Can an employee contribute to a SEP IRA?

A Simplified Employee Pension (SEP) is a type of IRA that employers can establish for the benefit of themselves and their employees. If you are self-employed, you can also open a SEP IRA account to save for retirement. Although SEP IRAs and traditional IRAs share certain similarities, there are different rules on who can contribute to each type of IRA.

An employee cannot contribute to a SEP IRA; only the employer can contribute to a SEP IRA. The IRS requires that only employers can contribute to SEP IRAs on behalf of employees. The employer can contribute to a SEP IRA the lesser of $61,000 in 2022, or $58,000 in 2021, or 25% of employee’s compensation. Employers must make an equal percentage contribution to each employee’s SEP IRA

How SEP IRA works

If you own a sole proprietorship, partnership, or corporation, you may be eligible to establish a SEP IRA for your business. The IRS requires employers to contribute to the SEP IRAs of all employees working in the business, as long as they meet the eligibility rules.

The employer must contribute an equal amount to every eligible employee’s SEP IRA on a percentage-of-salary basis. For example, if the business owner contributes 15% of his/her SEP IRA, he must contribute 15% of salary to each eligible employee’s SEP IRA. As long as the percentage-of-salary basis is maintained, businesses facing a cash crunch may decide not to fund any of the employee’s SEP IRAs.

Generally, if an employer is unable to contribute to the employee's SEP IRAs, neither the employer nor the employees are allowed to contribute to their SEP IRAs.

Who can participate in a SEP IRA?

Employees must meet eligibility rules to enroll in a SEP IRA. For an employee to participate in the employer’s SEP IRA, they must be at least 21 years or older. He/she must have served in the employer’s business for at least 3 of the previous 5 years. Also, the employee must have earned a minimum compensation of $650 in 2021 and 2022, and a minimum of $600 in the period from 2016 to 2022 from the business.

The IRS allows employers to be less restrictive in their eligibility rules, and employees who do not meet the above requirements may still be eligible to contribute to SEP IRAs. However, where the employer chooses to be restrictive, the rules must apply to all employees and the employer.

Employers may also exclude certain employees from enrolling in the SEP IRA, even if they meet the eligibility requirements. For example, immigrant workers without papers and union workers covered in a union agreement that bargains retirement benefits can be excluded from participating in the SEP IRA.

SEP IRA Contribution Limits

Contributions made to a SEP IRA cannot exceed $61,000 for 2022 ($58,000 for 2021) or 25% of employee’s compensation, whichever is lesser.  

The compensation limit that can be used to calculate this contribution is $305,000 in 2022 or $290,000 in 2021. Since a SEP IRA is funded with employer contributions only, employees above 50 cannot make catch-up contributions to the account. The contributions must be paid in cash, not in property.

A SEP IRA has a higher contribution limit than a traditional IRA. However, contributions to a SEP IRA and traditional IRA must be made before the tax filing deadline.

Employer contributions to a SEP IRA do not have a vesting schedule, and this means that employees get to own the contributions immediately after they are deposited in the SEP IRA.

Why do you invest SEP IRA funds?

Once you have opened a SEP IRA with your employer, you must pick the preferred investments from a predetermined list provided by the employer. Generally, employers may allow participants to invest in stocks, bonds, and mutual funds. You can choose an investment profile depending on your age, expected retirement age, and the amount of risk you can tolerate.

If you have less time remaining before you attain the required retirement age, you can adopt a conservative investment approach. You can invest in bond funds and index funds for bonds. However, if you have a long time until retirement, and you can accommodate high risks, you should invest in stocks and stock index funds.

If you have a SEP IRA, can you contribute to a Roth IRA?

You can have a SEP IRA with your employer and still make contributions to your Roth IRA. Generally, the SEP IRA contributions you receive from your employer do not affect the amount you can contribute to a Roth IRA. This means that you can receive employer contributions in SEP IRA up to $61,000 in 2022, and still contribute up to $6,000 to a Roth IRA, or $7,000 if you are above 50.