SEP IRA vs Roth IRA

SEP IRA Definition

A Simplified Employee Pension (SEP) IRA is a type of retirement plan for self-employed individuals and small businesses wishing to set up an employee retirement plan. Business owners who have fewer than 100 employees who earned $5,000 or more in compensation during the prior year are eligible to open SEP IRAs. These accounts are funded by an employer on behalf of the employee. So if you have an SEP IRA account, some of your salary is automatically deducted from your paycheck and deposited into this retirement plan. In 2021, the maximum contribution limit is $58,000. The contributions are considered “employer contributions.” This means that any contribution you make isn’t taxed at the time of deposit, unlike if you were to contribute with your own money. Keep in mind that you are responsible for any SEP IRA fees. This means that if you choose to open an SEP IRA as an employee, you should consider how much it will cost and whether your employer will pay those fees. In addition, the IRS does not permit additional catch-up contributions for SEP IRAs. However, the contribution limit for SEP IRAs is still significantly higher than a Roth IRA. For employers, they must match SEP IRA contributions made by employees up to 25% of employee compensation.

Roth IRA Definition

A Roth IRA is a type of retirement account that allows qualified individuals to make tax-free investments. Contributions to a Roth IRA are made with after-tax dollars—you don’t receive any tax deductions for contributions as you would with a traditional IRA or SEP IRA. However, qualified distributions (money taken out) are tax-free. An important point to remember is that you cannot contribute to both a SEP IRA and Roth IRA in the same year, so you must choose between them if eligible. In 2021, the account contribution limit is $6,000 for employees who are 50 or younger. For employees who are over 50, Roth IRAs allow additional catch-up contributions up to $1,000. To be eligible for a Roth IRA, your Modified Adjusted Gross Income (MAGI) must be under the income limit. The maximum Modified Adjusted Gross Income is $140,000 if you are single and $208,000 if you are married and filing jointly. In other words, if you earn more than the limit, you are not eligible to contribute a Roth IRA.

Key Differences Between SEP IRA and Roth IRA

There are key differences between SEP IRAs and Roth IRAs:

Business Size

One of the major differences between both accounts is that SEP IRAs are specifically for businesses with fewer than 100 employees. Roth IRA eligibility requirements do not take into account a business’s size. The income limit applies to individuals, regardless of their profession.

Eligibility Requirement

SEP IRA eligibility is determined by your employer, meaning you must have fewer than 100 employees who earned $5,000 in compensation during the prior year. Roth IRAs require Modified Adjusted Gross Income (MAGI) below a certain limit and whether or not you participate in an employer-sponsored retirement plan.

Contributor

You can contribute SEP IRA funds as an employer on behalf of employees. Contributions to a Roth IRA must be made by the individual account holders themselves.

Contribution Limits

SEP IRAs allow for larger contributions than Roth IRA accounts with its maximum contribution limit of $58,000 per year. Roth IRAs only allow for up to $6,000 in 2021 ($7,000 if you are over 50).

Catch – Up Contributions

SEP IRAs do not permit catch-up contributions for anyone 50 or older, but the SEP IRA employer contribution is up to 25% of contributions made by employees. Roth IRAs allow catch-up contributions for those over 50.

Tax Consequences

SEP IRA contributions are not taxed at time of deposit unlike Roth IRA accounts which are considered after-tax money. SEP IRA contributions are also not subject to tax at withdrawal.

SEP IRA Pros and Cons

Pros – This plan is great for small business owners who want to limit the administrative work of setting up a retirement account. – The account can be set up quickly and allow employers to deduct contributions from payroll. – SEP IRAs are more beneficial for younger employees because the contribution limits are so much higher. – If your employer participates, SEP IRAs have an employer match of up to 25% on employee contributions. Cons – SEP IRAs only allow catch-up contributions for employees over 50. – Account contributions are not tax-deductible like they are for Roth IRAs. – The plan only allows for employee deferral and employer contributions, while Roth IRAs do not restrict any type of contribution. – Income limits are based on lower salaries of under $5,000. This retirement account is not beneficial for employees who earn a higher salary.

Roth IRA Pros and Cons

Pros – The plan is tax-free. You can withdraw contributions and earnings at any age, for any reason with no taxes due. – As long as you have a Roth IRA open for at least five years, all early withdrawals are not subject to any penalties. – Whether you are self-employed or work for a business, you can contribute to Roth IRAs. Cons – Roth IRAs have income limits that could affect eligibility to contribute, unlike SEP IRAs which only require fewer than 100 employees and compensation under $5,000. – Roth IRAs are limited to $6,000 per year ($7,000 for those over 50) while SEP IRAs allow up to 25% of an employer’s contribution. – The accounts can only be set up on your own, so it requires more work than SEP IRA plans.

Which One Is Right for You?

For self-employed individuals, SEP IRAs may be right for you. This type of retirement account can help bridge the gap between income and account contributions, which makes SEP IRAs especially valuable for high-income earners. If you are an employee with a business that has fewer than 100 employees, SEP IRAs offer additional advantages over Roth IRAs, such as the employer contribution. In addition, SEP IRAs also allow self-employed individuals to contribute based on net income rather than Modified Adjusted Gross Income (MAGI). If you are an employee with a business that employs more than 100 employees or want to save money tax-free for retirement, then a Roth IRA account may be right for you.

Final Thoughts

Whether you choose Roth or SEP IRA accounts, either plan has its advantages and disadvantages. Deciding which one is right for you depends on your personal preferences and financial situation, so you should consider all of the pros and cons before making a decision. If Roth IRAs are the best account option for you, then it’s time to open an account and start saving. These retirement plans allow you to invest your money, so be sure to learn how Roth IRAs work before making any decisions. If SEP IRA accounts are the best way for you to save, then you may contact your company’s human resources department to open the account with the help of an advisor. It is also advisable to ask questions regarding Roth or SEP IRAs and compare Roth IRA vs Roth 401(k) plans to decide which one is right for you.

A Simplified Employee Pension IRA is a type of retirement plan for employers and employees. This plan can be set up quickly and allow employers to deduct contributions straight from payroll.
SEP IRAs allow business owners and self-employed individuals to contribute a certain percentage of their earnings on a tax-deferred basis, up to $58,000 in 2021. Employee contributions are tax-deductible and employer contributions are deductible as a business expense. Roth IRA plans, however, can only be funded by employee contributions and not employer accounts.
Roth IRAs are types of individual retirement accounts that the government allows you to contribute to. Here, the plans allow your earnings to grow tax-free, meaning there are no taxes on contributions or account earnings.
Roth IRAs work more like traditional savings accounts. Here, you can contribute a set amount for yourself and your spouse on a tax-deferred basis up to $6,000 per year ($7,000 if you're 50 or older).
No, Roth IRAs cannot be SEP IRAs because Roth IRAs do not have an employer contribution. Roth IRA plans are funded through employee contributions and not through employer-sponsored accounts.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.