What Is a Self-Directed SEP IRA?

By Rebecca Lake. January 26, 2025 · 10 minute read

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What Is a Self-Directed SEP IRA?

A self-directed Simplified Employee Pension (SEP) IRA is a tax-advantaged retirement savings plan that’s designed for small business owners and self-employed individuals. When a SEP IRA is self-directed, it means that the account owner chooses their own investment options.

A self-directed SEP IRA can be used to invest in a broad range of investments. At the same time, the SEP IRA has the tax benefits of a standard IRA, when certain conditions are met.

Key Points

•   A self-directed SEP IRA allows small business owners and self-employed individuals to choose their own investment options, offering a broad range of investment opportunities.

•   Contributions are made by employers, with limits set at 25% of an employee’s compensation or $69,000 in 2024, and $70,000 in 2025.

•   The account offers tax benefits to employers and self-employed individuals, including tax-deferred growth. Employers, not employees, can deduct contributions.

•   Qualified withdrawals from a self-directed SEP IRA are taxed as ordinary income. Early withdrawals may incur a 10% penalty.

•   Self-directed SEP IRAs allow for a range of investments, including alternative investments and precious metals. Prohibited investments include life insurance and collectibles.

Understanding SEP IRAs

A SEP IRA is one of several types of retirement accounts that are geared toward business owners and self-employed individuals. Here’s a look at how these plans work.

Definition and Eligibility

A SEP IRA allows the self-employed and business owners to make contributions toward their own retirement — and toward the retirement of any employees they may have. SEP IRAs operate like traditional IRAs in terms of how they’re treated for tax purposes.

Here are some key points to know about these retirement accounts:

•   Contributions to a SEP IRA are made by the employer.

•   Employers are not required to make contributions to the plan every year.

•   If an employer decides to contribute to a SEP IRA, they must do so on behalf of all eligible employees.

•   Employees cannot contribute to their SEP IRA.

•   SEP IRA rules allow employers, not employees, to deduct contributions.

•   Employer contributions don’t affect what employees can contribute to any traditional or Roth IRAs they may own.

•   Qualified withdrawals beginning at age 59 ½ are taxed as ordinary income.

•   Withdrawals made before age 59 ½ can trigger a 10% early withdrawal penalty unless an exception is met.

•   SEP IRAs are subject to required minimum distribution (RMD) rules.

Small businesses of any size can open a SEP IRA, including sole proprietorships. If you run a small business alone you could use a SEP IRA to fund your own retirement.

If you’re self-employed and considering a solo 401(k) vs. SEP IRA, a SEP account is easier to start and generally has fewer fees and paperwork requirements. SEP accounts also offer the same annual contribution limits as individual 401(k) plans.

Contribution Limits and Tax Advantages

The IRS determines the annual contribution limits for SEP IRAs and other retirement plans. For 2024, employers can contribute the lesser of:

•   25% of the employee’s compensation

   OR

•   $69,000

For 2025, employers can contribute the lesser of:

•   25% of an employee’s compensation

   OR

•   70,000

Unlike other retirement plans, SEP IRAs do not allow for catch-up contributions. Again, all of the money comes from the employer; employees cannot make elective salary deferrals.

There are certain tax benefits of a SEP IRA for employers and self-employed individuals. Employers can deduct contributions made to employee plans. For the self-employed, there’s a special formula for determining what to deduct. You’ll use your net earnings from self-employment, less deductions for one-half of your self-employment tax and contributions made to the plan.

Employees don’t get a tax deduction and they’ll owe taxes on qualified withdrawals in retirement. However, they receive the benefit of contributions made to their account on their behalf and they still have the option to contribute to a traditional or Roth IRA themselves.

What Makes a SEP IRA Self-Directed?

With a traditional or Roth IRA, or a workplace retirement plan, your plan’s custodian, which is the financial institution that holds your plan’s investments, decides which investment options to offer. Typically, that might mean a mix of mutual funds, index funds, target-date funds, and exchange-traded funds (ETFs).

Self-directed SEP accounts allow you to choose investments yourself, including alternative investments. Your custodian holds your IRA but you decide how much to contribute up to the annual contribution limits, and how to invest that money.

Benefits of a Self-Directed SEP IRA

A self-directed SEP IRA offers several benefits for people who are comfortable choosing investments themselves. You’ll need to follow self-directed SEP IRA rules to set up one of these accounts, but it could be worth considering if you run a business or are self-employed. Advantages of a self-directed SEP IRA include:

Tax-Deferred Growth and Diversification

When you contribute to a SEP IRA self-directed plan, you fund your account with pre-tax dollars. Those contributions may grow in the account on a tax-deferred basis; qualified withdrawals are taxed at ordinary income tax rates in retirement.

You may be able to increase diversification in your portfolio with a self-directed SEP account since you can choose from a broader range of investment vehicles. While mutual funds can offer exposure to a variety of investments in a single basket, a self-directed IRA could allow you to move beyond that by choosing other types of investments.

Potential for Higher Returns

A self-directed retirement account has the potential to generate higher or lower returns than other retirement accounts, depending on what you choose to invest in and how those investments perform. No investment is without risk. It’s important to research investments for a self directed SEP IRA to compare:

•   Historical performance

•   How performance is affected by current market trends

•   Risk profiles

•   Fees

Higher returns often correspond to higher levels of risk, which is something you’ll need to factor into your decision-making. The closer you are to retirement age, the less comfortable you may be with taking on more risk for the possibility of more profits.

Estate Planning Opportunities

Self-directed SEP IRAs have potential as an estate-planning tool if you’re using them to invest in higher-value assets. The tax-advantaged status of a self-directed IRA may help you preserve more of your wealth if you hold investments that generate significant returns.

You can pass that wealth on by naming one or more beneficiaries to your SEP IRA. You could leave your account to an individual, or name a trust as the beneficiary. Choosing a trust to inherit your self directed IRA funds could make sense if you’d like to maintain a degree of control over how the money is managed after you’re gone.

For instance, if you’re caring for a child, sibling, or other relative with special needs, you might establish a special needs trust on their behalf. You could name the trust as beneficiary to your self- directed retirement accounts to ensure that money is set aside and used for their care.

Setting Up a Self-Directed SEP IRA

Establishing a self-directed IRA for yourself requires some research, as you’ll need to decide which IRA custodian to use and how to fund the account. Once your account is open you’ll need to adhere to tax and reporting requirements.

Choosing a Self-Directed IRA Custodian

A self-directed IRA custodian holds your account and has no responsibility for your investment choices or how those investments perform. When deciding which custodian to use, consider:

•   How easy the new account setup process is

•   What fees you’ll pay

•   Customer support and service if you have questions or need help

•   The company’s overall reputation

The SEC warns investors about fraudulent self-directed IRA custodians who may establish fake companies in an effort to take their money. It’s wise to verify whether a custodian is IRS-approved and licensed before opening a self-directed SEP IRA or transferring any money to the account.

Rollover or Transfer Process

Once you’ve found a reputable custodian to work with, you can begin the process of opening and funding your account. The IRS allows you to roll over or transfer funds from an existing retirement account into a self-directed SEP IRA.

•   Trustee-to-trustee transfers allow you to move money directly from your old IRA custodian or trustee to your new one. No money enters your hands directly and no taxes are withheld from the transfer amount.

•   Direct rollovers let you move money from one type of retirement account, such as a solo 401(k), into a different one, like a self-directed SEP IRA. Similar to transfers, no money enters your hands and no taxes are withheld from the rollover amount.

•   Indirect rollovers involve the administrator of your old retirement account sending you a check for the money in the plan, with taxes on the distribution withheld. You then have 60 days to deposit the check into your new self-directed SEP account to avoid a tax penalty.

Of these options, a direct transfer or rollover IRA is the simplest option. Your new custodian should provide you with the paperwork you need to fill out and the information you need to give to your old custodian to initiate a transfer or rollover.

Account Administration and Reporting

Your custodian should handle annual tax filing and reporting requirements with the IRS for you. However, you’re responsible for keeping track of contributions and investment choices, as well as adhering to self-directed SEP IRA rules to maintain the account’s tax-advantaged status.

The IRS outlines the prohibited transactions you must avoid. Failing to follow self-directed IRA rules would cause you to lose their associated tax benefits, including the ability to deduct contributions and tax-deferred growth.

Examples of prohibited transitions include:

•   Borrowing money from your self-directed IRA

•   Selling property to it

•   Using your IRA assets as collateral for a loan

•   Using money from your IRA to buy property for personal use

The rules surrounding self directed IRAs and prohibited transactions are complex. You may benefit from talking to a financial advisor so you know what to avoid when managing your account.

Investment Options in a Self-Directed SEP IRA

What can you invest in with a self directed SEP account? Besides mutual funds, ETFs, stocks, and bonds, there are typically a range of alternative investments, such as:

•   Real estate, including land

•   Precious metals

•   Private equity

•   Private debt

•   Cryptocurrency

•   Tax liens

•   Commodities

•   Mineral rights or land rights

•   Bonds

•   Convertible notes

•   Venture capital

There are, however, a few things you can’t use a self-directed IRA to invest in. The IRS does not allow you to use them to invest in life insurance or anything that’s considered a collectible, such as artwork, antiques, gems, stamps, coins, or fine wines.

The Takeaway

Self-directed SEP IRA accounts may help you build retirement wealth while enjoying some tax advantages along the way. Once you set up an investment account for your SEP IRA, you have the freedom to choose what you’d like to invest in and how you’d like to shape your investment strategy. Just be sure to thoroughly research any investment options you’re considering, and make sure you’re comfortable with the risk involved.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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FAQ

Who can open a self-directed SEP IRA?

Self-directed SEP IRAs are available to small businesses of all sizes, including sole proprietorships. If you’re self-employed, you may choose to invest for retirement through a self- directed SEP IRA instead of a solo 401(k) or SIMPLE IRA.

What are the contribution limits for a self-directed SEP IRA?

The annual contribution limit for a self-directed SEP IRA in 2024 is the lesser of 25% of an employee’s compensation or $69,000. In 2025, the contribution limit is the lesser of 25% or $70,000. If you’re self-employed, you’ll need to use a special formula to determine how much of your contributions you can deduct.

Are there any prohibited investments in a self-directed SEP IRA?

The IRS prohibits transactions that involve “self-dealing,” meaning using your self-directed SEP IRA in a way that gives you a personal financial benefit rather than benefiting the IRA (such as using the IRA to buy a property you already own). You’re also barred from using a self-directed SEP IRA to invest in life insurance and collectibles, such as artwork, antiques, fine wines, or rare coins.


photo credit: iStock/SethCortright
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