Key Points
Eligibility Requirements
If an employer makes contributions to a SEP, those contributions must be made for each 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 3 of the immediately preceding 5 years, and
- received at least $750 in compensation (2026, inflation-adjusted) from that employer for the year in which the contribution is made.
These are the maximum restrictions an employer may impose. An employer may adopt more generous eligibility rules — for example, covering all employees immediately with no age or service requirement — but may not be more restrictive than these four criteria.
Leased employees who meet these requirements must also be covered under the SEP. The employer indicates eligibility thresholds by completing the appropriate boxes on Form 5305-SEP.
Doug Roberts worked part-time for Spinning Disc Records in 2021, 2022, and 2023 while in college, never working more than 35 days in a particular year. In August 2024, Doug turned 21. In September 2024, he began working full-time, earning $30,000 for the year.
Spinning Disc must make a SEP contribution for Doug in 2024 because: (1) he met the minimum age requirement during 2024, (2) his $30,000 compensation exceeds the $750 threshold, and (3) he worked for Spinning Disc in 3 of the 5 years preceding 2024 (2021, 2022, and 2023).
Employers need not make SEP contributions for:
- Nonresident aliens who have no U.S. source of earned income, and
- employees covered by a collective bargaining agreement in which retirement benefits were the subject of good-faith negotiation.
The employer indicates its decision to include or exclude these categories by checking the appropriate boxes on Form 5305-SEP.
Employers must contribute on behalf of all employees who met the eligibility requirements during the contribution year — including:
- employees who are no longer employed when the contribution is made, and
- deceased employees, even if their whereabouts are unknown.
If a former or current employee established an IRA but subsequently closed it before the employer’s contribution date, or if an employee has never opened an IRA, the employer must establish an IRA on the employee’s behalf. The employer must deliver notice in person or by mail to the employee’s last known address. The IRS permits employers to safeguard their SEP’s qualified status by opening IRAs for employees who refuse to participate or cannot be located.
If an employee is not required to participate in a SEP as a condition of employment, that employee’s election not to participate could prevent all other employees from participating in the SEP. For this reason, employers who establish a SEP should mandate participation by all eligible employees as a condition of the plan’s ongoing validity.
Nondiscrimination in Contributions
As with all qualified plans, employer contributions to a SEP must not discriminate in favor of highly compensated employees. The IRS considers a SEP nondiscriminatory if employer contributions bear a uniform relationship to each employee’s compensation. The following allocation formulas are permitted:
Contributing the same percentage of compensation for every eligible employee is the clearest demonstration of uniformity. If an employer contributes 10% of each employee’s compensation, the dollar amounts will vary by salary level but the percentage relationship is identical.
Although not based on compensation, the IRS permits a flat dollar contribution made equally to every eligible employee’s SEP-IRA.
Spinning Disc proposes to contribute $3,500 to each eligible employee’s SEP-IRA regardless of the employee’s income. The IRS permits this fixed dollar formula because it does not discriminate in favor of highly compensated employees.
A contribution formula in which the rate actually decreases as employee compensation increases is also considered non-discriminatory — because it favors lower-paid employees.
Spinning Disc installs a SEP under which it contributes 7% of an employee’s first $15,000 in compensation and 5% of all compensation above $15,000. This is not considered discriminatory because the rate of contribution decreases as compensation increases — favoring rank-and-file workers.
The following types of formulas are discriminatory and will be rejected by the IRS:
Spinning Disc proposes to contribute 10% of compensation for employees with up to five years of service and 12% for those with more than five years. The IRS will rule this discriminatory because contributions are based on non-compensation factors (years of service), breaking the uniform relationship to compensation.
Spinning Disc proposes to contribute 10% of an employee’s first $50,000 of compensation and 12% of compensation above $50,000. This is disallowed because it favors higher-paid employees — the effective rate increases with compensation.
To limit the size of contributions made on behalf of very highly paid employees, employers may only take into account the first $360,000 of each employee’s compensation (2026, inflation-adjusted) when calculating SEP contributions. Any compensation above this cap is disregarded.
Spinning Disc Records has three eligible employees: Doug Roberts earns $30,000, John Thompson earns $80,000, and Jane Morgan earns $450,000. The SEP plan calls for a 15% contribution for each employee.
Doug: 15% × $30,000 = $4,500
John: 15% × $80,000 = $12,000
Jane: 15% × $360,000 (capped) = $54,000 (not 15% × $450,000 = $67,500)
Without the cap, Jane’s contribution would be $67,500 — but the $360,000 compensation ceiling limits it to $54,000, also subject to the $72,000 overall annual additions limit.
All employees of a commonly controlled group of businesses — including affiliated service groups, controlled groups of corporations, and trades or businesses under common control — are treated as if employed by a single employer. This rule prevents a business owner from routing highly paid employees through a separate entity to offer them more advantageous SEP benefits. All employees of a controlled group must be treated equally under the SEP.