SEP IRA vs. Roth IRA: How they compare

When you run a small business or you're self-employed, saving for retirement isn't as straightforward as electing to put a portion of your salary in a 401(k). Saving for your future self—and possibly helping any employees you have save as well—is up to you.

Two common options for building long-term retirement wealth are Simplified Employee Pension (SEP) IRAs and Roth IRAs.

As you look at SEP IRA vs. Roth IRA, understand that each can provide you with certain tax advantages, but they don't work the same way. They have distinct characteristics and rules regarding their contributions, taxation and distributions. Read on to learn more about how these accounts compare and when you may want to consider one or both.

Both the SEP IRA and Roth IRA are popular retirement plans for self-employed people and small business owners. Each offers powerful incentives that can boost the value of your savings and reduce your tax bill.

But their distinctions may make one a better choice depending on your needs. Understanding your retirement goals and what each plan provides is key to making the right choice. At a high level, the primary differences have to do with when you receive tax advantages:

• SEP IRAs allow you to save more, maximize tax-deferred contributions and reduce current taxable income. This helps you to potentially build a much larger nest egg with greater tax benefits on the front end.
• Roth IRAs have lower contribution limits, and while you don't get an upfront tax break, your growth can accumulate tax-free.

Let's explore these small business retirement options to better understand how each may fit into your plan.

A SEP IRA is a retirement plan that an employer of any business size may offer as a benefit, whether you have employees or are entirely self-employed. You just need to take the steps to establish the SEP IRA and then begin making contributions.

It's important to note that, unlike traditional employer-sponsored plans, only the employer can make SEP IRA contributions. You'll be required to contribute an equal percentage of each qualified employee's pay to their SEP IRA, up to $70,000 in 2025 or $72,000 in 2026, or a maximum of 25% of their salary, whichever is less. If you're a sole proprietor, you will have a 20% limit that applies to your net earnings from self-employment.

You can easily set up a SEP by completing an IRS plan document. It will establish the allocation and eligibility rules. The IRS has certain minimum eligibility requirements: Participants must be 21 or older, have worked for the employer for at least three of the previous five years and receive at least $750 in compensation—though employers can be less restrictive if they want.

Establishing a SEP IRA for your business may allow you to claim the Retirement Plan Startup Costs Tax Credit. This credit is designed to help offset startup costs for small businesses that set up retirement plans for their employees, and it's worth up to $5,000 per year for three years.

A Roth IRA is an individual retirement account you can open on your own at any time, regardless of whether you have an employer, are self-employed or own a business. The only requirement is that you or your spouse must have earned income and be under the IRS income limit.

Unlike traditional IRAs, Roth IRAs are funded with after-tax dollars, allowing your earnings and qualified withdrawals to remain tax-free in retirement.

Roth IRAs have annual contribution limits:

● 2025 contribution limit: $7,000; $8,000 if you're 50 or older.
● 2026 contribution limit: $7,500; $8,600 if you're 50 or older.

While both of these accounts help you save for retirement, SEP IRAs and Roth IRAs don't operate in the same ways. When you contribute to a SEP, you're doing so as an employer, even if you're self-employed. Meanwhile, any individual can contribute to a Roth IRA. Depending on whether you have employees—and how many—this can mean a difference in the level of set-up and maintenance work required. They also differ in their contribution limits, their tax implications and their distribution rules.

SEP IRAs are designed for small business owners and their employees. Any size business may have one, but business owners are required to contribute the same percentage of compensation to each employee who meets the eligibility criteria as set forth by the IRS, or less restrictive criteria if the plan sponsor chooses. For example, someone satisfies the age requirement if they are at least 21, but the business may choose to allow a 19-year-old to participate.

Anyone can open and contribute to a Roth IRA provided they do not exceed the income limitations. You do not need to be self-employed or work for a small business, since these are individual accounts.

The IRS limits how much you can contribute in total to all of your personally held traditional and Roth IRAs to the annual limit, with the exception of rollovers.

With a SEP IRA, you can contribute up to 25% of your salary (20% of net earnings from self-employment if you are a sole proprietor) up to $70,000 in 2025 or $72,000 in 2026. You must contribute the same percentage to all eligible participating employees, as well.

You fund Roth IRAs with money you've already paid income taxes on. But even though you pay taxes on them in the year you contribute, you enjoy tax-free growth of earnings and tax-free qualified distributions. The withdrawal rules to keep the earnings tax- and penalty-free generally include being at least age 59½ (or meeting certain exceptions if you're withdrawing early) and having owned the account for at least five years.

With a SEP IRA, your contributions are, instead, tax-deferred. This means you don't pay taxes when you put the money into it or while the earnings are growing. But your withdrawals are taxable when you take them. That's regardless of your age when you withdraw, but as long as you're at least 59½, you typically won't pay a penalty.

For both accounts, you must be at least 59½ when you withdraw, or you may face a penalty of 10% unless you qualify for an exception. However, the Roth IRA has additional withdrawal rules that you must adhere to as well.

For your entire distribution to be tax- and penalty-free, you must be over 59½, and five years must pass from the first time you contributed to a Roth IRA. If you withdraw from a Roth IRA before five years have passed, then your earnings will be subject to income taxation.

Certain retirement accounts have required minimum distributions (RMDs). You have to take a certain amount of money—as determined by IRS worksheets and calculation tables—out of your account by April 1 of the year after you turn 73 and every year after.

• SEP IRAs have RMDs. Remember, the taxes on these are deferred (you don't pay them until you withdraw your money), and the IRS wants to be able to take its cut at some point.
• Roth IRAs are not subject to RMDs. So, if you don't need the money in retirement, you can leave it in your account indefinitely. However, your beneficiary will be subject to specific withdrawal requirements.

SEP and Roth IRAs are both great choices. Neither account is fundamentally better than the other, because they serve different purposes. It depends on your situation. SEP IRAs have higher contribution limits that allow you to save more, and you may benefit from an immediate tax deduction. Roth IRAs grow tax-free, and you don't have to worry about RMDs.

Here are some scenarios to help you decide:

• A SEP IRA may be a better choice if you have a high income. A Roth IRA may not allow you to save enough to replace your income in retirement, and you may not qualify anyway. Having a higher income also likely means you're in a higher tax bracket, so the immediate tax deduction may be more valuable.
• Roth IRAs are a good way to grow a tax-free nest egg as long as you or your spouse has earned income and you make under the IRS income limits. Although they have a low annual contribution limit, you can use them alongside a workplace plan.

You can contribute to both a SEP IRA and a Roth IRA, creating a balanced strategy that combines tax-deferred and tax-free growth. You could offer a SEP IRA as a small business owner or have one as a self-employed person and also put money in a Roth IRA. This may be a tax-wise move and a particularly strong strategy if you're able to max out annual contributions to your Roth IRA, because you'll have your completely separate SEP IRA to keep contributing to.

Each of these accounts offers valuable tax and savings benefits for small business owners and the self-employed. SEP IRAs provide higher contribution limits and immediate tax reduction, while Roth IRAs allow your savings to grow tax-free. Making the right choice to use one or both can help you save in the most efficient way possible.