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How do I Choose Between a Roth and a SEP IRA?

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  • Written By: Dave Slovak
  • Edited By: Susan Barwick
  • Last Modified Date: 16 January 2020
  • Copyright Protected:
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    Conjecture Corporation
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If you are among the millions of people who are planning for retirement, you may be interested in investing in an individual retirement account (IRA). There are several different types of IRA, but two of the most common types are the Roth and the simplified employee pension (SEP) IRA. Depending on your personal investment and retirement goals, you may want to choose one over the other. Many financial experts suggest that you choose between a Roth and a SEP IRA based on your age, income, and investment and retirement goals.

Many people choose either a Roth or SEP IRA based on their age. Roth IRAs have a $5,000 US Dollar (USD) maximum annual contribution limit, whereas SEP IRAs allow the individual, through their employer, to contribute 25% of their annual income, up to $49,000 USD per year. If the person is younger, he or she can afford to invest a lesser amount per year, whereas an older individual, who is closer to retirement, may want the option of investing more per year. In some cases, individuals over a certain age are allowed to make catch-up contributions to a Roth IRA, which essentially increases the annual contribution limit by $1,000 USD.

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Another age-related difference between a Roth and a SEP IRA is the mandatory distribution age. Roth IRAs have no such requirement, and as long as the individual remains alive, he or she can defer distributions in light of growing the investment. SEP IRAs, however, require the individual to exercise a distribution at the age of 70.5.

Your income could be a determining factor in helping you decide between a Roth and a SEP IRA because of the different ways each type is taxed. With a Roth IRA, the investor makes a post-income tax contribution to the account and it grows without additional tax, even at the time of withdrawal. With a SEP IRA, the investor can contribute pre-tax funds or claim the investment against their gross income. Unlike a Roth IRA, however, funds in a SEP IRA are taxed when a distribution is exercised. You should analyze the potential tax benefits for both a Roth and a SEP IRA to see which is the most advantageous investment choice based on your income and tax bracket.

Other things you should consider when deciding between a Roth and a SEP IRA are factors such as your personal investment and retirement goals. Many people elect to invest in both types of IRAs. Investing in a Roth IRA gives them guaranteed, non-taxable retirement income. SEP IRAs allow higher contribution amounts and often benefit people who own their own businesses or perform a significant amount of freelance work because they can use a SEP IRA to increase their overall retirement savings at an aggressive pace. If you are trying to decide between a Roth and a SEP IRA, carefully review all of your options, understand all of the potential benefits and risks, and consult a financial planning professional if necessary.

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