SEP IRA
Also: SEP IRA, Simplified Employee Pension, SEP-IRA
A simplified pension plan for self-employed individuals and small business owners. 2025 contribution limit is the lesser of 25% of net self-employment income or $70,000.
A SEP IRA is an employer-sponsored retirement plan established under IRC Section 408(k). It is most often used by consultants, founders of single-employee businesses, and owners of small practices. Contributions are made by the employer only, up to 25% of net self-employment income (net of the deductible half of self-employment tax), capped at $70,000 for 2025. Contributions are pre-tax, grow tax-deferred, and are taxed as ordinary income at distribution. SEP IRAs enter into the pro-rata rule for backdoor Roth calculations.
Example: a former tech employee starts a consulting business earning $220,000 of net self-employment income in 2025. The deductible half of self-employment tax is approximately $8,500, producing net earnings of $211,500. The SEP contribution limit is $42,300 (20% of gross, the mathematical equivalent of 25% of the reduced base).
Common mistake: choosing a SEP IRA when a Solo 401(k) would allow much larger contributions. The SEP is simpler but caps employer contributions at 25%, while a Solo 401(k) adds employee elective deferrals of $23,500 on top.
SEP IRAs matter for sideline consulting income, for solo founders before hiring, and for any self-employment income layered on top of W-2 wages.