You're a freelance graphic designer. You cleared $100,000 in net profit last year. You heard you can shelter 25% of that in a SEP IRA, which sounds like $25,000. You run the numbers, set up the account, and discover you can actually contribute only $18,587.
That's not a mistake. It's how SEP IRA math works for self-employed individuals, and most articles skip the explanation. Let's fix that.
30-Second Summary: A SEP IRA (Simplified Employee Pension) lets business owners contribute up to 25% of employee compensation, or $72,000 for 2026, whichever is less. Self-employed individuals effectively contribute about 20% due to IRS calculations. Setup takes one form. Contributions are tax-deductible and discretionary year to year.
What Is a SEP IRA?
A SEP IRA is a tax-deferred retirement plan that allows employers (including self-employed individuals) to make contributions to traditional IRAs set up for themselves and their employees. The "Simplified" part is real: you fill out IRS Form 5305-SEP, and you're done. No annual filing. No compliance testing. No plan administrator fees [1].
The money goes into a standard IRA account and follows traditional IRA rules for withdrawals (taxed as ordinary income, 10% penalty before 59½, RMDs starting at 73).
The catch: only the employer contributes. Employees cannot make their own salary deferrals to a SEP IRA. This is the fundamental difference from a 401(k) or SIMPLE IRA.
2026 Contribution Limits
| Limit | 2025 | 2026 |
|---|
| Maximum contribution | $70,000 | $72,000 |
| Compensation cap | $350,000 | $360,000 |
| Contribution rate | Up to 25% of compensation | Up to 25% of compensation |
| Catch-up contributions | $0 | $0 |
| Minimum earnings threshold | $750 | $800 |
Source: IRS Notice 2025-67 [2].
Note the zero for catch-up contributions. Unlike a 401(k), SEP IRAs don't allow extra contributions for people over 50. That's a meaningful disadvantage for older self-employed individuals trying to maximize savings [3].
The 25% vs. 20% Problem
If you're a W-2 employee of your own corporation, the math is straightforward: your company contributes up to 25% of your salary. Earning $150,000? Your employer (you, through the corporation) can contribute up to $37,500.
But if you're a sole proprietor or single-member LLC, the IRS uses a circular calculation that effectively reduces your maximum rate to about 20% [4].
Worked Example: Alex, Freelance Designer
Net profit (Schedule C): $100,000
Step 1: Calculate self-employment tax deduction
- SE tax: $100,000 × 0.9235 × 0.153 = $14,130
- Deductible half: $14,130 ÷ 2 = $7,065
Step 2: Calculate adjusted net earnings
- $100,000 − $7,065 = $92,935
Step 3: Apply the reduced rate
- The IRS formula: 25% ÷ 1.25 = 20%
- $92,935 × 20% = $18,587
Alex can contribute $18,587. Not $25,000. The gap matters.
Why does this happen? Because the SEP contribution itself reduces the income it's based on (the calculation is circular), so the IRS uses this adjusted rate. It's spelled out in IRS Publication 560 [5], and it surprises nearly every sole proprietor the first time. I've seen freelancers budget around the 25% number, set up the account, and then scramble to revise their tax plan when the real number comes in $6,000 lower.
SEP IRA vs. Solo 401(k) vs. SIMPLE IRA
This is the table most self-employed people actually need:
| Feature | SEP IRA | Solo 401(k) | SIMPLE IRA |
|---|
| Max contribution (2026) | $72,000 | $72,000 | $17,000 + match |
| Employee deferrals | No | Yes ($24,500) | Yes ($17,000) |
| Catch-up (50+) | No | Yes ($8,000) | Yes ($4,000) |
| Employer contribution | Up to 25% | Up to 25% | 3% match or 2% non-elective |
| Best at lower income | Weak | Strong | Moderate |
| Roth option available | Legally yes, rare in practice | Yes | Yes (new under SECURE 2.0) |
| Annual filing (Form 5500) | No | Yes, if over $250k | No |
| Employees allowed | Yes (must cover all eligible) | No (solo or spouse only) | Yes (up to 100) |
The critical difference: at lower income levels, a Solo 401(k) almost always lets you save more.
Using Alex's $100,000 example:
- SEP IRA: $18,587 (employer contribution only)
- Solo 401(k): $18,587 (employer) + $24,500 (employee deferral) = $43,087
That's $24,500 more in tax-advantaged savings with the Solo 401(k). The tradeoff is slightly more paperwork (Form 5500-EZ once your balance exceeds $250,000).
So when does a SEP IRA win? When simplicity matters most, and/or when you have employees. Setting up a SEP takes minutes. A Solo 401(k) requires more documentation. And if you have W-2 employees, you can't use a Solo 401(k), but a SEP IRA works fine (though you must contribute the same percentage for all eligible employees) [6].
Key Rules and Deadlines
Establishment and funding deadline: You can set up and fund a SEP IRA for the prior tax year all the way until your tax filing deadline, including extensions. That means October 15 if you file an extension. This is one of the most generous deadlines of any retirement account [7].
Contribution flexibility: Contributions are completely discretionary. You can contribute 25% this year and 0% next year. But if you have employees, the percentage must be the same for everyone in a given year.
Eligibility (the 3-of-5 rule): Employees who have worked for you in at least 3 of the past 5 years, earned at least $800 (2026), and are at least 21 years old must be included in the plan [8].
Vesting: Immediate. 100%. There's no vesting schedule. Every dollar contributed is the employee's from day one.
Can You Have a SEP IRA and Other Accounts?
Yes. A SEP IRA doesn't prevent you from contributing to a personal Roth IRA (assuming your income qualifies). The SEP contribution doesn't count against the $7,500 IRA limit, because it's an employer contribution, not an employee deferral [9].
A SEP IRA does make you an "active participant" in a retirement plan, though. That affects your ability to deduct Traditional IRA contributions at higher incomes.
If you have a day job with a 401(k) and a side business, you can contribute to both the 401(k) and a SEP IRA for the side business, though total contributions across all plans are subject to Section 415(c) limits.
Your Next Move
-
If you're self-employed with no employees and net profit above ~$50,000: Compare a SEP IRA and Solo 401(k) using the math above. The Solo 401(k) usually wins on savings capacity.
-
If you have employees you want to cover: A SEP IRA is the simplest option. Set it up with Fidelity, Vanguard, or Schwab. File Form 5305-SEP.
-
If you're starting late (over 50): The SEP's lack of catch-up contributions hurts. A Solo 401(k) with its $8,000 catch-up (or $11,250 super catch-up for ages 60–63) gives you more room.
-
To figure out your maximum SEP contribution: Use our compound interest calculator with your net self-employment income reduced by half of SE tax, then multiply by 20%.
For a broader look at which IRA type fits your situation, see our IRA overview. And if you're building your freelance financial plan from scratch, our guide on building a budget is a good starting point.
References
- Internal Revenue Service. (2025). Retirement Plans FAQs regarding SEPs. IRS.gov. https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-seps
- Internal Revenue Service. (2025). Notice 2025-67: Cost-of-Living Adjustments for 2026. IRS.gov. https://www.irs.gov/pub/irs-drop/n-25-67.pdf
- Internal Revenue Service. (2025). SEP Contribution Limits (including grandfathered SARSEPs). IRS.gov. https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-seps
- Fidelity. (2025). SEP IRA Contribution Limits. Fidelity.com. https://www.fidelity.com/retirement-ira/small-business/sep-ira
- Internal Revenue Service. (2024). Publication 560: Retirement Plans for Small Business. IRS.gov. https://www.irs.gov/publications/p560
- Internal Revenue Service. (2025). Retirement Plans FAQs regarding SEPs. IRS.gov.
- Fidelity. (2025). SEP IRA Contribution Limits. Fidelity.com.
- Internal Revenue Service. (2024). Publication 560: Retirement Plans for Small Business. IRS.gov.
- Fidelity. (2025). SEP IRA Contribution Limits. Fidelity.com.
