Self-Employed or Have a Side Hustle? A SEP IRA Can Help You Invest for Retirement

An image of two people talking is used to illustrate an article about SEP IRAs. Edgar Barragan Juarez / Getty
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Self-employed and struggling to save for retirement? Meet the SEP IRA. 

When you’re your own boss or run your own business, it can be difficult to prioritize saving for retirement, especially if it’s your sole source of income. Not having access to a company-sponsored retirement plan or contribution matching is a hurdle, sure. However, entrepreneurs don’t have to give up hopes for retirement, even if it feels that way. 

If retirement is something you see for yourself down the line, it’s never too early to start saving for it, even if your focus is glued to the present.

 In order to maintain your standard of living in retirement, experts say you will need about 70-90% of your pre-retirement income. Like a 401(k) or an IRA, entrepreneurs can utilize a SEP IRA, or a Simplified Employee Pension IRA, as a retirement savings tool that comes with higher contribution limits and other perks. 

Here’s how it works.

What is a SEP IRA?

While there are a plethora of retirement plan options for the self-employed, a SEP IRA is “geared towards folks who have up to 25 employees and want to offer an easy retirement benefit,” says Jill Schlesinger, a CFP, Emmy-winning business analyst at CBS News, and host of the podcast “Jill on Money.”.

SEP IRA contributions for 2022 can be up to the lesser of $61,000 or 25% of your compensation, while contributions to a traditional or Roth IRA are capped at $6,000 annually for most people. 

Unlike an IRA or a 401(k), a SEP IRA does not have a Roth option. In a SEP IRA, contributions are untaxed when you make them, but are taxed as income when you take the money out in retirement. Contributions to a Roth 401(k) or Roth IRA are taxed as income when you make them, but can be withdrawn tax-free after you retire.  

There are a lot of advantages to a SEP IRA, including its low administrative burden and high contribution limits. There are a few restrictions you’ll want to consider before opening up a SEP IRA.  

 “I find these are great plans if it’s just a few employees, and certainly if it’s just a sole proprietor, it’s awesome,” says Schlesinger. 

SEP IRA Basics

Pros and Cons of a SEP IRA

Determining which retirement plan is right for your situation comes down to a few factors. “With every bit of flexibility and customization comes some burden and some costs,” Schlesinger says. While you consider the pros and cons, keep in mind the most important aspect of any retirement plan: consistently putting money away, regardless of how you go about it. 

Pros 

A SEP IRA helps entrepreneurs reach retirement despite lacking access to a large company-sponsored plan, but you can still take advantage if you have a side hustle and still have a full-time job. “You can contribute both to a SEP IRA and a company-sponsored 401(k), as long as they’re offered by separate employers,” says Jason Siperstein, head of financial planning at Eliot Rose Wealth Management, a Rhode Island firm focusing on retirement planning.  

This provides a great opportunity for individuals who have recently started their own businesses or side hustles. During the COVID-19 pandemic, you likely knew someone or were that someone to start hustling on the side. Whether to fill time, secure their financial situation, or maybe both – there are millions of individuals that may not be capitalizing on their status as self-employed.  

“So few people know about these plans. I worry a little bit that entrepreneurs may forget about all the beautiful benefits they got from their bosses, like a matching contribution to your 401(k),” Schlesinger says. While self-employed individuals have to handle their retirement planning on their own, they aren’t without options. Far from it.   

By and large, experts recommend saving at least 15% of your pre-tax income for retirement. The high contribution limits for a SEP IRA – potentially 10 times the limit for a traditional IRA – make it “…an easy way for small-business owners to get a pretty sizable contribution in their retirement account,” Siperstein says.   

Cons 

 Remember those high contribution limits? Well, the drawback is that whatever you contribute to your SEP IRA, you must make equal contributions for all of your employees. Unlike a company-sponsored 401(k), a SEP IRA requires you as the employer to make these contributions.  

“This is an example of checks and balances,” says Summer Red, an accredited financial counselor and senior educator at Association for Financial Counseling & Planning Education. “The government wants more employers to have retirement accounts available for employees,” and a simple process helps incentivize entrepreneurs to set up a SEP plan. This requirement can be either a pro or a con. “For me, it’s a pro,” Red says, especially if you look at the situation from “a very pro-employee perspective.” 

If you only have a few employees or you’re the sole proprietor, “It’s almost hard to find anything better than a SEP IRA,” Siperstein says. With more employees, however, “It’s going to be awfully hard to make the maximum contribution, because that’s going to make for very high percentage requirements that you’ll have to contribute for your employees.”  

The lack of a Roth option could be a negative for some. Those who benefit the most from a Roth option are individuals who have “a lower income now, but expect to be in higher tax brackets later in life,” Siperstein says.  

Since a SEP IRA doesn’t allow for catch-up contributions, entrepreneurs over 50 may opt for another plan that does. Take, for example, a Solo 401(k), “which is fantastic for sole proprietors or those who have maybe just a spouse as an employee,” says Schlesinger. 

Pros

  • Easy to set up

  • High contribution limits compared to traditional/Roth IRAs

  • Flexible contribution timelines: You can pause or delay

  • Great for side hustles to augment a company-sponsored retirement plan

Cons

  • No Roth version

  • Requires equal contribution for all employees

  • Only the employer can contribute

  • Doesn’t allow for catch-up contributions

How to Open a SEP IRA

As its name states, a SEP IRA is intended to be simple. “I don’t think I’ve ever seen anything easier to set up than a SEP IRA,” says Red.

There are just a few steps, according to the IRS

First, you will agree in writing to provide equal contributions for any and all eligible employees. Experts recommend using a custodian, which is “the entity that holds the funds like Fidelity, Schwab, or Vanguard. They will provide you with the right paperwork,” says Siperstein. 

Once the paperwork is complete, you are required to inform any eligible employees that you have established a SEP IRA. Finally, it is the employer’s responsibility to open IRA accounts for each employee. If you are a sole proprietor, the process for setting up a SEP IRA will be even simpler as you will only be making contributions for yourself. 

Once you have the account set up, be sure you invest the money. Long-term index funds are an excellent way to set money aside for retirement. Broad index funds allow you to enjoy the growth of the market over decades without the risk and difficulty of picking individual stocks.

Target-date index funds are one option. They allow you to set a date – think your retirement age – at which you can access your money. Target-date index funds are managed to optimize your investments leading up to said target date, making it a low-risk investment strategy. 

Pro Tip

If your business is a side-hustle, you can still have a SEP IRA alongside your company-sponsored retirement plan.

Other Retirement Planning Options for Entrepreneurs

When you work for yourself, there are multiple paths to retirement, and a SEP IRA could be a great one. The most important factor when setting yourself up for retirement is to pick the one that makes the most sense for you and commit to it. 

Here are some other options to consider.

Solo 401(k)

A Solo 401(k) is much like a traditional 401(k) except you will serve as both the employer and employee for your business. You can contribute as both the employer and employee, up to the 2022 limit of $20,500. 

Simple IRA

A Simple Incentive Match Plan for Employees, or a Simple IRA, is another option. This plan has lower contribution limits – up to $14,000 for 2022 – and there is no Roth option. 

Defined Contribution Plans

These allow you to establish your own pension plan as a small-business owner.  They tend to be more rare because they are tedious and expensive to set up. Defined Contribution Plans tend to be used by wealthy individuals as the contribution limit for 2022 is up to the lesser of 100% of compensation or $245,000. 

The Bottom Line

There’s no hidden gem of a retirement plan. The most important part is to make sure you keep putting money away and take care of yourself.

“I think the only hidden part of it is that people just tend to blow off taking care of themselves when they have a business,” Schlesinger says. “Yes, your business is important. And yes, you are important too.”