What Is a SEP IRA?
A Simplified Employee Pension Plan (SEP IRA) is an employer-sponsored plan that allows an employer to make contributions toward their employees' retirement.
Business owners who had fewer than 100 employees earning $5,000 or more in compensation during the prior year are eligible to open SEP IRAs.
These accounts are funded by an employer on behalf of the employee. So, if you have a SEP IRA account, some of your salary is automatically deducted from your paycheck and deposited into this retirement plan.
The contributions can be made as a percentage of income or as a flat amount, whichever the employer decides upon. It is important for you as an employee to understand how much you will be contributing as a part of your total compensation package.
Up to 25% of employees’ compensation can be contributed by the employer. For 2023, contributions of up to $66,000 can be paid into the employee's account.
The contributions are considered "employer contributions". This means that any contribution you make is not taxed at the time of deposit, unlike if you were to contribute with your own money.
Keep in mind that you are responsible for any SEP IRA fees. This means that if you choose to open an SEP IRA as an employee, you should consider how much it will cost and whether your employer will pay those fees.
In addition, the IRS does not permit additional catch-up contributions for SEP IRAs. However, the contribution limit for SEP IRAs is still significantly higher than for a Roth IRA.
What Is a Roth IRA
A Roth IRA is a type of individual retirement account (IRA) that is named after former United States Senator, William Roth.
Roth IRAs are funded with money from post-tax income. This means that if you withdraw your money before you turn 59½ years old, you have to pay income taxes on it.
An important point to remember is that you cannot contribute to both a SEP IRA and a Roth IRA in the same year, so you must choose between them if eligible.
For 2023, the account contribution limit is $6,500 for employees who are 50 or younger. For employees who are over 50, Roth IRAs allow additional catch-up contributions up to $1,000.
To be eligible for a Roth IRA, your Modified Adjusted Gross Income (MAGI) must be under the income limit.
The maximum Modified Adjusted Gross Income is $153,000 if you are single and $228,000 if you are married and filing jointly.
In other words, if you earn more than the limit, you are not eligible to contribute a Roth IRA.
Setting Up Each Plan
SEP IRA
SEP IRA plans are established by employers for their employees.
Employers complete the paperwork, including the plan document and any amendments, then send copies of these documents to all eligible employees along with IRS Form 5305-SEP.
Employers can set up SEP IRA accounts online through companies like Fidelity or Vanguard. These companies help employers maintain tax forms, process transactions, and track their employees' accounts.
Roth IRA
The most common method is to set up a Roth IRA at an online brokerage that will allow you to open the account in just a few steps.
If you want to open up an IRA at an online company, make sure that the account minimum is low and decide how much your contribution will be each month before opening any accounts.
There are additional fees associated with online brokerage accounts besides the actual brokerage fee, including maintenance fees or inactivity fees. Research these costs before opening any accounts.
Major Differences Between a SEP IRA and Roth IRA
There are key differences between SEP IRAs and Roth IRAs:
Business Size
One of the major differences between both accounts is that SEP IRAs are specifically for businesses with fewer than 100 employees.
Roth IRA eligibility requirements do not take into account a business' size. The income limit applies to individuals, regardless of their profession.
Eligibility Requirement
SEP IRA eligibility is determined by your employer, meaning you must have fewer than 100 employees who earned $5,000 in compensation during the prior year.
Roth IRAs require Modified Adjusted Gross Income (MAGI) below a certain limit, as well as whether or not you participate in an employer-sponsored retirement plan.
Contributor
You can contribute SEP IRA funds as an employer on behalf of your employees.
Contributions to a Roth IRA must be made by the individual account holders themselves.
Contribution Limits
A SEP IRA allows for larger contributions than Roth IRA accounts with its maximum contribution limit of up to 25% of employees' compensation, or up to $66,000 for 2023 can be paid into the employee's account.
Roth IRAs only allow up to $6,500 in 2023, with an additional $1,000 if you are over 50.
Catch-Up Contributions
SEP IRAs do not permit catch-up contributions for anyone 50 or older, but the SEP IRA employer contribution is up to 25% of contributions made by employees.
Roth IRAs allow catch-up contributions for those over 50 years old.
Tax Consequences
SEP IRA contributions are not taxed at the time of deposit. This is unlike Roth IRA accounts, which are considered after-tax money. SEP IRA contributions are also not subject to tax at withdrawal.
In Conclusion
Whether you choose Roth or SEP IRA accounts, either plan has its advantages and disadvantages.
Deciding which one is right for you depends on your personal preferences and financial situation, so you should consider all of the pros and cons before making a decision.
Unlike SEP IRAs, Roth IRA accounts are not taxed at deposit. Roth IRA contributions are also not subject to tax at withdrawal.
If you meet Roth IRA eligibility requirements and think that you can afford to make the maximum contribution each year, then this is a great account for your long-term savings goals.
On the other hand, if you are looking for an account that allows larger contributions and tax-exempt deposits, then the SEP IRA is a good option to consider.
Keep in mind that SEP IRAs do not allow catch-up contributions, while Roth IRAs do. Both accounts also have different contribution limits: $6,000 with a $1,000 catch-up fund for Roth IRA accounts, and a maximum contribution of up to 25% of employees' compensation or $61,000 for SEP IRAs.
Whichever account you choose, both options allow you to save on taxes while also investing towards your future.
FAQs
1. What is a SEP IRA?
It is an employer-sponsored individual retirement account that is used as a supplemental retirement plan. A SEP IRA allows employees to contribute a percentage of their salary, with the employer also contributing to employees' accounts.
2. What is a Roth IRA?
It is an individual retirement account that can be opened by anyone with earned income. Contributions to a Roth IRA are made on an after-tax basis, which means you do not get a tax deduction for money contributed.
3. Who can contribute to a SEP IRA?
Anyone who has self-employed income and runs a small business with 100 employees or fewer (i.e. a sole proprietor, partnership, LLC, or corporation) can contribute to SEP IRA accounts.
4. Who can contribute to a Roth IRA?
Any U.S. citizen who receives earned income and has a valid Social Security number can open a Roth IRA account and contribute to it.
5. How much can be invested in SEP IRAs and Roth IRAs?
You can contribute up to 25% of your compensation or $66,000 for 2023. The contribution limit is the same as 401(k) plans. You can invest up to $6,500 in a Roth IRA account for 2023, with an additional $1,000 if you are over 50.
