SEP IRA vs Traditional IRA: Which One Is Right for You?

Like anything in life, planning is key to achieving your goals, and retirement is no exception.

Among the many retirement savings options, IRAs stand out for their tax benefits and flexibility. Knowing the difference between a SEP IRA and a Traditional IRA is essential for choosing the one that best aligns with your financial goals.

By understanding SEP IRA vs a Traditional IRA, you can make a smart decision and build the retirement you deserve. Let’s break it down.

Understanding SEP IRA and Traditional IRA

What is a Traditional IRA?

Think of a Traditional IRA as the “classic” retirement account that’s been around since the 70s. It’s pretty straightforward – you put money in now, get some tax breaks, and pay taxes when you take the money out in retirement.

• Who can open one? Pretty much anyone with a job or self-employment income can open a Traditional IRA. As long as you’re earning money and you’re under 73 years old, you’re good to go.
• Contribution limits: For 2024, you can toss in up to $7,000 per year. If you’re 50 or older, you get to add an extra $1,000 as a “catch-up” contribution, bringing your total to $8,000. Not too shabby, but not massive either.

For many individuals, opening a Traditional IRA is one of the foundational ways to prepare for retirement, especially for those who don’t have access to an employer-sponsored plan.

What is a SEP IRA?

A SEP IRA (Simplified Employee Pension) is basically a souped-up IRA designed with business owners and self-employed folks in mind. It works similarly to a Traditional IRA but with some key differences.

• Who can open one? SEP IRAs are available to self-employed individuals, including freelancers, small business owners, independent contractors, gig workers, and people with side hustles.
• Contribution limits: Here’s where SEPs really shine – the contribution limits are WAY higher than Traditional IRAs. For 2024, you can contribute up to $69,000 or 25% of your compensation, whichever is less. That’s nearly 10 times more than a Traditional IRA!

If you’re self-employed, you may be able to contribute to both a SEP IRA and Traditional IRA, maximizing your tax-advantaged retirement savings by leveraging the benefits of each.

Tax Implications of SEP IRA vs. Traditional IRA

Tax Benefits

• SEP IRA: Contributions are fully tax-deductible for the business.
• Traditional IRA: Contributions may be tax-deductible, but that depends on your income and whether you’re covered by a workplace retirement plan.

How Withdrawals Are Taxed

• Both types of IRAs get taxed as ordinary income when you take money out.
• If you withdraw before 59½, you could face a 10% penalty (unless you qualify for an exception).

Roth Conversion Considerations

• Both SEP IRAs and Traditional IRAs can be converted into a Roth IRA, but you’ll need to pay taxes on the amount converted in the year of the conversion.

Smart Tax Moves

A few clever strategies to consider:

• For Traditional IRAs: If you’re close to the income limit for deductibility, look for ways to lower your adjusted gross income. Maybe bump up your 401(k) contributions or HSA contributions to squeeze under the threshold.
• For SEP IRAs: Since you can contribute until your tax filing extension deadline, you can calculate exactly how much to contribute to get your tax bill where you want it. It’s like having a tax adjustment knob!

SEP IRA vs Traditional IRA: Pros and Cons

Choosing the right IRA depends on your financial situation, contribution goals, and whether you’re self-employed or have employees. Below is a side-by-side comparison of the key advantages and limitations of SEP IRAs and Traditional IRAs to help you make the best decision.

	Pros	Cons
SEP IRA	– Much higher contribution limits than a Traditional IRA. – Super simple to set up and maintain. – Great for self-employed individuals and business owners.	– If you have employees, you must contribute the same percentage for them as you do for yourself. – Employees can’t contribute on their own—only the employer can.
Traditional IRA	– Lower contribution limits make it accessible for everyone. – Good for people who don’t have an employer-sponsored retirement plan. – Contributions may be tax-deductible.	– Lower contribution limits compared to a SEP IRA. – Your tax deduction could be limited if you earn too much and have a workplace retirement plan.

SEP IRA

Pros – Much higher contribution limits than a Traditional IRA. – Super simple to set up and maintain. – Great for self-employed individuals and business owners.

Cons – If you have employees, you must contribute the same percentage for them as you do for yourself. – Employees can’t contribute on their own—only the employer can.

Traditional IRA

Pros – Lower contribution limits make it accessible for everyone. – Good for people who don’t have an employer-sponsored retirement plan. – Contributions may be tax-deductible.

Cons – Lower contribution limits compared to a SEP IRA. – Your tax deduction could be limited if you earn too much and have a workplace retirement plan.

Which IRA Is Right for You?

If You’re Self-Employed

• Want to contribute more than $7,000 per year? → Go with a SEP IRA.
• Need a plan that allows employees to contribute too? → Consider a SIMPLE IRA or Solo 401(k) instead.

If You’re a W-2 Employee

• No 401(k) at work? → Traditional IRA is a great option.
• Already have a 401(k)? → Make sure you can still get a tax deduction before contributing.

If You’re a Small Business Owner

• Want a simple, high-contribution retirement plan? → SEP IRA is the way to go.
• Want employees to contribute, too? → Look into a SIMPLE IRA instead.

Rookie Mistakes to Avoid

Don’t trip yourself up with these common errors:

Traditional IRA Blunders

• Not checking if you qualify for the tax deduction
• Missing the April 15th contribution deadline
• Contributing too much and getting hit with penalties
• Forgetting you can set up an IRA for a non-working spouse
• Ignoring those required minimum distributions after 73

SEP IRA Slip-ups

• Calculating your maximum contribution incorrectly
• Leaving out eligible employees
• Using different contribution rates for different people
• Not keeping good records
• Forgetting that employees immediately own all the money you contribute for them

Other Retirement Savings Options to Consider

• SIMPLE IRA: A solid option for small businesses that want both employer and employee contributions.
• Solo 401(k): Great for self-employed individuals who want even higher contribution limits.
• Roth IRA: Perfect if you expect to be in a higher tax bracket later in life and want tax-free withdrawals.

Maximizing Your Retirement Strategy

Many people use multiple accounts to maximize benefits:

• SEP IRA + Roth IRA gives you both current tax breaks and future tax-free money.
• Traditional IRA + 401(k) lets you save in multiple tax-advantaged buckets.
• SEP IRA for self-employment income + workplace retirement plan gives you the best of both worlds.

Final Thoughts

Both SEP IRAs and Traditional IRAs offer valuable tax advantages, but the best choice depends on your financial situation and long-term goals.

Regardless of which IRA you choose, the key to a secure retirement is starting early, contributing consistently, and taking advantage of tax-saving strategies. And remember, you don’t have to choose just one—a mix of different retirement accounts can provide flexibility and long-term financial security.