The SEP-IRA: The Retirement Account You Didn't Know You Qualified For

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Here’s something I’ve seen play out dozens of times: Someone in their late forties or early fifties finally gets serious about retirement savings. They’re maxing out the 401(k) at work, maybe contributing to an IRA, feeling pretty good about it. Then they mention, almost as an afterthought, that they also do a little freelance work on the side. Or they drive for DoorDash a few hours a week. Or they sell things on Etsy. Or they pick up occasional consulting projects.

And I ask: “Do you have a SEP-IRA?”

The answer is almost always no. Usually followed by: “A what?”

The SEP-IRA—Simplified Employee Pension IRA—is one of the most powerful and underused retirement accounts available. It’s free to open, takes under fifteen minutes to set up, and allows you to contribute roughly 20% of your net self-employment income, up to a maximum of $72,000 for 2026.

The exact calculation is a little quirky — we’ll get to that — but the important thing is this: even modest side income can unlock a meaningful, tax-advantaged retirement account that most W-2 workers don’t realize they qualify for.

Let me explain why that matters first - because understanding this one concept can change your entire retirement savings strategy.

When it comes to retirement contributions, there are two colors of money. This is the key insight that unlocks everything else.

The first color is employee contributions. This is money you put in from your paycheck—the deferrals you make to a 401(k), the dollars you contribute to an IRA. The IRS limits how much you can contribute as an employee across all your plans combined. For 2026, the 401(k) employee contribution limit is $24,500 (plus $8,000 more if you’re 50 or older, or $11,250 if you’re 60-63). If you have two jobs, each with a 401(k), you can’t exceed that employee limit between them. It’s one pool of money.

The second color is employer contributions. This is money the company puts in for you—matching contributions, profit sharing, that kind of thing. And here’s what matters: employer contributions are limited per plan, not across all your accounts. Each business can contribute its own limit.

Now here’s the magic of the SEP-IRA: it’s 100% employer contributions. There’s no employee contribution component at all. The IRS treats your business as the employer making contributions on your behalf—even if you’re the only person in the business.

What this means in practice: you could max out your 401(k) at your day job ($24,500 as an employee contribution) AND contribute to a SEP-IRA from your side business (up to 25% of that business’s net profit). They don’t interact. They don’t share a limit. They’re completely separate buckets.

You could have a 401(k) at your day job and SEP-IRA contributions from one or more side businesses. The important part is that SEP contributions don’t interact with your employee 401(k) deferrals. The two colors of money don’t mix — even though the total SEP contributions across all businesses still have to stay within the annual limit.

Let’s make this concrete.

Imagine Lisa has a full-time W-2 job where she contributes $20,000 to her employer’s 401(k). That’s her employee money.

On the side, she runs two small businesses:

· a consulting practice that nets $20,000 a year

· an Etsy shop that nets $10,000 a year

Together, her side businesses generate $30,000 of net self-employment income.

Using the SEP-IRA rule of thumb (about 20%), Lisa can contribute roughly $6,000 total to a SEP-IRA for the year.

It doesn’t matter whether that $6,000 comes from one business or is split between the two. The IRS doesn’t give her two SEP limits just because she has two side businesses. She still gets one SEP-IRA contribution limit for herself.

But here’s the key part:

That $6,000 SEP contribution has no impact at all on the $20,000 she put into her 401(k) at work.

The employee money and the employer money don’t mix — even though all the SEP contributions together still have to stay under one annual limit.

One important caveat: If your day job’s 401(k) includes profit-sharing contributions (not just matching, but additional employer contributions based on company profits), or if you have a business that sponsors both a SEP-IRA and a 401(k) with profit-sharing, those employer contributions do share a combined limit—the lesser of 25% of compensation or $72,000 for 2026. But for most people with a regular W-2 job plus side business income, this isn’t an issue. Your day job’s employee contributions and your side business’s SEP contributions are in completely different buckets.

Now let’s talk about the confusing 25% versus 20% math, because this trips people up.

Earlier I said “roughly 20%,” and that word roughly matters.

The IRS technically describes SEP-IRA contributions as “up to 25% of compensation.” That’s accurate — but it’s written for employers. When you’re self-employed, the math gets circular, because your contribution reduces the income it’s based on.

Here’s the problem: Your SEP contribution is a tax deduction. That deduction reduces your net earnings. But your net earnings determine how much you can contribute. So the contribution affects the number it’s based on. It’s a calculation that feeds back on itself.

If you have $50,000 in net profit and try to contribute 25% ($12,500), your adjusted profit drops, which changes your limit, which means $12,500 was too much. The IRS has worksheets in Publication 560 to work through this, and it involves subtracting half your self-employment tax first, then applying an adjusted rate.

The shortcut: for most self-employed people, 20% of your net profit gets you very close to the maximum contribution without the headache. If you want the exact number down to the penny, use a calculator from Fidelity or Schwab, or ask your accountant. But 20% is a solid rule of thumb that keeps you safely within the limit.

The point is: don’t let the math intimidate you. The circular logic is annoying, but the outcome is the same—you can put away a significant chunk of your self-employment profit, tax-deferred, into a retirement account that’s entirely separate from your 401(k).

Let me show you what this looks like with real numbers.

Take Marcus, 48, married, household income around $85,000 from his W-2 job. He also does IT consulting on the side—helping small businesses with their systems, mostly through referrals. Last year he netted about $15,000 from consulting after expenses.

At his day job, Marcus contributes $12,000 to his 401(k). That’s solid—not the max, but meaningful. He figured that was about as much as he could do.

But he also has that $15,000 in side income. Using the 20% shortcut, he can contribute roughly $3,000 to a SEP-IRA. That contribution reduces his taxable income by $3,000 immediately. At a combined 26% marginal rate (22% federal plus 4% state), that’s $780 in tax savings in year one.

Now let’s look at the long game. Say Marcus keeps consulting at roughly the same level for 15 years, contributing $3,000 annually to his SEP-IRA. At a 7% average return, that SEP-IRA grows to approximately $75,000 by the time he’s 63. That’s $75,000 in a tax-deferred account that didn’t exist before—money that didn’t come from his household budget, didn’t compete with his 401(k), and reduced his tax bill every single year along the way.

If Marcus hadn’t opened the SEP-IRA? That $3,000 a year would have been taxed as regular self-employment income. He might have saved some of it, but probably not all, and certainly not in a tax-advantaged account. The SEP-IRA turned what felt like “just extra income” into a genuine wealth-building tool.

And here’s what makes the SEP-IRA even more attractive: it’s genuinely free and genuinely easy.

I timed setting one up once. From clicking “Open a SEP-IRA” to having a funded account: under fifteen minutes.

What you need: your basic personal information (name, Social Security number, address), your business information (an EIN if you’re incorporated, or just your SSN if you’re a sole proprietor), and a bank account for funding. That’s it.

The major brokerage houses—Fidelity, Schwab, Vanguard—all offer SEP-IRAs with no account fees, no setup costs, no minimum balance requirements. You go to their website, select “Open a SEP-IRA,” fill in your information, and you’re done. Once it’s open, it works just like any other investment account. You transfer money in, invest it however you want, and watch it grow.

People are naturally skeptical when something is free. “What’s the catch?” The catch is that the brokerage makes money when you invest—through expense ratios on funds, interest on cash balances, trading activity. They’re betting that if they make it easy to open the account, you’ll invest with them. And they’re usually right. But here’s the thing: you’d pay those same expense ratios wherever you invest. The account being free is a real benefit.

The flexibility is another underrated advantage. You have until your tax filing deadline—including extensions—to make SEP-IRA contributions for the prior year. For most self-employed people filing Schedule C, that’s the normal tax filing deadline — April 15. If you file an extension, you generally have until October 15 to make the contribution.

This means you can wait until you actually know how your business did before deciding how much to contribute. You can look at your final numbers in February or March, run the math, and fund your SEP-IRA accordingly. You can even open the account after the tax year ends and still get the contribution credit for that year—as long as you make the contribution before the deadline.

And unlike some retirement accounts, there’s no requirement to contribute every year. Had a great year? Contribute more. Had a tight year? Contribute nothing. No penalties, no problems. The contribution amount is entirely at your discretion, anywhere from 0% to 25% of net self-employment earnings.

Even small amounts matter more than you think.

Let’s say your side business is genuinely small—maybe $5,000 a year in net profit. That’s a SEP contribution of around $1,000 annually. Doesn’t sound like much.

But $1,000 a year for 20 years, invested at a 7% average return, grows to roughly $44,000. That’s money you wouldn’t have in a tax-advantaged account otherwise. It’s money that reduced your taxable income every year during your peak earning years, when you’re likely in your highest tax bracket. And it’s money that will continue growing tax-deferred until you need it in retirement.

The earlier you start, the more it compounds. Someone who starts a side business at 45 and contributes even modest amounts for 20 years builds something meaningful. The SEP-IRA doesn’t need to be your entire retirement plan—it’s a supplement, an extra layer, a way to capture value from income that would otherwise just flow through your checking account and get spent.

This account is ideal for several specific situations.

It’s perfect for W-2 employees with side income—whether that’s freelance work, consulting, gig economy stuff, or any other 1099 income. It doesn’t matter if it’s $500 or $50,000. If you have self-employment income, you can open a SEP-IRA.

It’s excellent for people starting a business who worry about losing their retirement savings momentum. Maybe you’re thinking about going full-time with a side business eventually, but you’re nervous about giving up the 401(k) at your day job. A SEP-IRA shows you that self-employment doesn’t mean losing access to retirement accounts—it actually opens up new ones.

It’s also great for very small businesses—even just a single owner—who want a simple, no-cost retirement option. The SEP-IRA has essentially no administrative burden compared to setting up a 401(k) for a small business.

Here’s who it might not be for.

If you have employees, a SEP-IRA requires you to contribute the same percentage for all eligible employees that you contribute for yourself. Want to contribute 20% of your own compensation? You must contribute 20% for everyone who qualifies. For some small businesses, this is fine—the owners want to provide good benefits anyway. For others, it makes the SEP prohibitively expensive. If you have employees and want to contribute more for yourself than for them, a Solo 401(k) might be a better fit.

If you want catch-up contributions, the SEP-IRA doesn’t offer them. Unlike 401(k)s and traditional IRAs, there’s no extra contribution room for people 50 and older. If you’re in your fifties and trying to maximize every possible dollar of retirement savings, a Solo 401(k) allows both employee and employer contributions—potentially letting you save more.

If you’re a higher earner with more complex needs, a Solo 401(k) also offers Roth contribution options that SEP-IRAs don’t have. We’ll cover the SEP-IRA versus Solo 401(k) decision in a future play. For now, know that both are good options—the SEP is simpler, the Solo 401(k) is more flexible.

One more thing worth knowing, especially if you’re a higher earner: the pro-rata rule.

If you’re already doing—or planning to do—backdoor Roth IRA conversions, having a SEP-IRA creates a tax complication. The IRS treats all your traditional IRAs, including SEP-IRAs, as one combined pool when you convert money to a Roth. You can’t cherry-pick which dollars to convert. If you have pre-tax money in a SEP-IRA and try to convert after-tax money from a traditional IRA to a Roth, the IRS calculates a ratio across all your IRA accounts, and part of your conversion becomes taxable.

If you don’t know what a backdoor Roth is: don’t worry about this for now. It’s a strategy primarily for higher earners, and we’ll cover it in a future play.

If you are doing backdoor Roths: look into the pro-rata rule before opening a SEP-IRA, or talk to your accountant. There are workarounds—including rolling your SEP-IRA funds into a 401(k) at your day job before doing the conversion—but you need to plan for them.

Here’s the real mistake I see people make: not doing anything at all.

I’ve never heard of someone over-contributing to a SEP-IRA or setting one up wrong. The forms are simple, the limits are clear, and the major brokerages walk you through every step. The mistake people make is avoiding retirement savings for their side income entirely.

They don’t open a SEP-IRA because they only know about 401(k)s—and 401(k)s are expensive and complicated to set up on your own. So they do nothing. They let their side income flow into their checking account, pay taxes on the whole thing, and miss the chance to build something for the future.

The SEP-IRA exists specifically to solve this problem. It’s the retirement account for people who don’t want complexity, don’t want fees, and just want to save tax-advantaged dollars from their self-employment income. It takes fifteen minutes to set up. It costs nothing to maintain. And it opens a door that stays closed for most W-2 employees.

I’ll share something from my own experience: my main business adopted a 401(k) years ago—partly because everyone knows what a 401(k) is, and it felt like the “real” retirement account choice. In retrospect, we were small enough that a SEP-IRA would have been simpler and cheaper. I didn’t know the full array of options. I only knew “401(k)” because that’s what everyone knows.

Later, when I had other side ventures, I discovered the SEP-IRA—and realized how powerful it was. The contributions don’t interact with 401(k) employee deferrals. The setup is trivial. The fees are zero. For small operations, it’s often the better choice.

Don’t make the mistake I made early on. If you’re small—especially if it’s just you—start with a SEP-IRA. You can always graduate to a 401(k) later if you grow. But don’t let the complexity of a 401(k) stop you from doing anything at all.

So where does this leave you?

If you have 1099 income and no SEP-IRA, you probably qualify for one and didn’t know it. Go to Fidelity, Schwab, or Vanguard. Click “Open a SEP-IRA.” Fill in your information. It takes less time than watching an episode of whatever you’re streaming right now. You can contribute until April 15 for last year, or start fresh for this year. Either way, you’re opening a door that most people don’t even know exists.

If you already have a SEP-IRA but you’re not maximizing it, run the numbers. Twenty percent of your net self-employment earnings is a good target. Even if you can’t hit that—even if you can only do $1,000 or $2,000 a year—it’s still money growing tax-deferred in an account that doesn’t compete with anything else you’re doing.

And if you’ve been assuming that retirement savings is limited to whatever your employer offers—that the 401(k) at work is your only option—now you know better. If you have self-employment income of any kind, you have options your W-2-only colleagues don’t. The SEP-IRA is one of the best.