An IRA is an individual retirement account that provides you with a tax advantage while you work to establish a nest egg for your future. There are many types of IRAs, and all are designed to help you achieve your retirement goals with as little tax burden as possible. SEP IRAs and Roth IRAs are two of the types -- each providing different advantages for your financial portfolio.
A SEP IRA is a simplified employee pension that you may only open if you are self-employed. However, your employer may also open a SEP IRA on your behalf and make contributions to it in a similar way that he would contribute to a 401k retirement account. Nevertheless, only employers or self-employed individuals may contribute to a SEP IRA. You cannot contribute if you are an employee, meaning there will be no personal tax deduction. Roth IRAs, however, are available to any individual -- self employed or not -- with an adjusted gross income (AGI) less than $120,000 if filing taxes as single or $176,000 if filing taxes as married. An employer cannot open a Roth IRA on behalf of an employee.
The taxation policies of SEP and Roth IRAs are very different from each other. The IRS will tax a SEP IRA in a similar fashion to a traditional IRA, in that all contributions to your SEP account are tax deductible and may lower your annual tax liability. Your contributions to a Roth IRA are not tax deductible, and you receive no immediate tax benefits from the account. The advantage of a Roth IRA, however, is that your contributions will grow with interest tax-free, and you will pay no income taxes at all when you begin making withdrawals from the account during retirement.
The maximum annual contribution for a Roth IRA is $5,000 per person. If you are over 50 years of age, you may also contribute an additional $1,000 per year in catch-up contributions. SEP IRAs, on the other hand, have much higher contribution limitations. An employer or self-employed individual may contribute the lesser of 25 percent of income or $49,000 per year to the account. If you are self-employed, a SEP IRA may be preferable to a Roth IRA if you want to contribute more than $5,000 per year.
The Roth IRA holds an advantage over other IRAs with regard to distributions. Not only are distributions 100 percent tax-free, but there is also no mandatory time period in which you must begin taking distributions from the account. In fact, you may pass on your Roth IRA to an heir without ever taking distributions from the account. Conversely, if you have a SEP IRA, you must take distributions by the sixth month following your 70th birthday. Additionally, if you take a distribution prior to the sixth month following your 59th birthday, your withdrawal will be subject to a 10 percent tax penalty.