Eligible Employees

If an employer contributes to a SEP, the employer must contribute for each employee who has:

  • Reached age 21
  • Worked for the employer in at least three of the immediately preceding five years
  • Received at least $800 in compensation (2026, adjusted annually for inflation) from that employer for the year the contribution is made

Employers can set less restrictive (but not more restrictive) participation requirements by filling in the appropriate amounts on Form 5305-SEP. For example, an employer may choose to cover employees immediately upon hire.

Example: Spinning Disc Music Co., Inc. maintains a SEP. Doug Roberts worked for Spinning Disc while in college in 2020, 2021, and 2022, never working more than 35 days in a particular year. In February 2025, Doug turns 21. In April, he begins working for Spinning Disc full-time, earning $30,000. Spinning Disc must make a SEP contribution for Doug because he meets the minimum age requirement, the minimum compensation threshold of $800 for 2026, and has worked for Spinning Disc in 3 of the 5 years preceding 2026.

The “three-out-of-five” year service requirement is unique among qualified plans and is an effective way of restricting participation to employees who have devoted a substantial amount of time to the company. Most other types of qualified plans allow participation after only one or two years of service.

Controlled Groups and Affiliated Businesses

All employees of a commonly controlled group of businesses or affiliated group are treated as if they were employed by a single employer. This eliminates the possibility of a business owner creating a separate entity to hire highly-paid employees and offering them more advantageous benefits. All employees of a controlled group must be treated equally.

This “single employer” rule can also work to the advantage of a business owner who owns several businesses but wants the low administrative and documentation costs of one SEP covering all employees across all entities.

Leased Employees

If an employer uses leased employees, those employees generally must be included in SEP coverage. Leased employees include those whose services are provided under an agreement between the employer and a leasing organization. To be eligible for SEP participation, a leased employee’s services must be performed on a substantially full-time basis for at least one year and must be of a type historically performed by employees in that organization’s field of business.

Former Employees, Deceased Employees, and Unreachable Employees

Employers must contribute on behalf of all employees who meet the SEP eligibility requirements during the year for which a contribution is made — including:

  • Employees who are no longer employed when the contribution is made
  • Employees who died during the year
  • Employees whose whereabouts is unknown

If a former or current employee established an IRA but closed it prior to the date of the employer’s SEP contribution, the employer must establish an IRA on behalf of that employee and deliver notice in person or by mail to the employee’s last known address. The same applies for employees who have never opened an IRA. The IRS permits employers to establish IRAs on behalf of employees who refuse to do so or cannot be located in order to safeguard the tax qualification of their SEPs.

Mandatory Participation

If an employee is not required to participate in a SEP as a condition of employment, that employee’s election not to participate may prevent all other employees of the employer from participating. For this reason, employers who establish a SEP should mandate participation in the plan by all eligible employees.

Excluded Employees

Employers need not make SEP contributions for:

  • Employees who are nonresident aliens with no U.S. source of earned income
  • Employees covered by a collective bargaining agreement in which retirement benefits were negotiated

The employer indicates its decision to include or exclude these employees by checking the appropriate boxes on Form 5305-SEP.

Nondiscrimination

As with all qualified plans, employer contributions to a SEP must not discriminate in favor of any officer, shareholder, or “highly compensated employee” as defined in the Internal Revenue Code (the “prohibited group”). The IRS considers a SEP plan nondiscriminatory if the employer contributes:

  • A flat percentage of earnings
  • A fixed dollar amount, or
  • A formula in which contributions decrease as earnings increase

SEPs are discriminatory unless employer contributions bear a “uniform relationship” to compensation.

Example — Discriminatory (not allowed): Spinning Disc Records proposes to contribute 10% of compensation for employees with up to five years of service and 12% for those with more than five years of service. The IRS will rule this discriminatory because contributions are based on a non-compensation factor (years of service) and do not bear a uniform relationship to each employee’s compensation.
Example — Also discriminatory (not allowed): Spinning Disc proposes to contribute 10% of an employee’s first $50,000 of compensation and 12% of any compensation above $50,000. This formula is disallowed because it favors higher-paid employees at the expense of lower-paid workers.
Example — Nondiscriminatory (allowed): Spinning Disc installs a SEP under which it will contribute 15% of an employee’s first $15,000 in compensation and 10% of all compensation above $15,000. This is not discriminatory because the rate of contribution decreases as compensation increases.
Example — Fixed dollar (allowed): Spinning Disc proposes to contribute $3,500 to each eligible employee’s SEP-IRA regardless of income. Although not based on compensation, the IRS allows such a “fixed dollar” formula.
Compensation Cap

To limit the size of contributions made on behalf of highly-paid employees, employers must limit the total annual compensation taken into consideration when making a SEP contribution to $360,000 (2026, adjusted annually for inflation).

Example — Compensation cap in action: Spinning Disc Music has three eligible employees: Doug Roberts earned $30,000, John Thompson earned $50,000, and Jane Morgan (the owner) earned $400,000. The SEP plan calls for a 10% contribution for each employee.

Spinning Disc contributes $3,000 to Roberts’ IRA (10% × $30,000) and $5,000 for Thompson (10% × $50,000). For Morgan, only the first $360,000 of her compensation may be considered, so her contribution is $36,000 (10% × $360,000) — not $40,000 (10% × $400,000). Note: this is still below the $72,000 annual contribution ceiling.
For SEP nondiscrimination purposes, all employees of a commonly-controlled group of businesses or affiliated group are treated as if employed by a single employer. This prevents a business owner from creating a separate entity to offer more favorable benefits to highly compensated employees.
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