Higher Limits Aren't Everything: My Reasons for Not Switching to a SEP IRA

Being able to contribute more to a retirement account isn't everything. Clarity is important, too. I recently teed myself up to lose over $11,000 in retirement money to capital gains taxes. Reason: it was unclear to me how much I could save by investing for retirement through an IRA instead of a regular taxable brokerage account.

Recently, I looked into opening a SEP IRA, which is like a traditional IRA but comes with higher contribution limits. It's also exclusive to self-employed individuals and small business owners. I use a Roth IRA right now, and after comparing the two, I'm sticking with my Roth.

I'm not switching from a Roth IRA to a SEP IRA for three reasons. Here's what they are.

1. Roth IRAs are simple

Roth IRAs are clear and predictable. You contribute post-tax dollars, and you're taxed nothing on withdrawals post-retirement. What you get is what you see in your brokerage account.

But SEP IRAs are more complicated. You contribute pre-tax dollars, which is nice, but when you withdraw, you are taxed a variable amount. You won't know how much you'll earn until the dust settles, your income is calculated, and you're left with less than you might've thought.

There are ways to lower your tax burden post-retirement, but I don't want to deal with that. I want to know exactly how much I'm getting at a glance, and that's something only a Roth IRA can provide.

2. My inflation-adjusted income will be higher in retirement

Roth IRAs are well suited to long-term savers who believe they'll retire in a higher income tax bracket. That's because you pay taxes on your Roth IRA contributions now, but you're spared from paying taxes in a higher bracket later.

SEP IRAs are the opposite: You pay no taxes on contributions, but your withdrawals are taxed like income. If you're in a much higher tax bracket post-retirement, you could be on the hook for quite a bit of cash.

I'm an optimist. While anything is possible forty years from now -- I could very well be eating leftover pizza out of a cardboard box -- I'd rather bet on my success. That's a big reason why I'm putting my money in a Roth instead of a traditional or SEP IRA.

3. I won't exceed my Roth contribution limits

Roth IRAs offer lower contribution limits than SEP IRAs do. As of 2024, you can contribute up to $7,000 in a Roth (or $8,000 if you're over age 50). For an IRA, that's standard.

Meanwhile, in 2024, you can contribute up to 25% of an employee's compensation or $69,000, whichever is less, to a SEP IRA. (Self-employed persons count as employees for the sake of calculating limits, though the calculation is a bit more complicated and may effectively reduce the amount they can contribute.)

In 2024, I've got a lot going on. Chances are, I won't be exceeding my Roth IRA $7,000 annual contribution limit. Should that change, I'd consider opening up a SEP IRA as well.

Opening both a Roth IRA and a SEP IRA

Despite my stance, I like both Roth and SEP IRAs; they have clear pros and cons. In some cases, it might be worth opening one of each to boost your contribution limits. After all, employer contributions to a SEP IRA don’t impact your personal traditional or Roth IRA limits.

For example, say my Roth IRA contribution limit is $7,000 in 2024. As a self-employed individual, I open a SEP IRA with a maximum contribution limit of $10,000. Between the two, I can contribute up to $17,000 total. Contributing to my Roth doesn't shrink my SEP limits.

I'll be sticking with my Roth IRA for the reasons mentioned above. But I'd consider opening a SEP IRA as well if my income exceeds expectations and I have more to contribute in 2024. Luckily, it's easy to get started. Some of the best IRA brokers offer both Roth and SEP IRAs.