IRA and SEP

There are two types of individual IRAs, the Traditional IRA and the Roth IRA.

Individual Retirement Account (IRA)

A Traditional IRA is an account that holds investments you’ve made (for example, CDs, mutual funds, or stocks) to help pay for your retirement. If you have earned income, you can contribute up to age 70½, and your contributions may be tax deductible. The major benefit is that the government doesn’t tax the interest you earn until you withdraw it, normally when you retire. This can help your account compound faster to give you more money at retirement.

Traditional IRAs are good investments for money you don’t need right away and can afford to invest for a period of time. If you need it before you reach age 59½ (unless it’s to buy your first home or pay education expenses) you’ll pay both a penalty fee and taxes on your withdrawal.

A second type of IRA is called a Roth IRA. When you open this type of IRA, you make after-tax contributions, but the money you withdraw after retirement may be free from federal taxes. You can contribute at any age as long as you have earned income and meet the income limitations.

Currently, the maximum you can contribute to all of your Traditional and Roth IRAs is the smaller of:

  • $5,500 ($6,500 if you’re age 50 or older), or
  • Your taxable compensation for the year.

Since laws frequently change, check with your banker, a financial advisor, or a retirement specialist for current limits, maximum contributions, and potential tax deductions.

This chart compares the traditional IRA and the Roth IRA. To learn more about the differences and to set up an IRA, it’s important to work with a banker, a financial advisor, or a retirement specialist.

Traditional IRA vs. Roth IRA

Characteristics Traditional IRA Roth IRA
Account description Your earnings grow tax-deferred and, if eligible, your contributions may be tax deductible as well.

You can also roll over your 401(k)s, IRAs, or employer-sponsored qualified retirement plan to consolidate your retirement assets without having to pay taxes currently.

You make after-tax contributions but the money you withdraw after retirement may be free from federal taxes.
Eligibility to contribute You can contribute up to the year you turn 70½ as long as you have earned income. You can contribute at any age as long as you have earned income and meet the income limitations
Tax deductible contributions You can deduct your contributions if you meet the eligibility requirements. Contributions are made in after-tax dollars if you meet the eligibility requirements.
Taxation of earnings and withdrawals Tax-deductible contributions and earnings are taxed as ordinary income when withdrawn.

After-tax contributions are withdrawn tax-free.

Contributions (all are made after tax) and earnings are income tax-free if the account is held for 5 years and are withdrawn for a qualified reason.

Withdrawal of earnings for non-qualified reasons may be taxed as ordinary income.

Withdrawal Penalties 10% IRS early withdrawal penalty if withdrawn before age 59½ unless exception applies. No penalties for withdrawals of contributions.

10% IRS early withdrawal penalty if earnings withdrawn before age 59½ unless exception applies.

Required withdrawals Must begin at age 70½. Upon death of owner.

SEP

A Simplified Employee Pension (SEP) is designed for people who are self-employed. Funds may be invested the same way as an IRA. A SEP does not have the start-up and operating costs of a conventional retirement plan and allows for a contribution of up to 25 percent of each employee’s pay.

Considerations

  • Easy to setup and operate
  • Low administrative costs
  • withdrawal restrictions
  • Flexible annual contributions – good plan if cash flow is an issue
  • Employer must contribute equally for all eligible employees
  • Available to any size business
  • No filing requirement for the employer
  • Only the employer contributes
  • Employee is always 100% vested in (or, has ownership of) all SEP-IRA money
  • Participants (employees) cannot take loans from or use as collateral
  • Withdrawals subject to additional tax of 10% if under age 59 1/2

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