As for a SEP Roth IRA? There is simply no such thing. However, if you’re interested in some tax-free retirement income, it could pay to maintain both a SEP and a Roth. You also have the option to convert your SEP IRA to a Roth IRA. Learn more about how a SEP IRA works, how one can work in tandem with a Roth, and how to conduct a SEP IRA to Roth IRA rollover.
SEP IRA Basics
SEP IRAs are only available in traditional IRA form, not as an after-tax Roth account. They are designed to be a long-term investment vehicle for businesses and solo practitioners who may not have the option of setting up other types of employer retirement accounts, such as a 401(k). Like traditional IRAs, contributions are tax-deductible, but SEP IRAs have higher contribution limits.
Who Can Set Them Up?
SEP IRAs primarily are geared toward small business owners or those who are self-employed. People who have full-time employment and participate in their company’s retirement plan can still open a SEP if they earn self-employment income on the side.
How Do SEP IRAs Work?
Like other IRAs, SEP IRAs are intended to be withdrawn after age 59½. You can make a withdrawal before that, but you’ll pay a 10% early withdrawal penalty. Once you turn 72, you must begin taking required minimum distributions (RMDs). The key differentiator with a SEP is that the yearly contribution limit is much higher than the $6,000 (or $7,000 catch-up amount for those over 50) allowed for traditional and Roth IRAs.
How Are They Taxed?
SEP IRA contributions are made with pretax dollars, and so the amount you deposit each year is tax deductible. The maximum deduction a business can take tax for contributing to its employees’ SEP IRAs is the total contributions, or 25% of compensation, whichever is less. Self-employed IRA holders must follow an IRS formula to calculate their maximum deduction. Later on, when you eventually make withdrawals or get RMDs from your SEP IRA, you will be taxed as those withdrawals will count as taxable income.
What Are the Contribution Limits?
The maximum SEP IRA contribution for 2022 is 25% of compensation, up to $61,000. If you’re the employer, you must contribute the same percentage to each eligible employee.
Contributing to Both a SEP IRA and a Roth IRA
It is possible to contribute to both a SEP IRA and either a traditional IRA or a Roth IRA (if you are within the income limit requirements) in the same year. If you are receiving employer contributions to a SEP IRA, they are independent of the $6,000 you are allowed to contribute to other IRAs you have, including a Roth. If you are a self-employed person who contributes up to the maximum allowed in your SEP, you also can still contribute to a Roth IRA. The only time it gets tricky is if you make non-SEP contributions to your SEP IRA (if it’s allowed). Those contributions will count toward your yearly IRA allowance, the total of which cannot exceed $6,000 for 2022.
Rolling Your SEP Contributions into a Roth IRA
If you want to roll your SEP contributions into a Roth IRA, you can do a rollover called a Roth conversion. You will have to pay taxes on the amount that you move over. That’s because with a Roth, you must use after-tax dollars so that your money can grow and be withdrawn tax-free later. Therefore, the amount you roll over will be added to your taxable income for that year. So if you earned $50,000 and you decided to roll over $10,000 from your SEP into a Roth, your taxable income would increase to $60,000. At that income level, you’d be in the 22% tax bracket (for 2022), so you’d have to pay $2,200 on the amount converted to your Roth IRA at tax time. There are no limits on the amount you can roll over, but once you convert to a Roth, you can’t go back into a traditional IRA (as of tax year 2018). To go from a SEP IRA to a Roth account, you have three main options. You can do an indirect rollover in which the financial institution will issue you a check and you have 60 days to put that amount into a new or existing Roth IRA. You can do it the easy way and request a trustee-to-trustee transfer. The brokerage firm will transfer your SEP IRA funds directly to the Roth IRA financial institution. Or you can request a same-trustee transfer of the savings if you use the same firm for both your SEP and your Roth. This may be the simplest way of all.
The Bottom Line
Although a SEP Roth IRA product doesn’t currently exist, there’s no reason why you can’t leverage both a SEP IRA and a Roth IRA (if you meet each one’s eligibility requirements and income limits). Work with your financial advisor to figure out which type of IRA is best for you, and if or when it might be worth it to roll some of your SEP IRA funds over to a Roth IRA.
