ROTH, SEP, and Traditional IRA: What’s the Difference?

ROTH, SEP, and Traditional IRA: What’s the Difference?

ROTH, SEP, and Traditional IRA: An Overview

What is the difference between a Roth IRA, individual IRA, and SEP IRA? Which one is best for you? All three are retirement savings accounts. Participants deposit money into the account, where it is invested using various financial products available to account holders. But there are some differences among these common retirement savings accounts

Learn more about these three common types of retirement savings accounts below.

Traditional IRA

The traditional IRA is the most common type of IRA. It allows individuals to direct pre-tax income toward investments that can grow tax-deferred. Millions of 401(k) and other company retirement plans are rolled over into traditional IRAs each year when workers retire or change employers.

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 pre-tax contributions and, when withdrawals are made later in life, the withdrawals are then taxed as ordinary income. At age 70½, traditional IRA holders are required to take required minimum distributions (RMD), so money cannot grow tax-deferred forever.

Traditional IRA contributions are capped at $6,000 a year, as of 2019, with an additional $1,000 catch-up contribution allowed for people over the age of 50.

SEP IRA

The simplified employee pension IRA (SEP IRA) is set up by an employer or self-employed person. It allows self-employed individuals to contribute to retirement plans for themselves or their employees without involvement in a complex qualified retirement plan. Employers are allowed a tax deduction for contributions and make contributions on a discretionary basis.

Many small employers favor SEP plans because of eligibility requirements for contributors, including a minimum age of 21, at least three years of employment, and a $500 compensation minimum. In addition, a SEP IRA gives employers the option to skip contributions during years when business is down. Contributions made by employers cannot exceed the lesser of 25 percent of an employee’s compensation or $56,000 maximum (for 2019). As with the traditional IRA, withdrawals from SEP IRAs in retirement are taxed as ordinary income, while contributions are tax-free. However, age 70½ withdrawal requirements apply.

Roth IRA

The Roth IRA was established in 1997 as the newest addition to the individual retirement accounts 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, since contributions were taxed when they were initially made. Roth IRAs are attractive options for people who expect to pay a higher tax rate at retirement than they do currently. It gives them the option to pay tax upfront, at the lower rate, then withdraw tax-free, though the benefit of allowing a larger amount of money to compound is lost. At age 70½, required minimum distributions (RMDs) are not required.

  • The traditional IRA, SEP IRA, and Roth IRA are all retirement savings accounts that people can use to prepare for retirement.
  • A Roth IRA is unique in that money is deposited post-tax and is not taxed when withdrawn.
  • SEP IRAs are generally established by employers or self-employed individuals.

Advisor Insight

Rebecca Dawson
Silber Bennett Financial, Los Angeles, CA

With a traditional IRA, you contribute pre-tax money that reduces your taxable income. When you withdraw the money in retirement, it is taxed as ordinary income, meaning your tax obligation was deferred.

With a Roth IRA, you contribute post-tax money. Contributions do not offer any up-front tax break. Instead, withdrawals are tax-free in retirement.

A SEP is set up by an employer, as well as a self-employed person, and permits the employer to make contributions to the accounts of eligible employees. The employer gets a tax deduction for contributions and the employee is not taxed on those contributions, though their eventual withdrawals will be taxed at their income tax rate. A self-employed person is both employer and employee so he or she funds their own account.

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