If you’re self-employed or a business owner, you often have to figure out your own retirement plan without an employer-sponsored account.
Roth IRAs and SEP IRAs are both feasible options, but there are key differences between the two that can make one better suited for your needs than another.
If you’re debating the benefits of a SEP IRA vs. Roth IRA, there are several things to keep in mind, including the rules and contribution limits of each type of retirement account.
What Is a Roth IRA?
A Roth IRA is a tax-advantaged individual retirement account that is funded with after-tax dollars. Money in your account will grow tax-free and is not taxed when you take a qualified distribution or withdrawal.
When you open a standard Roth IRA, you can invest in a variety of common assets, including stocks, bonds, CDs, and mutual funds. If you want to invest in alternative assets, such as real estate or commodities, you can opt for a self-directed Roth IRA.
Roth IRA Rules and Contribution Limits
To be eligible for a Roth IRA, you must have a taxable income and a modified adjusted gross income (AGI) that is below the limits set by the IRS (see table below).
Roth IRAs, like traditional IRAs, have an annual contribution limit of $6,500. If you’re 50 years of age or older, you can also make a $1,000 catch-up contribution annually. Your tax status and adjusted adjusted gross income (AGI) further influence Roth IRA contributions.
You can withdraw contributions penalty-free from a Roth IRA account at any time as long as the account has been open for at least five years. Withdrawals from earnings are penalized if they are taken before the age of 59 ½; after that, they are penalty-free.
Roth IRA contribution limits
| Tax filing status and income | Contribution limit |
| Married and filing jointly with a modified AGI less than $218,000 | Up to $6,500 ($7,500 if you’re 50 years of age or older). |
| Married filing jointly with a modified AGI of $218,000 or more but less than $228,000. | Reduced amount. |
| Married filing jointly with a modified AGI of $228,000 or more. | Zero. |
| Married filing separately, lived with your spouse at any time during the tax year, and have a modified AGI less than $10,000 | Reduced amount. |
| Married filing separately, lived with your spouse at any time during the tax year, and have a modified AGI of $10,000 or more. | Zero. |
| Single, head of household or married filing separately, did not live with your spouse, and have a modified AGI less than $138,000. | $6,500 ($7,500 if you’re 50 or older). |
| Single, head of household or married filing separately, did not live with your spouse, and have a modified AGI of $138,000 or more but less than $153,000. | Reduced amount. |
| Single, head of household or married filing separately, did not live with your spouse, and have a modified AGI of $153,000 or more. | Zero. |
What Is a SEP IRA?
A Simplified Employee Pension Plan (SEP) IRA is a retirement account designed for business owners as well as the self-employed, freelancers, contract workers, and sole proprietors. It is structured as a traditional IRA and thus follows the corresponding IRS rules and regulations.
Like a Roth IRA, you can invest in common assets with a standard SEP IRA. A self-directed designation will allow you to invest in alternative assets.
SEP IRA Rules and Contribution Limits
To be eligible for a SEP IRA, you must be a business owner or self-employed individual, such as a freelancer, gig worker, or independent contractor. You can contribute to your account, but you can also fund SEP IRAs for your employees.
SEP IRAs have higher contribution limits than Roth IRAs. You can contribute 25% of your adjusted net earnings or up to $66,000, whichever is lesser.
Because SEP IRAs follow traditional IRA rules, withdrawals are penalty-free as long as you are 59 ½ or older. Withdrawals before that age are subject to a 10% penalty tax.
Key Differences Between SEP IRA and Roth IRA
| Feature | Roth IRA | SEP IRA |
| Tax structure | Funded with after-tax dollars, tax-free withdrawals. | Funded with before-tax dollars, taxed withdrawals based on your tax bracket. |
| Contribution limits | $6,500 annually ($7,500 if you are 50 or older). | The lesser of $66,000 or 25% of your adjusted net earnings. |
| Eligibility requirements | Must have an earned income and an AGI that is less than the IRS Roth contribution limits for your tax-filing status. | Must be a business owner or self-employed. |
| Withdrawal requirements | Qualified distributions are not taxed. Can withdraw from contributions at any time as long as the account is open for 5 or more years. Withdrawals from earnings are penalty-free after age 59 ½. | Qualified distributions are taxed based on your income bracket at the time. Withdrawals are penalty-free once you reach 59 ½. Withdrawals before that are subject to a 10% penalty. |
Pros and Cons of SEP IRA vs. Roth IRA
If you’re considering a SEP IRA or Roth IRA, it’s important to evaluate the features, benefits, and drawbacks of both.
Pros and Cons of a Roth IRA
| Pros | Cons |
| Tax-free withdrawals. | Contribution limits are lower than those available with a SEP IRA. |
| Withdraw from contributions at any time as long as the account is open for at least 5 years. | Can’t open and fund employee accounts. |
| No required distributions. | Can’t deduct contributions. |
Pros and Cons of SEP IRA
| Pros | Cons |
| Higher contribution limit when compared to Roth and traditional IRAs. | Withdrawals are taxed. |
| Can deduct contributions. | Can’t take penalty-free withdrawals from contributions until 59 ½. |
| Can open and fund your own SEP IRA as well as one for employees. | Must take required minimum distributions starting at age 72, or 73 if you turned 72 before December 31, 2022. |
Can I Have A SEP and Roth IRA?
You can have both a SEP IRA and Roth IRA, but it’s important to be mindful of both sets of contribution limits to avoid penalties. However, unlike traditional IRAs and Roth IRAs, which share a single contribution limit, SEP IRAs and Roth IRAs don’t share a single contribution limit. Still, it’s important to be mindful of the contribution limits of each to avoid penalties.
Which IRA Is Right for Me?
If you expect to be in a higher tax bracket when it comes time to retire, a Roth IRA can help you avoid higher taxation, as contributions are made with after-tax dollars and not taxed upon withdrawal. And, unlike traditional and SEP IRAs, you are not required to take required minimum distributions.
Another benefit of Roth IRAs is that you can withdraw from contributions before 59 ½ as long as your account is old enough. The same is not true of SEP IRAs, which penalize all withdrawals taken before 59 ½.
If you’re a self-employed individual or business owner, a SEP IRA can be a good fit, especially if you want to contribute more annually than is allowed under Roth IRA rules. Another perk of this plan is that contributions can be deducted for the tax year they were made.
FAQs
Who Is a SEP IRA Designed For?
A SEP IRA is designed for business owners, including those that own LLCs, S-corps, and C-corps. SEP IRAs are also a good fit for sole proprietors, freelancers, gig workers, and contractors.
Because a business owner can open a SEP IRA account for themselves as well as their employees, they are a good option for business owners looking for a simple, easy-to-administer retirement plan for their staff.
Can I Withdraw Money from a SEP IRA Without Penalty?
You can withdraw money from a SEP IRA without penalty if you are 59 ½ or older. Withdrawals before that age will be subject to a 10% penalty tax.
How Much Should I Put Into a SEP or Roth IRA Each Month?
You should put enough into your SEP or Roth IRA account to support your retirement goals and budget. Also, keep in mind that each account has a contribution limit, so your monthly contribution should be structured to avoid exceeding the IRS limit.
If you’re not sure how much you need to contribute to reach your retirement goals, speak to a financial advisor who can help you look at your finances and how they relate to your future.
