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 1Top 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
- Higher contribution limits: You can to the SEP for all eligible employees. With a Traditional or a Roth IRA, an individual's contributions are generally limited. To learn more, refer to the annual contribution limits guide. 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.
- 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.
- 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.
How a SEP IRA compares to Traditional and Roth IRAs: |
| |
SEP IRA |
Roth IRA |
Traditional IRA |
| Who's it for? |
Small business owners and the self-employed |
Individuals |
Individuals |
| 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 proprietorships — 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 proprietorship — 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.