Common Questions About a SEP IRA

Your standard IRAs and 401(k)s hog a lot of the attention when it comes to defined contribution retirement plans. While these can be terrific vehicles for creating a long-term nest egg, we don’t want to discount another effective option, the SEP IRA.

At Heritage Capital, we’re often asked about the SEP IRA, which can be a low-cost alternative to other employee retirement plans.

  • Can I convert a SEP IRA to a Roth IRA?
  • Can I roll a SEP IRA into a Traditional IRA?
  • How can a SEP IRA benefit me?
  • What are the drawbacks?

Retirement planning can be complicated. Here are the answers to some of these common questions.

What is a SEP IRA?

A Simplified Employee Pension Individual Retirement Arrangement, or SEP IRA, is a written, qualified retirement plan that allows an employer to contribute money to a tax-sheltered account on the behalf of employees. As of 2020, employers can contribute any amount up to 25 percent of employee compensation (for compensation up to $285,000 in 2020), but annual contributions cannot exceed $57,000 per employee. Generally, employers must contribute the same percentage of salary for each employee. Employees cannot contribute to their SEP IRA accounts.

The contributions are tax-deferred to employees and tax-deductible for employers. Employees must include any money they take out of their SEP IRA in their current income and might have to pay a 10 percent early withdrawal penalty for money withdrawn before age 59-½. SEP IRA account owners must start making minimum withdrawals by age 72.

Employees can accept SEP IRA contributions and still make full contributions to a Traditional and/or Roth IRA. In 2020, you can contribute up to $6,000 ($7,000 if you are at least 50 years old) to your IRAs.

What Are the Eligibility Requirements?

If an employer offers a SEP IRA, employees are eligible to join if they are at least 21 years old, have worked for the employer for at least three out of the last five years and have received at least $550 a year in compensation.


Have questions about your retirement? Contact Heritage Capital to see how we can help.


Can I Roll a SEP IRA Into a Traditional IRA?

You can indeed roll money from a SEP IRA into a Traditional IRA. These rollovers do not trigger a tax bill as long as you follow the rules. The rollover must be completed within 60 days of withdrawal from the SEP IRA or the money will become taxable. If you’re under age 59-½ and don’t complete the rollover by the deadline, the IRS can charge you a 10 percent penalty for an early withdrawal. A better strategy may be to perform a trustee-to-trustee transfer, which sidesteps any risk of missing the deadline.

SEP IRAs are Traditional accounts, not Roth accounts. Nonetheless, you can roll your SEP IRA into a Roth IRA, but the rollover amount must be included in your taxable income. Naturally, that amount, or base, is not taxable when withdrawn. The rollover proceeds can grow tax-deferred in a Roth IRA and the growth amount usually isn’t taxable when withdrawn unless the withdrawal occurs within five years of the initial contribution.

When making any type of change to any retirement plan, it’s wise to discuss your options with a financial advisor. What might seem like a small decision can have a big impact on your future finances. Even a small mistake can be hard to recover from, especially as you near retirement.

What are the Early Withdrawal Penalties for a SEP IRA?

Contributions to a SEP IRA are tax-deductible to the employer. As is the case with a Traditional IRA, you must pay taxes on all withdrawals, which count as ordinary income taxable at your marginal tax rate. A SEP IRA has the same withdrawal penalties as a Traditional IRA. The most basic SEP IRA distribution rule is that the IRS hits you with a 10 percent penalty on the money you withdraw before age 59-½. The IRS is not completely without compassion, however. You may be able to escape the penalty under certain circumstances.

You may avoid the 10 percent penalty if an early withdrawal is due to death or disability. You can pull up to $10,000 from your SEP IRA to purchase your first home. You can avoid the penalty if you are ill or injured and withdraw money to pay unreimbursed medical bills in excess of 7.5 percent of your adjusted gross income. If you are unemployed, the IRS will forgive the penalty on the money you take out to pay for health insurance premiums. Other exceptions apply for withdrawals you spend on higher education, to pay tax on a qualified retirement plan, a qualified rollover to another IRA and distributions to active-duty reservists.

You can also avoid penalties if you agree to take Substantially Equal Periodic Payments (SEPPs) before age 59-½. The payment size is determined using an IRS-approved method based on your life expectancy. Once you begin taking SEPPs, you must continue for at least five years or age 59-½, whichever comes later.

Again, it’s always wise to discuss your options with a financial advisor before making a decision.

What are the Advantages and Disadvantages of a SEP IRA?

Employers should consider the advantages and disadvantages of adopting a SEP IRA rather than another plan. Here’s a quick breakdown:


SEP IRAs have several advantages:

  1. They’re suitable for small businesses. SEP IRAs can be established for any type of business, including self-employed ones.
  2. They’re flexible. Contributions are discretionary. This gives employers the ability to skip payments during tough years.
  3. They’re tax-deductible. An employer’s contributions to a SEP IRA are tax-deductible. Sole proprietors can claim SEP IRA contributions to themselves.
  4. They’re generally low cost. It can be cheaper to set up and administer a SEP IRA compared to a 401(k).


A SEP IRA has the following disadvantages:

  1. Immediate vesting. Unlike other types of retirement plans, all contributions are immediately vested in the employee’s account. This doesn’t give the employer the flexibility to require a minimum vesting period to help offset the costs of recruiting and training new employees.
  2. Loans not permitted. Unlike 401(k)s and 403(b)s, SEP IRAs do not permit employees to borrow from it.
  3. No minimum hours of work. Other qualified plans can require employees to work up to 1,000 hours to gain one year of service. No such rule exists for a SEP IRA.


Businesses that want a simple and inexpensive retirement plan for employees and owners should consider a SEP IRA. Since all contributions come solely from the employer, a SEP IRA can serve as an attractive recruitment and retention tool.

Discuss your options with a financial advisor. The team at Heritage Capital has been helping people retire with confidence for more than 30 years. We use active investment management and comprehensive financial planning to help you control your risks, so you can have a successful retirement no matter what happens with the markets or your world. To learn more about how we can help you, reach out to me directly to schedule a no-obligation consultation and get the conversation started.



Paul Schatz, President, Heritage Capital