There are a lot of choices when it comes to saving for retirement. Understanding the different options available is the first step. The variety of IRA account types can be confusing, but fortunately, once you break them down into basic groups, understanding them becomes much easier. Once you understand their differences, choosing between a Roth IRA and a SEP-IRA is simple.
IRAs, or Individual Retirement Arrangements, are tax-advantaged ways to save money for retirement. The IRS regulates IRA accounts and provides rules regarding how they can be used and how they must be setup.
A Simplified Employee Pension, or SEP, is a type of small business retirement plan. Once a business establishes a SEP plan, each qualified employee establishes a SEP-IRA. The SEP-IRA is an individual account owned by the employee. However, only the business may contribute to the SEP-IRA. The business receives a business tax deduction for contributions made to the SEP. In all other ways, a SEP-IRA functions like a traditional IRA.
Roth IRA Basics
A Roth IRA is a personal IRA account. It is established and maintained by an individual. Only the individual account holder may contribute to the IRA. No employer contributions are allowed.
SEP-IRA and Roth IRA Differences
A SEP-IRA functions like a traditional IRA for tax purposes. All money inside the account grows tax-deferred until withdrawn. When funds are withdrawn during retirement, they are taxed as ordinary income. Conversely, although funds within a Roth IRA also grow tax-deferred, when withdrawn in retirement, all money is tax-free.