How Does a SEP Roth IRA Work?

They don’t exist, but you can benefit from both types of accounts

 Person looking out of a food truck
•••

 Maskot / Getty Images

A SEP IRA, or Simplified Employee Pension Plan, allows small business owners to set aside money in retirement accounts for their employees and themselves. Someone who’s self-employed also may open a SEP IRA. These accounts work much in the same way as a traditional IRA account, except there’s a much higher contribution limit. 

As for a SEP Roth IRA? There is simply no such thing. However, if you’re interested in some tax-free retirement income, it could pay to maintain both a SEP and a Roth. You also have the option to convert your SEP IRA to a Roth IRA. Learn more about how a SEP IRA works, how one can work in tandem with a Roth, and how to conduct a SEP IRA-to-Roth IRA rollover.

Key Takeaways

  • There is no such thing as a SEP Roth IRA; a SEP IRA is a type of traditional IRA.
  • You can make contributions to both a SEP IRA and a Roth IRA, as long as you meet each one’s income and other eligibility requirements.
  • If you decide you want to roll funds over from your SEP IRA into a Roth IRA, you can do so, but there are tax implications.

SEP IRA Basics

SEP IRAs are only available in traditional IRA form, not as an after-tax Roth account. They are designed to be a long-term investment vehicle for businesses and solo practitioners who may not have the option of setting up other types of employer retirement accounts, such as a 401(k). Like traditional IRAs, contributions are tax-deductible, but SEP IRAs have higher contribution limits.

Who Can Set Them Up? 

SEP IRAs primarily are geared toward small business owners or those who are self-employed. People who have full-time employment and participate in their company’s retirement plan can still open a SEP if they earn self-employment income on the side.

How Do SEP IRAs Work? 

Similar to other IRAs, SEP IRAs are intended to be withdrawn after age 59 ½. You can take a withdrawal before that, but you’ll pay a 10% early withdrawal penalty. Once you turn 72, you must begin taking required minimum distributions (RMDs). The key differentiator with a SEP is that the yearly contribution limit is much higher than the $6,000 (or $7,000 catch-up amount for those over 50) allowed for traditional and Roth IRAs.

How Are They Taxed? 

SEP IRA contributions are made with pretax dollars, therefore the amount you deposit each year is tax-deductible. The maximum deduction a business can take tax for contributing to its employees' SEP IRAs is the total contributions, or 25% of compensation, whichever is less. Self-employed IRA holders must follow an IRS formula to calculate their maximum deduction.

Later on, when you eventually make withdrawals or get RMDs from your SEP IRA, you will be taxed as those withdrawals will count as taxable income.

What Are the Contribution Limits? 

The maximum SEP IRA contribution for 2022 is 25% of compensation, up to $61,000. If you’re the employer, you must contribute the same percentage to each eligible employee.

For self-employed people, compensation is based on net earnings. That is important to keep in mind when figuring out your contribution limit for the year.

Contributing to Both a SEP IRA and a Roth IRA


It is possible to contribute to both a SEP IRA and either a traditional IRA or a Roth IRA (if you are within the income-limit requirements) in the same year.

If you are receiving employer contributions to a SEP IRA, they are independent of the $6,000 you are allowed to contribute to other IRAs you have, including a Roth. If you are a self-employed person who contributes up to the maximum allowed in your SEP, you also can still contribute to a Roth IRA. 

The only time it gets tricky is if you make non-SEP contributions to your SEP IRA (if it’s allowed). Those contributions will count toward your yearly IRA allowance, the total of which cannot exceed $6,000 for 2022.

Both SEP IRA and Roth contributions can be made up until the federal income tax return due date. For the 2021 tax year, you have until April 18, 2022.

Rolling Your SEP Contributions Into a Roth IRA

If you want to roll your SEP contributions into a Roth IRA, you can do a rollover called a Roth conversion. You will have to pay taxes on the amount that you move over. That’s because with a Roth, you must use after-tax dollars so that your money can grow and be withdrawn tax-free later. 

Therefore, the amount you roll over will be added to your taxable income for that year. So if you earned $50,000 and you decide to roll over $10,000 from your SEP into a Roth, your taxable income would increase to $60,000. At that income level, you’d be in the 22% tax bracket (for 2022), so you’d have to pay $2,200 on the amount converted to your Roth IRA at tax time.

There are no limits on the amount you can roll over, but once you convert to a Roth, you can’t go back into a traditional IRA (as of tax year 2018).

To go from a SEP IRA to a Roth account, you have three main options. You can do an indirect rollover in which the financial institution will issue you a check, and you have 60 days to put that amount into a new or existing Roth IRA. Or, easier than that, you can request a trustee-to-trustee transfer, in which the brokerage firm transfers your SEP IRA funds directly to the Roth IRA financial institution. Or, the simplest way of all—if you use the same firm for both your SEP and your Roth—you can request a same-trustee transfer of the savings.

The Bottom Line

Although a SEP Roth IRA product doesn’t currently exist, there’s no reason why you can’t leverage both a SEP IRA and a Roth IRA (if you meet each one’s eligibility requirements and income limits). Work with your financial advisor to figure out which type of IRA is best for you, and if or when it might be worth it to roll some of your SEP IRA funds over to a Roth IRA.

Frequently Asked Questions (FAQs)

When are SEP IRA contributions due?

The deadline to make IRA contributions for a tax year is the federal income-tax filing due date. So for tax year 2021, you have until April 18, 2022.  

What is a SEP IRA versus a SIMPLE IRA?

A SIMPLE IRA, or Savings Incentive Match Plan for Employees, is another option for small business employers who wish to offer a retirement plan. It differs from a SEP IRA in a couple of ways. First, a SEP is an option for any sized business, while a SIMPLE IRA is only for companies with 100 or fewer employees. Also, SEP plans don’t allow employee contributions; a SIMPLE IRA can be funded by both employee elective deferrals and employer contributions.

How much does a SEP IRA affect my taxes?

SEP IRAs work like traditional IRAs when it comes to tax treatment. You make pretax contributions, so you must pay taxes later when you take withdrawals or RMDs. For each tax year you contribute, that amount is deductible. The maximum deduction on your business's tax return if you contribute to your employees' SEP IRAs is the lesser of your contributions or 25% of compensation. Self-employed contributors must use the IRS’ formula to calculate the maximum deduction.

Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!

Article Sources