SEP IRA vs. traditional IRA: How do they compare?

Although both can give you a tax-advantaged way to prepare for retirement, Simplified Employee Pension (SEP) IRAs and traditional IRAs have distinct qualities that appeal to savers. Understanding them can help you realize how each might affect your retirement strategy and choose the one that fits you best—or to decide if you want to contribute to both.

A SEP IRA is a retirement savings plan for small business owners, either with or without employees. It offers a convenient way for employers to contribute to their employees' retirement savings as well their your own. Contributions are made with pretax dollars, and those funds grow tax-deferred. Over time, the funds in the account benefit from the power of compound interest.

A traditional IRA is a type of qualified retirement savings plan that you open on your own through a financial institution. You make contributions that benefit from compound interest and tax-deferred growth over time.

Even if you have access to an employer-sponsored retirement plan like a SEP IRA you also can contribute to an IRA to boost your savings.

Although they're both retirement savings vehicles, these accounts operate differently. Knowing how these differences affect you can help you decide which plan may be best for you.

SEP IRAs are available to you whether you are self-employed with no employees, or if you own a business and have employees working for you.

If your employer offers a SEP IRA, you must must meet the following criteria to participate (though your employer may choose to make these requirements less restrictive):

• You're at least 21 years old.
• You've been an employee during at least three of the previous five years.
• You’ve earned at least $750 during the tax year.

To qualify for a traditional IRA, you or your spouse must have earned income from wages, salaries or tips from working. Income from real estate rentals, interest, dividends and other types of passive income doesn't count.

There are no age requirements or income thresholds to open a traditional IRA.

If you are the employer, you can decide how much the business contributes to your SEP IRA. However, if you have employees, you must contribute the same percentage of compensation to each employee's account.

In 2024, you can contribute up to 25% of your employee's salary or $69,000, whichever is less. The limits are the same if you're contributing to your own SEP IRA as a sole proprietor, but your "salary" for the 25% calculation is considered your net earnings minus half of your self-employment tax and your SEP contributions.

You can't make your own contributions out of your own income; your employer makes them for you. Only the sponsoring employer contributes to your SEP IRA, and it's up to them to decide if they contribute and how much, up the annual 2024 limit of to 25% of your salary or $69,000, whichever is less.

With a traditional IRA, you contribute to your own account from your income. Annual contributions to traditional IRAs are limited to $7,000 if you're younger than age 50. If you're 50 or older, you also can make a catch-up contribution of an additional $1,000 for a max of $8,000.

One of the biggest benefits of retirement accounts is you receive certain tax advantages on contributions, earnings and withdrawals. Most contributions to tax-deferred retirement accounts are tax-deductible. The deductibility of contributions differs among a traditional IRA, a SEP IRA where you're an employee and a SEP IRA where you're the employer or self-employed.

SEP IRA contributions are a deductible business expense for the employer making the contributions.

If you're an employee receiving SEP IRA contributions, you don't receive a tax deduction for contributions made on your behalf. Your tax-advantage comes with the tax-deferred growth of earnings in the account over time.

In most cases, you can deduct your contributions to a traditional IRA on your personal income tax return, which may lower your taxable income for the year.

• If you make less than the modified adjusted gross income (MAGI) listed, you can fully deduct your traditional IRA contributions.
• If you make an amount with the maximum MAGI range, your tax deduction will be reduced.
• If you make equal to or more than the maximum limit listed, you will not be able to deduct your traditional IRA contributions.

• Employers: If you are an employer with a SEP IRA, you decide where to open the account, and the investment options you have will be determined by the provider you select.

• Employees: Although your employer makes all the contributions to your SEP IRA, you get to choose where and how they are invested. The contributions made on your behalf are generally a percentage of your compensation.

Because you can open a traditional IRA at the institution of your choosing, you may be able to access a wide variety of investment options.

In both cases, you'll generally be able to invest in a variety of securities, including mutual funds, exchange-traded funds, stocks and bonds.

Both SEP IRAs and traditional IRAs are useful tools that can help you save for retirement. If you're self-employed, a SEP IRA can allow you to save more than a traditional IRA, but be mindful that you have to contribute to an account for each employee as well. A traditional IRA may be a good option if you want to save more but aren't self-employed and can't open your own SEP IRA.

You don't necessarily have to choose between them, either. You can contribute to a SEP IRA and a traditional IRA at the same time.

The best route for you depends on your circumstances and goals. You may want to consider other options, too. Roth IRAs offer unique tax advantages, and SIMPLE IRAs are another great small business option. For help figuring out how to make the most of the retirement options available to you, consider meeting with a local Thrivent financial advisor.