SEP IRA vs Roth IRA
When you run a small business or you’re self-employed, saving for retirement isn’t as straightforward as electing to reroute a portion of your salary to a 401(k). Saving for your future self—and possibly helping any employees you have to save as well—is up to you to establish.
Two common options for putting away some of your income for retirement are simplified employee pension plan (SEP) IRAs and Roth IRAs.
Each can provide you with certain tax advantages, but they don’t work the same way. They have distinct characteristics and rules regarding their contributions, taxation and distributions. Read on to learn more about how these accounts compare to each other and when you may want to consider one or both.
Exploring the differences
While both of these accounts help you save for retirement, SEP IRAs and Roth IRAs don’t operate in the same ways. When you contribute to a SEP, you’re doing so as an employer, even if you’re self-employed. Meanwhile, any individual can contribute to a Roth IRA. Depending on if and how many employees you have, this can mean a difference in the level of set-up and maintenance work required. They also differ in their contribution limits, their tax implications and their distribution rules.
| SEP IRA | Roth IRA | |
|---|---|---|
| Who contributes | You as the employer | You as the account owner |
| Tax deduction for contributions | Yes | No |
| Taxation on withdrawals | Yes | No* |
| Eligibility | Determined by the employer within limits set by the IRS | Must make less than the IRA modified adjusted gross income (MAGI) limits |
| Contribution limit | Lesser of 25% of income | 2023: $6,500; 2024: $7,000 |
| or $66,000 in 2023 or $69,000 in 2024 | You can contribute an additional $1,000 if you’re 50 or older | |
| Penalty on withdrawals before age 59½ | Yes | Only the earnings portion |
| Required minimum distributions | Yes | No |
SEP IRAs have much higher annual contribution limits
The IRS limits how much you can contribute in total to all of your personally held traditional and Roth IRAs to the annual limit, with the exception of rollovers.
With a SEP IRA, you can contribute up to 25% of your salary (20% of net earnings from self-employment if you are a sole proprietor) up to $66,000 in 2023 or $69,000 in 2024. You must contribute the same percentage to all eligible participating employees, as well.
If you have a SEP IRA, you’re taxed later
You fund Roth IRAs with money you’ve already paid income taxes on. But even though you pay taxes on them in the year you contribute, you enjoy tax-free growth of earnings and tax-free qualified distributions. The withdrawal rules to keep the earnings tax- and penalty-free generally include being at least age 59½ (or meeting certain exceptions if you’re withdrawing early) and having owned the account for at least five years.
With a SEP IRA, your contributions are, instead, tax-deferred. This means you don’t pay taxes when you put the money into it or while the earnings are growing. But your withdrawals are taxable when you take them. That’s regardless of your age when you withdraw, but as long as you’re at least 59½, you typically won’t pay a penalty.
If you have a SEP IRA, you have to take RMDs
Certain retirement accounts have required minimum distributions (RMDs). You have to take a certain amount of money—as determined by IRS worksheets and calculation tables—out of your account by April 1 of the year after you turn 73 and every year after.
- SEP IRAs have RMDs. Remember, the taxes on these are deferred (you don’t pay them until you withdraw your money), and the IRS wants to be able to take its cut at some point.
- Roth IRAs are not subject to RMDs. So, if you don’t need the money in retirement, you can leave it in your account indefinitely. However, your beneficiary will be subject to specific withdrawal requirements.
Is a SEP better than a Roth IRA?
Neither account is fundamentally better than the other because they serve different purposes. It depends on your situation. SEP IRAs have higher contribution limits that allow you to save more, and you may benefit from an immediate tax deduction. Roth IRAs grow tax-free, and you don’t have to worry about RMDs.
Here are some scenarios to help you decide
- A SEP IRA may be a better choice if you have a high income. A Roth IRA may not allow you to save enough to replace your income in retirement, and you may not qualify anyway. Having a higher income also likely means you’re in a higher tax bracket, so the immediate tax deduction may be more valuable.
- Roth IRAs are a good way to grow a tax-free nest egg as long as you or your spouse have earned income and you make under the IRS income limits. Although they have a low annual contribution limit, you can use them alongside a workplace plan.
Should you contribute to both a SEP & Roth IRA?
You have the option to contribute to both a SEP IRA and a Roth IRA. You could offer a SEP IRA as a small business owner or have one as a self-employed person and also put money in a Roth IRA. This can be a tax-wise move and a particularly strong strategy if you’re able to max out annual contributions to your Roth IRA because you’ll have your completely separate SEP IRA to keep contributing to.
Rolling money over from a SEP-IRA account into a Roth IRA account?
Is it possible?
Based on the rollover chart, it looks like it is possible: https://www.irs.gov/pub/irs-tege/rollover_chart.pdf
Some more questions?
TODO
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What is the process to rollover money from SEP IRA account into a Roth IRA account?
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If the owner has the spouse as additional employee, how much should/can the contributions be for the owner and for the spouse?
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If 25% of the income is less than $69,000, how much can the owner put into the SEP account? $69K or 25% of the money that the owner is taking out of the business?
- Look at this: https://www.journalofaccountancy.com/news/2024/feb/helping-sole-proprietors-choose-between-a-solo-401-k-and-a-sep-ira.html
- It looks like the net profit for the year needs to be $345,000 to be able to put $69,000 in the SEP IRA account.
- According to this article, it looks like Solo-401K accounts allow the most contributions into the retirement accounts.
https://www.bankrate.com/retirement/sep-ira/#how-to-invest-with-a-sep-ira