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SEP IRA

  1. Established and funded by a business (including a sole proprietorship)
  2. Must be established and funded by the employer's tax filing deadline, including extensions
  3. Contribution limit is 25% of compensation or $45,000, whichever is less. For a sole proprietor, the contribution limit is 20% of the sole proprietor's adjusted net business income
  4. Contribution within the limits is deductible on the employer's business tax return
  5. Earnings grow on a tax-deferred basis
  6. Distributions will be treated as ordinary income and subject to income tax and early withdrawal penalties if you are under age 59.5 when the withdrawal is made, unless you are eligible for an exception

Roth IRA

  1. Established and funded by the individual taxpayer
  2. Must be established and funded by individual taxpayer's tax filing deadline (usually April 15), extensions not included
  3. Contribution limit is the lesser of 100% of compensation or $4,000 ($5,000 if you are at least age 50 by the end of the year for which the contribution is being made)
  4. Contributions are not deductible
  5. Earnings grow on a tax-free basis (certain rules apply)
  6. Qualified distributions are tax and penalty free

If you fund an SEP IRA and then convert those assets to a Roth IRA, the converted amount will be treated as ordinary income and subjected to income tax for the year you convert the assets.

Here are some additional points to consider:

Choosing the right plan type for your business (including sole proprietorship) - When you are trying to choose the best plan for your business, the options you consider are usually SEP IRAs, SIMPLE IRAs or qualified plans (such as profit sharing, money purchase, 401k plan etc.). (See our article Plans The Small Employer Can Establish for more information on these employer plans.)

Choosing the right type of IRA - In addition to your sole proprietorship making an employer contribution to an SEP IRA, you may also make an individual participant contribution to a Roth or Traditional IRA.

Generally, SEP IRAs and Roth IRAs are not substituted for each other, as they are two different types of retirement plans. An individual may be able to participate in both, if he or she meets the eligibility requirements. Consult with your tax professional to ensure that you choose the plan best suited to your financial profile.

This question was answered by Denise Appleby
(Contact Denise)

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