The market offers many options for retirement plans, including an Individual Retirement Account (IRA). Roth IRA and SEP IRA accounts are two of the most common types of individual accounts available. While the distribution and tax rules for both are similar, the contribution requirements and annual limits are quite different.
What is the difference between a Roth IRA and a SEP IRA?
Roth IRA:
- Available to individuals
- Allows the account holder to contribute
- Post-tax contributions, so they are not tax-deductible
- Employers must make equal contributions for all employees
- Employee annual contribution limit is 100% of all contributions
- Contributions allowed at any age
- Annual contribution limits are pre-tax
- Qualified distributions are tax-free
- No requirement to file a tax return with the federal tax office for employers
- Employee must be at least 21 years old
- Loans are not allowed for participants
SEP IRA:
- Available to individuals and all sizes of businesses
- Only the employer can contribute
- Post-tax contributions, so they are not tax-deductible
- Employers must make equal contributions for all employees
- Employee annual contribution limit is 100% of all contributions
- Contributions allowed at any age
- Annual contribution limits are pre-tax
- Qualified distributions are tax-free
- No requirement to file a tax return with the federal tax office for employers
- Employee must be at least 21 years old
- Loans are not allowed for participants
Which is right for you?
If you are self-employed, you can open either a Roth IRA or a SEP IRA. However, you need to consider the contribution limits for the Roth IRA. While the SEP IRA allows annual contributions up to $61,000, Roth IRA accounts limit contributions to $6,000 or $7,000, depending on your age.
If you are an employer for others, SEP IRA accounts can provide a retirement plan for your employees. But remember, when setting up SEP IRA accounts for more than one employee, you must make equal contributions for each person.
Due to the annual contribution limits, Roth IRAs may not provide a reliable retirement plan for many people. However, if you already have an employer-sponsored retirement plan, such as a 401(k), establishing a Roth IRA on your own can increase your retirement income and reduce taxes owed later, especially if you are still relatively young.
Conclusion
Roth IRAs and SEP IRAs are not the same. A Roth IRA requires you to contribute, while the SEP IRA places the funding burden on the employer. The low annual contribution limits of the Roth IRA may not be the ideal solution for retirement income, but a SEP IRA might be, especially if the employer is willing to make maximum contributions.
Both types of accounts allow for tax-free transfers to another type of IRA or retirement plan. They both provide tax-free distributions upon reaching age 59 and a half. Additionally, both of these accounts allow for qualified early distributions for unexpected emergency expenses, such as large medical bills or significant tax bills.
Choosing the right account will depend on your personal circumstances. If you are self-employed, you may benefit from the higher contribution limits offered by a SEP IRA, but if you already have an employer-sponsored retirement plan, a Roth IRA can complement your retirement income.
Source:
https://www.thebalancemoney.com/roth-ira-vs-sep-ira-what-s-the-difference-5222207
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