A Side-By-Side Comparison of Different IRA Types
As the saying goes, “a penny saved is a penny earned.” However, in the context of retirement savings, where exactly you put your pennies makes all the difference.
In the U.S., employees and employers alike have many options to choose from. IRAs are an attractive choice for individuals who want to enjoy significant tax benefits while also saving for retirement.
You might want to opt for a Traditional IRA, or you might look forward to the tax-free distributions you will get with a Roth IRA. Alternatively, if you are a small business owner, you might consider setting up a SEP IRA or a SIMPLE IRA, depending on the number of employees you have and how much you can commit to contributing without overcontributing to IRAs or other retirement accounts.
Working through the fundamental distinctions between these various accounts can make all the difference in how each penny you contribute grows until retirement.
If you are shopping for a new retirement account to start your savings, or if you are thinking about rolling over another account, the best place to start is by looking at eligibility criteria.
If you are an employer, you cannot set up a new SIMPLE IRA if you have more than 100 employees. A SEP IRA might be a good choice but remember that you must match the same percentage of employees’ salaries to their accounts as you contribute each year to yours.
You can see how each IRA type’s eligibility criteria varies in the chart below. Note the row about rolling over funds into these different account types.
|Who can start one?||Individuals earning taxable income||Individuals earning taxable income||Self-employed or small business owners||Small business owners with fewer than 100 employees|
|Who qualifies to open one?||
Anyone with taxable compensation
Individuals open & contribute to this account.
Anyone with taxable compensation less than $139,000 or $206,000 if married*
Individuals open & contribute to this account.
– Older than 21
– At least $600 in compensation- Employers can also require employees to have worked three out of past five years with the companyEmployers open & contribute to this account.
Employees with the company the last two years, making at least $5,000 in both years
Employers open this account; both employees & employers contribute.
|Rollovers are allowed from…**||All major retirement accounts except Roth||All major retirement accounts||All major retirement accounts except Roth||After first two years, all major retirement accounts except Roth|
|*Contributions are reduced after certain income thresholds. See IRS guidance for more details.|
|**See IRS Rollover Chart for more information.|
It seems as though a key factor driving how the IRS makes distinctions between the different types of IRAs are their contribution limits.
The different annual contribution limits are particularly pronounced when considering SEP IRAs alongside the other individual retirement accounts. SEP IRAs by far the highest contribution limits of the four different types; as a result, the IRS makes an exception and allows SEP contributions to continue through a tax filing deadline extension. (Contribution limits can change each year, so check with the IRS for information on the appropriate tax year. The information here reflects 2023 contribution limits.)
|Annual contribution limit||$6,500||$6,500*||Lesser of 25% employee compensation or $57,000||$15,500**|
|Catch-up contribution for individuals older than 50||$1,000||$1,000*||N/A||$3,500|
|Employer matching?||N/A||N/A||Allowed; employers must contribute equal percentage of employee salary as his/her own personal account contribution||Mandatory; either match up to 3% of employee salary or a fixed 2% even if employee doesn’t contribute|
|*If income is between $138,000 and $153,000 or single tax filers or between $218,000 and $228,000 for married joint-filers, this is reduced.|
|**Contributions to these plans count against certain other defined contribution plan limits like 401(k)s and 403(b)s but not against other IRA plans|
If you are self-employed or a freelancer with enough income to max out any contribution limit, the far more lenient contribution cap of an SEP IRA is its greatest draw. Though, keep in mind that if you have employees, any contribution to your own SEP account must be matched as a percentage of salary to your employees’ accounts as well.
Annual contribution limits do change from time to time. For instance, Traditional and Roth IRAs saw increased limits in 2023 from $6,000 (2022) to $6,500 (2023).
SEP and SIMPLE plans also saw their limits grow in 2023. SEP IRAs grew from $61,000 (2022) to $66,000 (2023).. SIMPLE IRAs similarly saw an increase from $14,00 (2022) to $15,500 (2023).
Roth IRAs Offer After-Tax Distributions
Traditional, SEP, and SIMPLE IRAs all offer tax-deferred contributions and tax benefits for employers who match contributions; contributions are tax-deferred and tax-deductible, with tax-free growth and distributions taxed as ordinary income as long as they occur after the age of 59 ½ (withdrawals before that age are subject to additional penalties, which are usually 10%).
Roth accounts operate differently, tax-wise. A Roth IRA does offer tax benefits, but at the opposite end of the timeline compared to other IRAs. Contributions to a Roth IRA are made with after-tax income, which means you have to pay your tax bill in parallel to your retirement contribution. However, unlike the other plans, distributions from a Roth account are tax-free.
If you expect your tax bracket will be higher in the years you begin taking distributions—which are mandatory after the age of 72—a Roth might bring major benefits since you will have paid taxes at a lower rate. Distributions taken from the other types of accounts are taxed as income at whatever your rate is in the year you take them.
Because Roth IRAs have a different tax setup, you generally can’t roll Roth accounts into other non-Roth IRAs. Likewise, if you roll others into a Roth, you’re forced to pay taxes on that full rollover amount at that time.
SEP and SIMPLE IRAs Offer Slightly Altered Timelines
Generally, the deadline for opening an IRA as well as for making contributions to it is Tax Day, which is the day the previous calendar year’s filing is due. Usually, this falls on April 15 or the first business day after, but there can be exceptions. For example, due to the COVID-19 outbreak in 2020, the 2019 tax deadline was extended to July 15, 2020.
One exception applies to SEP IRAs. These must be opened or contributed to by the filing deadline for the previous calendar year; and if an extension is filed, that becomes the new deadline.
Another exception applies to opening and contributing to a SIMPLE IRA. A SIMPLE IRA must be opened by October 15 of the tax year, and all contributions are due by December 31 of that same tax year.
Other Key Differences
While eligibility rules, contribution limits, and tax differences between these four types of IRAs are key differentiating factors, there are some other distinctions to keep in mind.
But before we examine those differences, it is worth noting that all four of these IRA types can be opened in the form of a self-directed IRA (SDIRA), which lets you hold any asset as long as it is not excluded by the IRS. In fact, SDIRAs are celebrated for giving you the widest choices of assets to buy and full control over the choices made regarding your retirement savings.
It can be helpful to consider which differences line up most smoothly with your individual retirement goals and lifestyle, with the ultimate goal of opening an SDIRA that lets you buy the specific assets you want.
Along with Roth IRAs, these are the most commonly opened IRAs. One thing to keep in mind is that the contribution limit on a Traditional IRA is the lowest on the range, at $6,500 per year. It’s always important not to overcontribute to an IRA.
We’ve highlighted Roth IRAs at length throughout this piece. To review, the three key differences separating Roth IRAs from the other IRA choices are:
- Paying taxes upfront instead of deferring them;
- Income caps on eligibility and contribution levels;
- Rollover restrictions stemming from the differences in how contributions are taxed.
The annual contribution limit is what sets a SEP IRA apart from all other individual retirement accounts. Capping contributions at $66,000 (or 25% of annual income, depending on which is lower) can make SEP IRAs an extremely attractive choice.
However, the way matching contributions operate under SEP IRAs is something to carefully consider if you have any employees. If you decide to put 10% of your salary as an employer into your SEP, you must also match 10% of every employee’s salary into theirs.
The pros of a SIMPLE IRA are clear: more than twice the contribution limit as Traditional and Roth IRAs, but without as high of matching requirement as SEPs for small businesses with just a few employees. But that’s not to say SIMPLE IRAs don’t have stiff employer contribution requirements of their own; employers must either contribute 2% of their employees’ salaries to their accounts or match up to 3% of whatever the employees themselves contribute.
Another thing to keep in mind with SIMPLE IRAs is the stiffer penalties for trying to take out money early in the account’s lifespan. After all, SIMPLE IRAs are designed to incentivize long-term retirement savings. Instead of a 10% early withdrawal penalty like the other IRAs (except Roth), SIMPLE IRA withdrawals within the first two years of opening the account incur a 25% penalty.
All four of these different IRAs offer something the others don’t. They all have their pros and cons, pluses and minuses. So, if you are considering getting started or rolling over a different plan, use this guide to help you decide which specific one is right for you.