How to Calculate SEP IRA Contributions: Formula & Example

What a SEP IRA contribution is

A SEP IRA lets a self-employed person put pre-tax money aside for retirement. The contribution is deductible, so it lowers your taxable income in the year you make it, and the money grows tax-deferred until you withdraw it. The catch is that the amount you can put in is not simply a percentage of your profit — the self-employment tax adjustment comes first, and that adjustment is what turns the headline 25% rate into a 20% effective rate. Every figure here is checked against the SEP IRA calculator.

The SEP IRA formula

The formula in one line: max contribution = 20% × (net business profit − half your self-employment tax), capped at $72,000 for 2026. The 20% is the effective rate for a self-employed person who elects the 25% rate; an employer contributing for an employee uses the full 25% of the employee’s compensation instead. Tax saved is the contribution × your marginal tax rate.

Step 1: Start with your net business profit

Start with your net business profit for the year — the figure on your Schedule C after business expenses, before any retirement contribution. This guide uses $100,000. Do not use gross receipts: rent, supplies, software, and every other business expense come off first, because the SEP IRA is calculated on profit, not revenue.

Step 2: Work out your self-employment tax and take half of it

Work out your self-employment tax on that profit. Self-employment wages are 92.35% of net profit, so on $100,000 they are $92,350. The tax is 12.4% Social Security on wages up to the $184,500 wage base for 2026, plus 2.9% Medicare on all of it, plus an extra 0.9% Medicare on wages above $200,000. Here that is 12.4% of $92,350 ($11,451.40) plus 2.9% of $92,350 ($2,678.15), for a total of $14,129.55. Take half of it: $7,064.78. The Social Security wage base caps the 12.4% part of the tax at $184,500 of self-employment wages for 2026.

Step 3: Subtract half the SE tax to get net adjusted income

Subtract half the self-employment tax from your net profit. That is $100,000 − $7,064.78 = $92,935.23 of net adjusted self-employment income. This is the income the contribution rate applies to — not the original $100,000. The reason is that the contribution itself reduces the income it is calculated on, and the half-SE-tax subtraction is the first half of that adjustment.

Step 4: Apply the 20% effective rate (25% of compensation)

Apply the effective rate to your net adjusted income. The elected rate is 25% of compensation, but for a self-employed person the contribution reduces their own compensation, so the effective rate is 25% ÷ (1 + 25%) = 20%. Here, 20% × $92,935.23 is $18,587.05. The 20% figure is not a different limit — it is what the 25%-of-compensation rate works out to once the contribution is subtracted from your own income.

Step 5: Cap the contribution at $72,000 for 2026

Cap the result at $72,000, the SEP IRA limit for 2026. The $18,587.05 from step 4 is well under the cap, so it stands. On a $500,000 profit, the uncapped contribution would be $96,137.55, so the cap bites and the contribution is $72,000.00. The cap is what stops very high earners from sheltering an unlimited amount.

Step 6: Multiply by your marginal rate for the tax saved

Multiply the contribution by your marginal tax rate to find the tax it saves. At a 22% marginal rate, $18,587.05 × 22% is $4,089.15 of tax saved. That is the immediate payoff of the contribution: the money goes into your retirement account instead of to the IRS. At 12% the same contribution saves $2,230.45; at 32% it saves $5,947.85.

Worked example

Put the six steps together for a sole proprietor with $100,000 of net business profit, a 25% elected rate, and a 22% marginal rate. Profit $100,000.00; self-employment tax $14,129.55; half the SE tax $7,064.78; net adjusted income $92,935.23; contribution at 20% $18,587.05; tax saved $4,089.15. Left to grow at 7% a year for 20 years, that one year’s contribution becomes $761,985.06, assuming the same contribution is made every year. Note that totals are computed from unrounded values, so rounded parts may differ by a cent from their rounded sum.

The employee version

An employer contributing for an employee skips the self-employment tax adjustment entirely and uses the full 25% of compensation. On $80,000 of W-2 compensation, the contribution is 25% × $80,000 = $20,000.00. At a 22% marginal rate the tax saved is $4,400.00, and the same contribution every year at 7% for 20 years grows to $819,909.85. The same $72,000 cap applies, and compensation itself is capped at $360,000 for 2026, so the largest possible employee contribution is 25% of $360,000, capped at $72,000.

Working backwards

The calculation also runs in reverse. For a contribution of exactly $25,000.00, a sole proprietor at the 25% rate needs net business profit of $134,502.28. One dollar less, $134,501.28, gives a contribution of $24,999.81. And for the $18,587.05 contribution to grow to at least $1,000,000 at 7%, the smallest term is 24 years, giving a future value of $1,081,332.40; at 23 years the future value is $993,219.96, just short of the million.

What the calculation leaves out

Four things this calculation leaves out. First, an employer must contribute the same percentage for every eligible employee — there is no picking favourites, so a generous rate for yourself is a generous rate for your staff too. Second, a SEP IRA can sit alongside a 401(k) or IRA, but the combined limits still apply, so the SEP does not stack on top of the others without limit. Third, contributions for a tax year can be made up to the tax-filing deadline, including extensions, so the calculation is not due on December 31. Fourth, this is federal only — state treatment varies, and some states do not follow the federal deduction. For the full limits table, see the 2026 retirement contribution limits page.

What to do next

Run your own numbers through the SEP IRA calculator: try your profit, your elected rate, and your marginal rate, then work backwards to see what profit your contribution goal needs.