limiting the participant’s ability to withdraw funds.

The IRS also allows employers to create unique SEP plans. Many financial institutions have received IRS approval for their own prototype SEPs, allowing them to combine plan administration and investment services — “one-stop shopping” for busy employers.

Unlike Model SEP plans, these non-model SEPs must be approved by the IRS. A copy of the proposed SEP must be filed with the IRS with a request for a “favorable ruling.” Any proposed amendments to the plan must also be filed with the IRS, even if those amendments are required due to changes in the tax code.

Under SECURE Act 2.0, eligible small employers with 100 or fewer employees may claim a tax credit equal to 100% of the cost to establish a SEP, SIMPLE, or other qualified plan. The credit is limited to $5,000 per year for each of the first three years of the plan’s existence.