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SMALL BUSINESS
AUGUST 8, 2021

As a small business owner, why open a SEP IRA vs. a Roth or Traditional IRA?

Answered by
Judith Anderson
Senior Vice President, Retirement & Personal Wealth Solutions at Bank of America
A SEP (Simplified Employee Pension) IRA is usually preferable because it lets small business owners make larger tax-deductible contributions to their employees' — and their own — retirement savings than individuals can make to Traditional or Roth IRAs.Footnote 1

Top 3 advantages of a SEP IRA over a Roth or Traditional IRA

"You can decide each year how much to contribute for you and your employees. If times are tight, you can reduce or skip contributions."
— Judith Anderson, senior vice president, Retirement & Personal Wealth Solutions at Bank of America
  1. Higher contribution limits: You can set aside as much as 25% of your employees' compensationFootnote 2 — up to $58,000 in 2021 ($57,000 for 2020) — to the SEP for all eligible employees. With a Traditional or a Roth IRA, an individual's contributions are generally limited to $6,000 a year in 2021, or $7,000 for those age 50 and older. If you're self-employed, use the Deduction Worksheet for Self-Employed in IRS Publication 560, Retirement Plans for Small Business to calculate your maximum SEP contribution.
  2. Greater flexibility: You can decide each year how much to contribute for you and your employees. If times are tight, you can reduce or skip contributions. But keep in mind that the contribution formula — such as a percentage of compensation — must be the same for all participants, including you.
  3. Bigger tax advantage: Contributions to both a SEP and a Traditional IRA are made pretax — but the amount an employer can contribute annually to a SEP is higher (see point 1 above). Your employees can make their own traditional IRA contributions to the same account that holds their SEP contributions rather than maintaining a separate IRA. One cautionary note: While employees can contribute to their own Traditional or Roth IRA, they are considered to be covered by a retirement plan at work — the SEP. This could have an impact on their ability to make deductible Traditional IRA contributions.
SEP IRA Roth IRA Tradi­tional IRA
Who's it for? Small business owners and the self-employed Individuals Individuals
Max contribution in 2021 25% of compensation,Footnote 3 up to $58,000 in 2021 — ($57,000 for 2020) Generally, $6,000 ($7,000 if you're age 50 or older)Footnote 4 Generally, $6,000 ($7,000 if you're age 50 or older)Footnote 5
Type of contribution Pre-tax After-tax Pre-tax
Can I roll over funds to and from other IRAs? Generally, yes Generally, yes Generally, yes
Are distributions subject to federal income tax? Yes No, provided certain requirements are met Yes
Required minimum distribution at age 72? Yes No, provided you are the original owner Yes

What else is there to know about SEP IRAs?

SEP IRAs are easy to set up and manage, and in addition:
  • Retirement contributions and plan expenses are tax-deductible for business owners.
  • You have until your standard tax filing deadline — generally, March for partnerships and S corporations and April for C corporations and sole propietorships — to make contributions for you and your employees for the prior tax year. If you file for an extension, you can delay making contributions until the extended filing deadline — generally, September for partnerships and S corporations and October for C corporations and sole propietorship — rather than the standard deadline. Many small business owners find this helpful in managing cash flow.
  • Money in a SEP IRA isn't taxed until withdrawn, when distributions are considered ordinary income.

When might it make sense to consider a 401(k)?

As your business grows, the simplicity of a SEP IRA may start to feel restrictive — if, for example, your employees want to use salary deferrals to save more for retirement. That's not possible in a SEP IRA, but it is allowed in a 401(k) plan.

Related Questions

What's the appeal of a SEP IRA for small business owners, compared with other retirement plans?
What are the rules for rolling over a SEP IRA?
How much can I contribute to my SEP IRA?

Related Questions

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Footnote 1 This article does not address SARSEPs (or salary reduction SEPs) which had to be in place as of December 31, 1996, or SIMPLE IRAs that also can be used if certain requirements are met.

Footnote 2 The maximum compensation that can be taken into account for purposes of this calculation is $290,000 per participant for 2021 ($285,000 for 2020).

Footnote 3 Subject to annual limits on eligible participant compensation. If you're self-employed, the maximum percentage may be 20% of net earnings from self-employment (determined under the SEP IRA rules). See IRS Publication 560, Retirement Plans for Small Business.

Footnote 4 A lower limit may apply, depending on your income and other factors.

Footnote 5 A lower limit may apply if you or your spouse is eligible to participate in an employer-sponsored retirement plan.

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