Key Differences Of SEP IRA And Roth IRA
Eligibility and Contributions:
- SEP IRA: Primarily for self-employed individuals or small business owners. Contributions are made by the employer only.
- Roth IRA: Available to anyone with earned income within certain income limits. Contributions are made by the individual with post-tax dollars.
- SEP IRA: Up to 25% of the employee’s compensation or a maximum of $61,000 for 2023. In 2024 it increases to $69,000.
- Roth IRA: Up to $6,500 ($7,500 if age 50 or older) for 2023. In 2024 those numbers increase to $7,000 and $8,000.
- SEP IRA: Contributions are tax-deductible, but withdrawals during retirement are taxed.
- Roth IRA: Contributions are made with after-tax dollars, but withdrawals during retirement are tax-free.
- SEP IRA: Penalties for withdrawals before age 59½. Required Minimum Distributions (RMDs) start at age 73.
- Roth IRA: Contributions can be withdrawn any time tax-free and penalty-free. No RMDs required.
Related Reading: When can I withdraw from Roth IRA
- Self-Employed Individual: A freelancer might prefer a SEP IRA for its higher contribution limits and tax-deductible contributions.
- Young Professional: An individual in their early career might choose a Roth IRA to benefit from tax-free growth and withdrawals in retirement.
Comparison of SEP IRA and Roth IRA
|Self-employed, small business owners
|Individuals within income limits
|Employer only, up to 25% of compensation
|Individual, with post-tax income
|Up to $69,000 (2024)
|Up to $7,000 ($8,000 if 50 or older) in 2024
|Penalties before age 59½
|Contributions can be withdrawn any time
|Start at age 73
Choosing between a SEP IRA and a Roth IRA depends on individual circumstances like employment status, income, and retirement goals. SEP IRAs are suitable for self-employed individuals or small business owners, offering higher contribution limits and tax-deductible contributions. Roth IRAs are ideal for those who expect to be in a higher tax bracket at retirement, offering tax-free growth and withdrawals. Understanding these differences is crucial for making an informed decision.
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Frequently Asked Questions
Does a SEP IRA reduce self-employment tax?
Contributing to your employees’ SEP IRA can lead to tax benefits for self-employed individuals and small business owners. For the former, both income tax and self-employment tax can be reduced; for the latter, income tax is lower, and contributions are exempt from Medicare and Social Security taxes.
At what age does a Roth IRA not make sense?
It’s a good idea to consider opening a Roth IRA regardless of your age. If you decide to open one later in life, you can avoid the early withdrawal penalty if you reach 59½ years old. Just remember that regardless of when you open the account, you’ll need to wait five years before being able to withdraw the earnings without paying taxes.
Can I transfer money from a SEP IRA to a traditional IRA?
Yes. The main distinction is that an employer can contribute to a SEP IRA, whereas only individuals can contribute to a traditional IRA. Therefore, you can merge a SEP IRA with a traditional IRA without consequences other than determining who can contribute.