Comparing IRAs: SEP vs Roth vs Traditional

There are many different kinds of IRAs, each with its own set of rules and benefits. A traditional IRA and Roth IRA are the most similar. They have the same contribution limits and eligibility rules, but only really differ in when and how they get taxed. A SEP IRA is actually closer in function to a solo 401k, but it also has a lot of similarities to a traditional IRA. It has much higher contribution limits than a traditional or Roth IRA, but is only available for business owners and self-employed individuals with or without employees.

If you’re wondering about the differences between a Roth, traditional, and SEP IRA, here’s everything you need to know.

Comparing the Roth, SEP, and traditional IRA

The traditional, Roth, and SEP IRAs are all individual retirement accounts. The traditional and Roth IRA are more common and easier to open since anyone with earned income can make contributions. The SEP IRA, on the other hand, requires that you’re a business owner or a self-employed individual.

Overview

Traditional IRA:  Any individual with earned income can open and contribute to a traditional IRA. Money that gets contributed grows tax deferred until you start taking distributions in retirement. With a traditional IRA, you contribute pre-tax income (money that you haven’t paid taxes on) and get a tax deduction. Withdrawals in retirement are taxed as regular income.

Roth IRA: Same as a traditional IRA, anyone with earned income can contribute to a Roth IRA. Unlike a traditional IRA, contributions are made with post-tax income (money that you’ve already paid taxes on) and you don’t get any tax deductions for the year. However, because you already paid taxes when you contributed, withdrawals in retirement are tax-free.

SEP IRA: A SEP IRA works like a traditional IRA, but has much higher contribution limits. Contributions are made in pre-tax dollars (money that you haven’t paid taxes on) and get deducted from your taxable income for the year. To open and contribute to a SEP IRA, you need to be a business owner or be self-employed.

Contribution limits

Traditional IRA: The contribution limit of a traditional IRA is $6,000 for 2022 and $6,500 for 2023. The amount that gets contributed gets deducted from your taxable income for the year.

Roth IRA: The contribution limit of a Roth IRA is the same as a traditional IRA – $6,000 for 2022 and $6,500 for 2023. You get no immediate tax benefits with a Roth contribution, but you get tax-free withdrawals in retirement.

SEP IRA: The contribution limit of a SEP IRA is $61,000 for 2022 and $66,000 for 2023. That’s over 10x the contribution limit of a traditional or Roth IRA. Money is contributed with pre-tax income, and taxes are deferred until you start taking distributions in retirement. A SEP IRA is entirely funded with employer contributions and is calculated by using 25% of your compensation if your business is incorporated, and 20% of your compensation if your business is not incorporated.

A SEP IRA has an additional contribution rule if you have employees. If you contribute to your own SEP IRA, you must make equal percentage contributions for every eligible employee that works in your business. For example, if you contribute 20% of your compensation to your SEP IRA, you must also contribute 20% of every eligible employee’s compensation into their SEP IRAs.

Catch-up contributions

Traditional IRA: A traditional IRA has catch-up contributions for people who are 50 years of age or older. You can contribute an additional $1,000 for both 2022 and 2023. With catch-up contributions included, the limit is $7,000 for 2022 and $7,500 for 2023.

Roth IRA: A Roth IRA also has catch-up contributions and it works the same way as a traditional IRA. You can contribute an additional $1,000 to a Roth IRA in 2022 and 2023 if you’re at least 50 years of age.

SEP IRA: A SEP IRA has no catch-up contributions. The contribution limit is the same whether you’re over or under 50 years of age.

Income limits

Traditional IRA: A traditional IRA doesn’t have income limits that restrict high income earners from making contributions. However, tax deductions could get reduced if you also receive a 401k or other retirement plan from an employer. If your income exceeds $78,000 for 2022 or $83,000 for 2023, you get no tax deductions when you contribute to a traditional IRA.

Roth IRA: A Roth IRA has income limits. If your income exceeds $144,000 for 2022 or $153,000 for 2023, you cannot contribute to a Roth IRA. However, you can get around the income limits by doing something called the backdoor Roth IRA, which involves contributing money to a traditional IRA and then converting it immediately to a Roth IRA.

SEP IRA: There are no income limits with a SEP IRA.

Investment options

The investment options of a traditional, Roth, and SEP IRA depend on what your plan provider offers, but typically consists of traditional assets like stocks, bonds, mutual funds, and ETFs. You can also open a self-directed IRA (traditional, Roth, or SEP) or a checkbook control IRA which allows you to invest in alternative assets like precious metals, private equity, and even crypto and NFTs.

What’s the difference between a self-directed IRA and a checkbook control IRA? Both are self-directed IRAs, but a checkbook control IRA removes the need for a custodian to approve all of your transactions. With a regular self-directed IRA, you’ll typically instruct your custodian to send funds whenever you want to make an investment. With a checkbook control IRA, you have have control over the checkbook and can write checks directly.

Withdrawals

Traditional IRA: With a traditional IRA, you can start to take qualified distributions from your account when you reach the age of 59½. Any earlier withdrawals are hit with an early distribution penalty of 10% plus income taxes.

Roth IRA: A Roth IRA has slightly different withdrawal rules. You can withdraw your contributions from your account at any age without penalties. However, to withdraw any earnings from your account, you must be at least 59½ years of age and your Roth IRA must be at least 5 years old (at least 5 years must have passed since your first contribution).

SEP IRA: A SEP IRA has the same withdrawal rules as a traditional IRA. You can start to take distributions when you reach the age of 59½. Any early withdrawals are hit with a 10% penalty plus income taxes.

Taxes on withdrawals

Traditional IRA: Since contributions to a traditional IRA are made with pre-tax income, withdrawals in retirement are taxed as regular income. The amount in taxes depends on your tax bracket and tax rates at the time of withdrawal.

Roth IRA: Since contributions to a Roth IRA are made with post-tax income (money you’ve already paid taxes on), withdrawals in retirement are completely tax-free.

SEP IRA: Same as a traditional IRA, withdrawals made from a SEP IRA will get taxed as regular income when you take distributions in retirement.

Required minimum distributions (RMD)

Traditional IRA: A traditional IRA has an RMD rule. Once you turn 72 years of age, you’re required to start taking distributions from your account each year, until emptied. If you fail to take an RMD, the penalty is 50% of the amount you were supposed to withdraw.

Roth IRA: The Roth IRA has no required minimum distributions. Account holders can keep money compounding tax-free as long as they’re alive, and can even pass down their accounts to their beneficiaries when they pass.

SEP IRA: A SEP IRA does have required minimum distributions and it works the same way as a traditional IRA. You must start taking distributions from your account when you reach 72 years of age.

Also read: IRA Required Minimum Distributions.

Required minimum distributions are calculated by taking your account balance on December 31 of the previous year, and dividing it by your life expectancy factor. You can calculate your RMD amounts using this table.

Overview comparison

Plan	Contribution Limit 2022	Withdrawals	Eligibility
Traditional IRA	$6,000	Taxed as regular income	Any individual with earned income
Roth IRA	$6,000	Tax-free	Any individual with earned income
SEP IRA	$61,000	Taxed as regular income	Business owners and self-employed individuals