Distinguishing Between SEP IRA and Roth IRA: Understanding the Contrasts

Individual retirement accounts, or IRAs for short, come in many different varieties.

The SEP-IRA, and Roth IRA are two options. What are they? Can you have either one or both? – or even both?

A reader actually submitted this question.

I have a question regarding the SEP & Roth IRA. If my employer does not offer any retirement benefits. However, I have a Roth IRA and a Rollover IRA from my previous employment. I contribute regularly to my Roth IRA.

I’d like to contribute as well to SEP and simple IRA. Can I contribute to each plan without any penalties?

What is the best way to contribute above mentioned IRA’s and not get penalized? “What is the best way to make IRA contributions above 50 and avoid penalty?”


Let’s take a deeper look and see if we can solve the mystery of the SEP IRA vs. a Roth IRA.

It is our goal to make you aware of the advantages and disadvantages so that you can make an educated decision.

Today is the best day to open a Roth Account.

It’s never too early to start planning for retirement. To learn more, click on your state.

What is a SEP IRA? How does it work?

SEP IRA is a hybrid plan that combines IRA and pension. The IRA portion is similar to a traditional IRA.

The pension aspect is that, if you have employees and own a company, you can include them in the plan.

SEP IRAs are easier to administer and set up than traditional pension plans like 401(k).

In just three easy steps , you can create a SEP IRA.

  1. Sign a written contract to offer benefits to eligible employees.
  2. Inform employees about the agreement.
  3. Create an IRA for every employee.

This last step needs some explanation. The is not the same for all participants, unlike most pension plans offered by employers.

Each participant, including you, will receive their own IRA. Accounts can be opened with a bank or insurance company.

A SEP IRA can be invested in any asset category that is not prohibited by IRS.

If you are self-employed and do not have any employees, you can set up a SEP IRA just for yourself. This will allow you to add more employees if you choose to do so later.

You can also encourage people to join your company by offering a retirement plan.

SEP IRA General Provisions

A SEP IRA can be compared to a traditional IRA, but on steroids.

  • SEP IRAs can be set up for a partnership, sole proprietorship (S or C), corporation (S or S), or a Limited Liability Company (LLC).
  • Contributions are deductible from taxes in the year they are made.
  • Contributions are only allowed from income earned.
  • Contributions are not required every year.
  • Contributions are due by today’s tax filing date, which is generally April 15 (but includes extensions).
  • The tax deferred accumulation of investment income is a feature.
  • A SEP IRA is not allowed to have a Roth option.
  • Dividends received after age 59 1/2 will be taxed as ordinary income.
  • The ordinary income tax plus 10% penalty is applied to distributions made before the age of 59 1/2.
  • Minimum distributions (RMDs), begin at 72 years of age.

The SEP IRA has a tax benefit which is not widely known, but is very important.

Contributions to SEP IRAs are exempt from FICA (Social Security, Medicare and Medicare Part A) and federal unemployment taxes (FUTA).

For example, 401(k), plans do not offer the same benefit. Your entire income will be taxed by FICA and FUTA, including the 401(k plan contributions.

IMPORTANT SEP IRA participants who are over 50 years old do not receive a catch-up contribution. The maximum contribution of $66,000 is the same regardless of age.

SEP IRA Contribution limits

The annual contribution limits for both traditional and Roth IRAs are fixed. SEP IRAs do not have this limitation.

Your income determines the maximum contribution you can make to a SEP IRA. You can contribute 25% of your net income as a business, up to $66,000 in 2023.

Jacqueline Reeves is the Managing Director at Bell Rock Capital LLC. She says that a SEP IRA structure is a good choice for small businesses, particularly those with a single owner. It allows employers to contribute up to 25 percent of employee pay.

The SEP IRA contributions come before tax. SEP IRAs may allow employees to make contributions similar to a traditional IRA, depending on the plan structure.

The calculation of the contribution is not as simple as taking 25 percent of your net earnings. You must subtract the amount of your contribution before applying 25% to the income.

You’ll be effectively contributing 20% of your income.

Let’s look at an example.

You will receive $305,000 as your total compensation. Multiplig $305,000 by 25 you get $76,250. You can only contribute up to $66,000 per year.

The calculation is actually as follows:

A $305,000 net profit minus the $66,000 contribution equals $239,000 X 25 = $59750

If you want to do a quick calculation for your SEP IRA contribution amount, use 20% of the net income from your business.

If you have a SEP IRA, I recommend that you hire a CPA for your income tax preparation. This is especially true if your employees are part of the plan.

There is still one more complication. You must subtract your contribution to your SEP IRA from your income before you can calculate it. This amount will be reduced by half of your self employment tax.

Yeah, hire a CPA!

What about employee contributions?

You must apply the same percentage to all employees who participate in your SEP IRA. The employer will be the one to make the contributions, not the employees. You will still be able to deduct these contributions.

You must also contribute the same amount to your employees’ accounts if you decide to contribute 25% to your plan. Each employee is also subject to the maximum contribution of $66,000 (for 2023).When contributions are made by an employee, they immediately become their property. There is no vesting requirements.

What is a Roth IRA?

A Roth IRA is very different from a SEP IRA, even though both are IRAs. It is more similar to a traditional IRA with some special provisions.

Roth IRAs are only available to individuals. Roth provisions may be allowed in some retirement plans, but not SEP IRAs. They are typically individual accounts.

The maximum contribution per year is $6,500 or $7,000 for those over 50.

Roth IRAs offer a unique opportunity to save money.

Roth IRA Contribution Limits

Contributions to a retirement plan are not deductible. Once you’ve reached age 59 1/2 and participated in the plan for five years or more, you are able to withdraw money tax-free. This includes both your contributions over the years as well as the income that you have earned in the account.

Roth IRAs offer another tax benefit over other retirement plans. Plan contributions aren’t tax deductible so they can be withdrawn before age 59 1/2 without any income tax consequences. This means that there is no ordinary income taxes and no 10% penalty for early withdrawal.

Important: Roth IRAs offer tax-free withdrawals

Benefits are only applicable to contributions, not income earned in the plan. If you withdraw the income portion of the plan before age 59 1/2, the ordinary income tax and 10% penalty will apply.

The IRS allows you first to withdraw your contributions and then your income only after your contributions are completely removed from the plan.

The Roth IRA is the only IRA that offers this benefit. Some financial advisors suggest using the plan to combine an emergency fund with a retirement plan.

Lyle Solomon is Principal Attorney of Oak View Law Group. You can withdraw money from a Roth IRA at any time, since you’ve already paid tax on the funds invested.

You will have to pay 10% in tax if you withdraw any of your investment earnings, unless you’re older than 59 and 1/2. The Roth IRA is a great emergency fund because it’s so easy to access.

Another benefit of a Roth IRA compared to a SEP IRA, is that you don’t have to begin taking the required minimum distributions until after 72 years of age.”

Investing in a Roth IRA can help you make your retirement plan more effective.

Roth IRAs are a flexible way to save for retirement while still allowing you to achieve the savings that traditional retirement plans do not allow. Learn more by clicking below.

Roth IRA Income Limits

Roth IRA contributions can only be made up to certain income levels. You can contribute to a Roth IRA up to certain income limits for 2023.

  • Married filing joint, or qualified widow(er), Full contribution up to a adjusted gross income up to $218,000, gradually phased out up to $228,000.
  • If you are married and filing separately but lived with your spouse during the year, a reduced contribution is allowed up to a maximum income of $10,000.
  • If you are single, married filing separately, or head of household and did not live together with your spouse during the year, You can deduct up to $138,000 before it is phased out.

Roth IRAs differ from traditional IRAs in the income limits.

If you have an employer-sponsored retirement plan, the income limits on a traditional IRA may limit or even eliminate your ability make a contribution. You can still contribute non-tax deductible funds even if your income exceeds the limits.

The Roth IRA is different. You can still have a Roth IRA through an employer-sponsored program, but you will not be able to make any contributions if you exceed the IRS income limits.

You can keep a Roth IRA along with a plan sponsored by your employer, such as a SEP IRA. The combined contributions of the two plans can’t exceed $66,000.

Roth IRA General Provisions

The provisions of a Roth IRA, aside from the tax implications, are very similar to a conventional IRA.

Roth IRAs = Tax-Free Money!

  • Contributions are tax-deductible for the year received.
  • Contributions are only allowed from income earned.
  • The plan can be invested in any asset class that is not prohibited by IRS.
  • Contributions are not required every year.
  • Contributions are due by April 15, which is the date of tax filing. This does not apply to extensions.
  • The tax deferred accumulation of investment income is a feature.
  • If you have been a Roth participant for five years, then distributions made after age 59 1/2 will be tax-free.
  • If you withdraw the income portion before age 59 1/2, your distributions are subject to income tax and a 10% penalty for early withdrawal.
  • Roth IRAs do not have to make required minimum distributions. You can literally let them continue to grow throughout your life.

Benefits of SEP IRA

  • With a SEP IRA, you can contribute more than with a Roth IRA or a traditional IRA. A traditional or Roth IRA can only accept a maximum contribution of $6,500. The maximum SEP IRA contribution is $66,000.
  • Contributions to a SEP IRA can be deducted for FICA, FUTA, and federal income tax, as well as most state income tax.
  • Employees can be included in the plan.
  • As a sole practitioner you can create an individual plan and then add new employees as they are hired.
  • Each employee may maintain their own IRA within the plan.
  • Set up and maintain a retirement plan easily.
  • A SEP IRA plan is completely self-directed. You can choose any financial institution and invest in any type of asset not prohibited by IRS.
  • Contributions are accepted up to the date of your tax return or tax extension.

Roth IRA Benefits

  • Once you have reached age 59 1/2, and participated in a Roth Plan for at least five consecutive years, withdrawals from a Roth IRA will be tax-free.
  • Accounts can be directed in any direction and invested in almost any investment.
  • Your contributions are not deductible for tax purposes, so you can withdraw them before the age of 59 1/2. The 10% penalty for early withdrawal and ordinary income tax will not be applicable. The 10% early withdrawal penalty will not apply to your investment income.
  • If you have a Roth IRA and an employer-sponsored plan, the combined contributions of all plans must not exceed the IRS limit.
  • Roth IRAs, as the only retirement plans that do not require minimum distributions by age 72, are the only ones. Your plan can be kept for the rest of your life.

SEP IRA disadvantages

  • SEP IRA contribution limits are based on a percent of your net income (effectively 20%). You’ll need to have a business income of at least $30,000.
  • If you are 50 years old or older, there is no provision for catching up.
  • SEP IRAs are subject to the same minimum distribution requirements as other retirement plans. They begin at 72 years old.
  • You must include all eligible employees in the plan if you employ any and make contributions for them. Their contribution percentage must match your contribution percentage.
  • A Roth provision can’t be added to a SEP IRA even though it is an IRA.
  • You’ll need a CPA for your tax return, as the calculation of contributions is complex.

Roth IRA Disadvantages

  • Contributions to the plan do not qualify as tax-deductible contributions.
  • Roth IRA contributions are not allowed if you earn more than the IRS limits.
  • The maximum contribution amount is $6,500 or $7,000 for those over 50.

Can I have both a SEP IRA and a Roth IRA at the same time?

The answer to this question is an unequivocal yes! Although a SEP IRA does not contain a Roth provision you can still have a SEP and create your own Roth IRA.

Your total contributions to the two plans cannot exceed the IRS limit, which is $66,000.

You can then allocate $60,000 into your SEP IRA and $6,000 into a Roth IRA.

In fact, if you have both plans set up at the same, the SEP IRA will provide a significant tax deduction, while the Roth IRA provides tax diversification for retirement.

You can use the Roth IRA to supplement your taxable income. This can help you stay in a lower income tax bracket when you retire, even if your income is higher than expected.

Sallie Mullins Thompson CPA PLLC says that it is feasible to have a SEP IRA as well as a Roth IRA. I believe that everyone should have a Roth IRA, which can be funded in the same way as tax-deferred plans. It also provides a tax free source of income during retirement. It is best to start a Roth IRA as soon as possible, since earnings are tax-deferred. They can also be withdrawn tax-free if all regulations are met.

Plan to redirect $6,000 to a Roth IRA even if you are eligible to contribute the full $66,000 through a SEP IRA.

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