What's the difference between SEP IRA and ROTH IRA?

First some background: I am a 27 year old sole proprietor of my own business. I have no employees.

So I'm trying to research retirement options and kind of stuck between SEP and ROTH IRA's.

My understanding of a Roth: You pay taxes when you put money in. When you retire you do not have to pay taxes on anything.

How is a SEP different? I've read that you're allowed to contribute more into SEP than Roth. Is there any other difference?

Thanks!

Reply to
Costas
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A SEP is a company plan. It defines what the owner can put in, and what the owner has to put in for employees. A Roth is a personal plan. It is like a traditional IRA, except in the way it is taxed. You should look at a company plan first, then a personal plan. The SEP is nice in that the contribution limits are higher than personal plans. There are a number of other plans out there, too, such as the Simple, Keogh, 401K, 403B, etc. You may want to talk to both a financial planner and a tax attorney, and then decide exactly how to structure your business to take maximum advantage. Put another way, this is simply too good of a tax break to miss out on.

-john-

Reply to
John A. Weeks III

Hi John,

Can you tell me anything about how the SEP is taxed? Or what "features" specifically are different from a ROTH?

THanks,

-Costas

Reply to
Costas

I'm not sure what John means -- to the best of my knowlege SEP-IRAs are taxed exactly like traditional IRAs (except for different

*contribution* rules).

Thus they differ from Roth IRAs pretty much exactly how traditional IRAs differ from Roth IRAs.

-- Rich Carreiro snipped-for-privacy@rlcarr.com

Reply to
Rich Carreiro

Here's a pretty nice article about the various types of retirement savings plans for the self-employed:

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8473(by Sue Stevens, entitled "Retirement Savings for theSelf Employed" and posted in 9/27/07) As John said, "SEP" and "Roth" are orthogonal issues - it's "Individual" versus "SEP" and "traditional" vs. "Roth".

You can, in fact, make *both* SEP and Roth IRA contributions in a given year, though, of course, they have to be separate accounts. see

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of course, points to the standard reference onpersonal IRAs, the IRS Publication 590 which is actuallyquite readable and worth looking at, and 560 which iswhere SEP-IRAs are discussed)

Reply to
BreadWithSpam

I'll try to summarize, it's a big topic.

As a sole-proprietor you can set up what amounts to an "employer" retirement plan. It's a bit of a fiction because you are really both the employer and employee, but it lets you tap into some good alternatives - meaning, you can set aside quite a bit of your money in a tax-deferred account.

A SEP-IRA is one of those. You're able to defer, in effect, up to 20% of your sole-pro net income into an IRA. You won't pay income taxes on any amount you defer. The money can be invested in a wide range of investments -- mutual funds, stocks, bonds, depends on where you open the account -- and isn't taxed until you take it out at retirement. If you take it out earlier, you're hit with taxes as well as early-distribution penalties. But let's say you make $50k...you could set aside $10k of it (not exactly, see the worksheets for the exact calculation).

These days many are using "solo-k" plans instead of SEPs -- 401(k) plans with only one owner/participant. The advantage is that you can defer a flat $15,000 in addition to the 20% "employer" contribution. These used to be very expensive but in the past few years they got a lot cheaper or even "free", though you may have fewer investment alternatives.

You'll find some other alternatives out there, unfortunately "employer based" retirement plans are governed by a patchwork of tax laws so it's a bit confusing.

Now forget all that for a moment...any individual with earned income can put money into an IRA, which is a tax-deferred account for retirement savings. The annual contribution limit is currently $4,000 so it's not as good as the employer-based alternatives. You have two basic alternatives, a Traditional IRA and a Roth IRA. See the MIFP FAQs for a discussion of the differences.

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Which to do depends on your current tax rate and how much you want to defer for retirement. You could do a combination of SEP-IRA or 401(k) plus a Roth IRA (if you qualify), or only one of these. Or if you only want to defer $4k or less, the Trad-IRA is a simple way to do it.

-Tad

Reply to
Tad Borek

The way the original question was worded, I thought John's answer made perfect sense. He pointed out this is not an apple to apple comparison.

I'd look at:

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a comparison of the employer type plans (i.e. page does not discuss regular IRA or Roth IRA which have a $4000/yr cap on contributions.) Without knowing more about the OP, (he's 27, sole proprietor, no employees) I'd think the self-employed 401(k) has some great advantages. If he is in the 15% bracket, I might recommend a Roth flavor of savings, but 25% or higher, and the pre-tax deposit is still appealing to me. I am working on an article which has a major point that it would take over $2M right now, current tax laws and tax rate schedule, to have an annual withdrawal at the top of the 15% bracket, still not 25%. I think that if one has any years of low income, due to unemployment, health, etc., that's a great time to convert to a Roth. Even if tax rates rise (I know that's the risk) there needs to be some amount that will be subject to these lower rates, it's the higher end that's at greater risk. JOE

Reply to
joetaxpayer

Of course one problem is that if you ever do get an employee, you must contribute as much to the plan for them as you do for yourself in any given year. Thumper

Reply to
Thumper

Good point. Also, there is no telling from the posting that sole proprietorship is the best form of business, or that the business will stay small. I'd hate to see the OP make a decision based on one year, and have that be a bad decision for the next 10. When you consider the long time horizon, there is so much money at stake here, potentially millions, that the OP really does want to engage some professionals to help him out.

-john-

Reply to
John A. Weeks III

So if he started with a self-employed 401(k) but then hired someone, couldn't he then leave the 401(k0 to grow but with no further deposits, and open a different plan suitable for a business with employees? Anyone else in favor of a retirement system that has fewer rules and can be understood by more than a handful of people? JOE

Reply to
joetaxpayer

I appreciate everybody's input. This is more helpful than 1 week of google searches! :)

So what would be a compelling reason to go traditional over SEP? So far SEP sounds exactly the same only allowing me to contribute much more.

I hear what some have said about taking on employees in the future, or changing business entities as my business evolves. So could I open a SEP for now and change it later (to a traditional/Roth) if it makes more sense?

This is really my first educational experience with this stuff. I've never spoken with a professional (CFP) because I'm thinking they will give me biased advice.

What's your opinion: Should I seek professional assistance to help me sort through these things or will I do OK "going nuts" with research for another month or so?

What companies do you all recommend for starting SEP's or IRA's? I have a savings with ING and they offer IRA's (but no SEPS).

Thanks - I appreciate you guys!

Reply to
Costas

The traditional might be the way to go if the business was a one-time only thing, you were very short on cash, you needed the tax deduction badly, and you didn't want to bother to do the SEP paperwork. Another case is where the business shows a loss, but you have other W-2 income.

-john-

Reply to
John A. Weeks III

Your accountant should be able to help you figure out what's up. Do make sure you read that Morningstar article I mentioned last time. It's the most concise overview of the various kinds of accounts for the self-employed that I've seen.

We've been very happy opening and managing a variety of SEP, Roth, Traditional, even defined-benefit plans - for very small business and one-person self employed - at both Fidelity and Vanguard. Great funds available in both places, very low costs, easy access/management, and folks to talk to on the phone. There are certainly other options, but actual real-life experience with both of them - recently - has been very good.

Reply to
BreadWithSpam

You can have both, you know.

As a self-employed person you can make the 20% of net profits contribution to the SEP-IRA *and* make an annual $4000/$5000 contribution to a "normal" traditional IRA as well.

-- Rich Carreiro snipped-for-privacy@rlcarr.com

Reply to
Rich Carreiro

I believe that once a SEP always A SEP. You can stop contributing to it and start a traditional. The main reason I started a SEP is that I had maxed out my traditional IRA and this allowed me to put more away with hardly any cost or paperwork. Thumper

Reply to
Thumper

Until and unless one converts it to a Roth IRA, in which case those (converted)funds are longer called SEP.

JOE

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Reply to
joetaxpayer

Just saves a step - an easy one. Either way you need to open the IRA account itself to receive contributions. With the SEP you also need to sign a form establishing your "plan" and stick it in a file and remember to amend it if things change (e.g. employees). Also: if you were married the SEP could affect the deductibility of your spouse's trad-IRA contributions (see IRS publication 590 for the chart).

Not change the SEP, but change which one you use (the Roth IRA is a different type of account). Extreme example: this week, if you were still on an extension for 2006, you could open and fund a SEP-IRA for your business for 2006, terminate it for the 2007 tax year and establish a solo-401k for 2007, then terminate that in 2008 and do something else.

Well I'm in that business and I'd say, do it yourself if you have the time, hire someone if it's not worth your time. This isn't rocket science but it does take time to figure out.

The last Q could be the easiest...many self-directed investors use Vanguard or Fidelity for their no-load funds. If your contributions are small at this point, a fund-of-funds (eg Vanguard's Lifestrategy series) is an easy way to do it. No need to plot a 30-year investment strategy if you have $5k to sock away.

-Tad

Reply to
Tad Borek

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