What is the difference between a ROTH, SEP and Traditional IRA?

By Steven Merkel AAA
A:

The Roth IRA was established in 1996 as the newest addition to the individual retirement accounts (IRAs) available to individuals. Its tax treatment differs greatly from most other IRAs. Contribution limits are the same as those for Traditional IRAs, but tax deductions are not available on contributions to Roth IRAs. Unlike all other IRA types, ordinary income tax is not paid on withdrawals. At age 70.5, required minimum distributions (RMDs) are not required.

The simplified employee pension IRA (SEP IRA) allows self-employed individuals to contribute to retirement plans for themselves or their employees without involvement in a complex qualified plan. Many small employers favor SEP plans because of eligibility requirements for contributors, including minimum age of 21, at least three years of employment and a $500 compensation minimum. In addition, an SEP IRA allows employers to skip contributions during years when business is down. Contributions made by employers cannot exceed the lesser of 25% of an employee's compensation, or $46,000 maximum (for 2008). As with the Traditional IRA, withdrawals from SEP IRAs in retirement are taxed as ordinary income.
However, age 70.5 withdrawal requirements apply.

The Traditional IRA is the most common type of IRA. Millions of 401(k) and other company retirement plans are rolled over into Traditional IRAs each year when workers retire or change employers. Unlike the Roth, tax deductions for annual contributions may apply to this type of IRA when income falls below certain limits. Unfortunately, the IRS views those funds as pretax contributions and, when withdrawals are made later in life, the withdrawals are then taxed as ordinary income. At age 70.5, Traditional IRA holders are required to take RMDs.

(For more on this topic, read Which Retirement Plan Is Best? and Individual Retirement Accounts.)

This question was answered by Steven Merkel.

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