Roth IRA vs. SEP IRA: What's the Difference?

Make the most of your retirement investment

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The market offers numerous retirement plan options, including the individual retirement account (IRA). Roth and Simplified Employee Pension (SEP) IRAs are among the most common types of IRAs available. While their distribution and taxation rules are similar, contribution requirements and annual limits are quite different.

Employers—including self-employed people—establish and fund SEP IRAs, while individuals shoulder the burden of making Roth IRA contributions. The Internal Revenue Service (IRS) caps annual IRA contributions, and offers much higher limits on SEP IRAs than for Roth IRAs. Which type of IRA is right for you?

What’s the Difference Between a Roth IRA and a SEP IRA?

Roth IRA SEP IRA
Available to individuals Available to all sizes of businesses
Owner makes contributions Only allows employer contributions
Contributions are post-tax, so not tax-deductible Employer must make equal contributions for all employees
Annual contribution limits Employee is 100%-vested in all contributions
Contributions allowed at any age Annual pretax contribution limits
Qualified distributions are not taxable   No IRS filing requirement for employers
  Employee must be at least 21 years old
  Participant loans not permitted

Eligibility and Ownership

Individuals can open a Roth IRA, but only employers can establish an SEP IRA. SEP IRAs are available to businesses of all sizes, but are particularly popular with small businesses and self-employed workers.

SEP IRAs are only available to employees aged 21 and older, who have worked for the employer for at least three of the past five years and earned at least $650 in the previous or current year. Roth IRA owners can contribute at any age.

Because individuals establish and contribute to Roth IRAs, they retain ownership. Although employers establish SEP IRAs for employees, the individual workers own them.

Contributions and Limits

Individual Roth IRA owners make all contributions, while only employers can make contributions to SEP IRAs. In 2022, the IRS allows employers to make SEP contributions up to the employee’s first $305,000 of earnings, and the employer must apply the same percentage of contribution to each employee.

For example, let’s say a company makes a 10% contribution to each employee's SEP IRA. If John earns a salary of $50,000 annually, the company will contribute $5,000 to his SEP IRA, and if Sally makes $100,000 per year, she will receive contributions of $10,000.

The IRS also limits the amount of contributions to Roth and SEP IRAs. For 2022, individuals under age 50 can contribute up to $6,000 to their Roth IRA; those over 50, or turning 50 during the calendar year, can contribute up to $7,000. In 2022, employers funding SEP IRAs can contribute the lesser of 25% of an employee’s compensation, or up to $61,000.

Distributions

Roth IRAs: While traditional IRAs require owners to start minimal distributions at around age 72, Roth IRAs do not have the same requirement. Qualified distributions require the Roth IRA owner to make contributions for at least five years. Roth owners can receive tax-free distributions after age 59 ½ or earlier, or if they meet other qualified distribution requirements, which may include:

  • Suffering a disability
  • Higher-education expenses
  • Medical expenses
  • Federal tax levies

If the Roth IRA owner dies, their beneficiary can receive qualified distributions, regardless of age.

Roth IRA owners can make a qualified tax-free withdrawal of up to a $10,000 lifetime limit when purchasing their first home.

SEP IRAs: The IRS requires SEP IRA owners to take a minimum distribution at age 71 ½ or 72, depending on your birth date. At any age, SEP owners can roll over to another type of IRA or retirement plan without tax consequences.

Like Roth IRA owners, SEP IRA owners can receive qualified distributions before age 59 ½ under certain circumstances such as disability or to purchase their first home.

SEP IRAs do not allow owners to borrow against their earnings.

Taxation

Contributions to Roth IRAs are not tax-deductible. Roth owners over the age of 59 ½ can receive tax-free distributions. Typically, SEP IRA contributions do not require IRS filings by the employer that makes the contributions. However, employers can deduct SEP IRA contributions when filing their federal tax returns.

Employees can exclude SEP IRA contributions from their gross income. However, distributions are considered taxable income. But SEP IRA owners are allowed tax-free rollovers to other types of IRAs or retirement plans.

Non-qualified distributions taken before age 59 ½ incur an additional 10% tax.

Which Is Right For You?

If you’re self-employed, you can open a Roth or SEP IRA. But bear in mind the limits of Roth IRA contributions. While an SEP IRA allows for annual contributions up to $61,000, Roth IRAs cap contributions at $6,000 or $7,000, depending on your age.

If you’re an employer of others, SEP IRAs can provide a retirement plan for your staff. But remember, when setting up SEP IRAs for more than one worker, you must make equal contributions for each person.

Due to annual contribution limits, Roth IRAs do not provide a sound retirement plan for many people. However, if you already have an employer-sponsored retirement plan, such as a 401(k), establishing a Roth IRA on your own can boost your retirement income and reduce your tax burden later on, especially if you’re still relatively young. 

The Bottom Line

Roth and SEP IRAs are not created equally. Roth IRAs require you to make contributions, while SEPs put the burden of funding on the employer. The low annual contribution limits of a Roth IRA might not be the ideal single solution for retirement income, but a SEP IRA might be, especially if an employer is willing to make maximum contributions.

Both types of IRAs allow for tax-free rollover to another IRA or retirement plan. And both provide tax-free distributions at age 59 ½. Also, each of these IRAs allows for qualified early distributions for unexpected emergency expenses, such as significant medical expenses or a major tax bill.

Choosing the right IRA will depend on your circumstances. If you’re self-employed, you can take advantage of the higher contribution limits offered by a SEP, but if you already have an employer-funded retirement arrangement, a Roth IRA can round out your retirement income.

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