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.

RELATED FAQS

  1. Can I purchase mutual funds for my IRA?

    Learn how to invest your IRA assets in mutual funds. Discover a few of the different types of mutual funds available for ...
  2. How do Pay As You Go pension plans work?

    Learn how pay-as-you-go pension plans are different than fully funded pension plans and why some government plans are running ...
  3. Who is eligible for a Teacher Retirement?

    Learn about the retirement option, the Teacher Retirement System, offered to teachers and other public school employees, ...
  4. What are the main benefits of a Locked-in Retirement Account (LIRA)?

    Read about the main benefits you can realize from transferring your Canadian pension funds into a Locked-in Retirement Account, ...
RELATED TERMS
  1. Elder Care

    Elder care, sometimes called elderly care, refers to services ...
  2. Gold IRA

    Definition of Gold IRA
  3. Eligible Transfer

    An IRS-allowed movement of assets into or out of an individual ...
  4. Death Master File (DMF)

    Also known as Social Security Death Index. A list of people whose ...
  5. Leveraged Benefits

    The use – by a business owner or professional practitioner – ...
  6. Peri-Retirement

    A term for the period of time leading up to actual retirement. ...
Related Articles
  1. The Best Way To Build Your Retirement ...
    Retirement

    The Best Way To Build Your Retirement ...

  2. Want To Know How To Save For Retirement? ...
    Retirement

    Want To Know How To Save For Retirement? ...

  3. Could Being A Landlord Pay For Your ...
    Retirement

    Could Being A Landlord Pay For Your ...

  4. Smart Retirement Strategies Even Without ...
    Retirement

    Smart Retirement Strategies Even Without ...

  5. 8 Essential Tips For Retirement Saving
    Investing Basics

    8 Essential Tips For Retirement Saving

Trading Center