Features and Benefits of Sep IRAs and Roth IRAs

Table of Contents

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.

Key Takeaways

  • While traditional IRAs remain the most popular type of individual retirement account, alternatives exist.
  • A SEP IRA is a retirement savings plan established by employers—including self-employed people—for the benefit of their employees and themselves that are low-cost and have higher contribution limits.
  • A Roth IRA uses after-tax contributions that then grow tax-exempt, but have a $6,000 annual contribution limit (for 2021 and 2022) and are subject to income eligibility caps.
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SEP Account: Jessica Perez

SEP IRA

A simplified employee pension (SEP) IRA is established and funded by a business (including a sole proprietorship) and has the following criteria or components:

  • It must be established and funded by the employer's tax filing deadline, including extensions.
  • The contribution limit is 25% of compensation or $58,000 for 2021 ($61,000 for 2022), whichever is less. For a sole proprietor, the contribution limit is 20% of the sole proprietor's adjusted net business income.
  • The contribution within the limits is deductible on the employer's business tax return.
  • Account earnings grow on a tax-deferred basis.
  • Distributions are treated as ordinary income and are 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.

Roth IRA

A Roth IRA is established and funded by the individual taxpayer using after-tax dollars and grows tax-exempt. It has the following criteria or components:

  1. It must be established and funded by individual taxpayer's tax filing deadline (usually April 15th), extensions not included.
  2. The contribution limit is the lesser of 100% of compensation or $6,000 (for 2021 and 2022) and $7,000 if you are at least age 50 by the end of the year for which the contribution is being made.
  3. Contributions are not deductible.
  4. Earnings grow on a tax-free basis (certain rules apply).
  5. Qualified distributions are tax- and penalty-free.

If you fund a 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.

In order to contribute to a Roth IRA, you must make less than $140,000 per year as a single filer ($144,000 for 2022) or $208,000 as married filing jointly ($214,000 for 2022).

The Bottom Line

Choosing a retirement plan that can maximize your benefits is essential. Here are some additional points to consider:

  • Choosing the right plan type for your business (including a 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 a 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 they meet the eligibility requirements.

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  1. Internal Revenue Service. "SEP Plan FAQs." Accessed Dec. 23, 2021.

  2. Internal Revenue Service. "Retirement Topics - IRA Contribution Limits." Accessed Dec. 23, 2021.

  3. Internal Revenue Service. "Roth IRAs." Accessed Dec. 23, 2021.

  4. Internal Revenue Service. "Publication 560 Cat. No. 46574N Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans)," Page 3 and 6. Accessed Dec. 23, 2021.

  5. Internal Revenue Service. "Simplified Employee Pension Plan (SEP)." Accessed Dec. 23, 2021.

  6. Internal Revenue Service. "Traditional and Roth IRAs." Accessed Dec. 23, 2021.

  7. Internal Revenue Service. "Publication 590-A (2020), Contributions to Individual Retirement Arrangements (IRAs)." Accessed Dec. 23, 2021.

  8. Internal Revenue Service. "Topic No. 451, Individual Retirement Arrangements (IRAs)." Accessed Dec. 23, 2021.

  9. Internal Revenue Service. "Rollover Chart." Accessed Dec. 23, 2021.

  10. Internal Revenue Service. "Amount of Roth IRA Contributions That You Can Make For 2021." Accessed Dec. 23, 2021.

  11. Internal Revenue Service. "Amount of Roth IRA Contributions That You Can Make for 2022." Accessed Dec. 23, 2021.