There are a variety of individual retirement accounts (IRAs) on the investment landscape these days. Here's a breakdown of two of the less-traditional types, the Simplified Employee Pension (SEP) IRA and the Roth IRA. All dollar figures are for tax year 2020 (unless noted otherwise).
- Established and funded by a business (including a sole proprietorship)
- Must be established and funded by the employer's tax filing deadline, including extensions
- Contribution limit is 25% of compensation or $57,000 ($56,000 for 2019), whichever is less. For a sole proprietor, the contribution limit is 20% of the sole proprietor's adjusted net business income
- Contribution within the limits is deductible on the employer's business tax return
- Account earnings grow on a tax-deferred basis
- Distributions treated as ordinary income and subject to income tax and early withdrawal penalties if you are under age 59½ when the withdrawal is made, unless you are eligible for an exception
- Established and funded by the individual taxpayer
- Must be established and funded by individual taxpayer's tax filing deadline (usually April 15), extensions not included
- Contribution limit is the lesser of 100% of compensation or $6,000 (for 2019 and 2020) and $7,000 if you are at least age 50 by the end of the year for which the contribution is being made
- Contributions are not deductible
- Earnings grow on a tax-free basis (certain rules apply)
- 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 made the conversion.
SEP Account: Jessica Perez
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, other options to consider include SIMPLE IRAs or qualified plans such as profit sharing, money purchase, and 401(k) plan.
- Choosing the right type of IRA: Sole proprietors making an employer contribution to an SEP IRA 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.