Founders often struggle with balancing revenue and profit while retaining good employees. Often, they are hesitant to offer employee benefits due to their cost. Some business owners legitimately can’t afford to provide these benefits. Others may be looking at the bottom line too much.
However, the government provides simple ways to provide retirement benefits to your employees.
What is a SEP IRA?
The Simplified Employee Pension plan, commonly known as a SEP IRA, is a retirement plan designed for business owners and self-employed individuals. Unlike the Solo 401(k), which is built for one-person businesses, the SEP IRA is designed for businesses with multiple employees. If you have ten employees and want to offer them a retirement benefit, the SEP IRA is one of the primary options.
The SEP is an IRS designation that allows you to contribute to a traditional IRA on behalf of each eligible employee. The account itself follows the same investment, distribution, and rollover rules as a traditional IRA.
To establish a SEP, you fill out Form 5305-SEP. This form should not be filed with the IRS; it is simply your written agreement to provide this benefit. One important note: if you already have another retirement plan in place, such as a Solo 401(k) or SIMPLE IRA, you cannot use Form 5305-SEP. You would need to use a prototype or an individually designed SEP instead. Having another retirement plan does not disqualify you from a SEP; it just changes which form you use to set it up.
How it works
What makes the SEP IRA unique is that only the employer contributes to the plan. Employees cannot make their own contributions; unlike a 401(k), where employees defer a portion of their paycheck. The employer sets up a traditional IRA for each eligible employee, contributes to it on their behalf, and the employee has full ownership of that money immediately. This is called being 100% vested, meaning there are no vesting schedules or waiting periods. The money belongs to the employee the moment it hits the account.
The employer has flexibility in how much to contribute each year. They can contribute anywhere from 0% up to the maximum. But whatever percentage is chosen must be consistent across all eligible employees. If your business is doing well and you contribute 15% of compensation for a particular year, you must contribute 15% for every eligible employee. If business slows down and you want to contribute less next year, you can, but again, the same percentage must apply to everyone.
Employers may exclude employees covered by a union agreement and nonresident alien employees who do not have U.S. wages or compensation from the employer.
Who is eligible?
To participate in a SEP IRA, an employee must meet all three of the following requirements: be at least 21 years old; have worked for the employer in at least three of the last five years; and have received at least $750 in compensation in 2025. This threshold increases to $800 in 2026.
Employers can set their own eligibility criteria, but they cannot be more restrictive than the IRS minimums. For example, you cannot require employees to be 25 years old or to have worked four of the last five years. You can, however, make the requirements less restrictive. For instance, allowing employees to participate immediately upon being hired.
The contribution limits
For 2025, employers can contribute up to 25% of an employee’s compensation, with a maximum of $70,000 per employee. For 2026, that maximum increases to $72,000.
One important limitation worth noting: the SEP IRA does not offer catch-up contributions for those age 50 and older, unlike the Solo 401(k).
Let’s look at an example.
A business owner has two employees, Sally and Jimmy, each earning $80,000 per year. The owner decides to contribute 10% of compensation to the SEP IRA for 2026.
Sally’s contribution: $80,000 x 10% = $8,000
Jimmy’s contribution: $80,000 x 10% = $8,000
Owner’s contribution to own account: also calculated at 10%
Every eligible participant must receive the same percentage, including the owner.
How to establish a SEP plan
The first step is to choose a financial institution to hold the retirement plan assets. Fidelity, Schwab, and Vanguard all offer SEP IRAs. Second, execute a written agreement using Form 5305-SEP that outlines your intention to provide this benefit to all eligible employees. Third, provide employees with the necessary information about the plan. Fourth, set up an individual IRA account for each eligible employee.
There are no complex filings, no annual reporting to the IRS, and minimal ongoing administrative burden.
The benefits
Contributions are tax-deductible for the employer, reducing your taxable income for the year. Earnings in the account grow tax-deferred until withdrawal. Contribution amounts are flexible from year to year, so you can contribute more in good years and less in lean ones. The investment options are broad, with employees choosing their own investments within the account rather than being limited to a restricted menu like many workplace plans. And as mentioned, employees are 100% vested immediately.
Contributions must be made by the due date for filing your federal income tax return, including extensions. SEP contributions and earnings can be withdrawn at any time, though withdrawals are taxable in the year received. Withdrawals before age 59½ generally trigger a 10% early withdrawal penalty. SEP IRAs are also subject to required minimum distributions once you reach age 73.
There may be taxes and penalties for overcontribution to a SEP IRA. Working with your tax professional and financial advisor is important to ensure compliance.
The importance of employee retention
Finding good workers is hard. Keeping them is even harder. As a small business owner, you often compete with larger companies that can offer higher salaries and more robust benefits packages. Any opportunity to add value for your employees will strengthen your ability to keep them long-term.
From an ADP survey conducted in 2025, 38% of business owners point to retaining employees as an ongoing challenge. ADP argues that a competitive benefits package can lead to better job satisfaction, loyalty, and a stronger culture.
Employees who feel valued have a propensity to stay in their current position and perform their duties at a higher level.
Now, if you do not have the funds to do this responsibly, it would be unwise to force it. Opening a SEP plan generally only makes sense if your business has enough net capital to support it. If your business is breaking even or operating at a net loss, it may not be the right time.
But I would also argue that the timing question is more than just a numbers game. It is about looking at your business in totality and where you want it to go. For example, if you have an exceptionally valuable employee who contributes significantly to your business, it may be worth adjusting your own salary, even modestly, to either increase their compensation or establish a retirement benefit on their behalf. It is a strategic decision regarding the kind of business you want to build, not just a financial calculation.
As mentioned above, it’s hard to say what the best decision is for your business and your employees. However, I’m generally of the opinion that if you can feasibly offer these kinds of benefits, without the business going under, it can make a lot of sense.
Valuing the people helping you build your business, the SEP IRA is one of the simplest and most impactful benefits you can offer.
*This is not meant to be tax or investment advice and is for general information purposes only.
Did you know?
Something to ponder…
If your best employee received a job offer from a larger company tomorrow, what would make them stay?
Need help determining if a retirement plan is appropriate for your business? Schedule a free consultation with Texel Compass and we’ll guide you through the decision process.