Which Retirement Account Is Best for You: Roth IRA, Traditional IRA, or SEP?

February 05, 2017 · 6 minute read

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Which Retirement Account Is Best for You: Roth IRA, Traditional IRA, or SEP?

You might not believe it, but when it comes to retirement, Uncle Sam has your back. The proof is in the tax advantages you get by contributing to individual retirement accounts (IRAs).

Understanding how IRAs can help grow your retirement nest egg—and benefit you on tax day—is a smart money move. Even if you’re paying off student loans and have other debt obligations, allocating some money toward retirement during your early working years is crucial. The earlier you start, the longer your money has to grow. Your sixty-year-old self will definitely thank you for investing as much as you can now.

You can still make a contribution for the 2016 tax year, but you must open an account and contribute by tax day, which is April 18, 2017. Deadlines can be daunting, but don’t worry. We’ve got you covered.

Here’s a comparison of Traditional, Roth, and SEP IRAs to help you find the best fit for your income level and financial goals. Before we start, tally your total earnings for 2016 to determine if and how much you’re eligible to contribute to various IRAs. You should receive the necessary tax documents from your employers (W-2 forms) and/or clients (1099s) by mid-February.

Traditional IRA: Instant Tax Gratification

With a traditional IRA, you reap the tax benefits right away since your contributions are generally tax deductible. But, because you get an up-front tax advantage, you have to pay taxes on the money you withdraw in retirement.

Best For: This type of IRA is good if you think you’ll earn less in your retirement years and will be taxed at a lower rate than you are today.

Contribution limits for 2016: Under age 50: $5,500; ages 50-70½: $6,500

Income limits:  If neither you nor your spouse are eligible to participate in a company-sponsored retirement plan, like a 401(k), you can deduct the full amount of your traditional IRA contribution regardless of your income. However, The IRS only considers eligibility for a company plan, so whether or not you actually participate is irrelevant.

Here’s where things get complex. If you or your spouse are eligible for a company retirement plan, you can still contribute, but you might not be able to deduct the contribution if your income exceeds certain limits. Use our IRA Calculator to see if you qualify for a deduction, or talk to your tax preparer.

Early Withdrawal: Should you make an early withdrawal (before age 59½), you’ll generally pay a 10% penalty unless an exception such as death or disability applies.

Roth IRA: Flexibility Now, Tax Perks Later

If you’re looking for a tax break in your working years, you won’t get one by making Roth IRA contributions. That’s because Roth contributions are not tax deductible. However, when you withdraw funds in retirement, your withdrawals will be tax-free.

What’s really attractive about a Roth is that you are allowed to withdraw your contributions at any time without taxes or penalties. Investment earnings will have to stay put until the later of age 59½ or at least 5 years from your first contribution. Withdraw early and that 10% penalty happens.

As with a regular IRA, certain exceptions apply. For instance buying your first home, you can withdraw up to $10,000 of your earnings.

Best For: Many young people just starting out are in a lower tax bracket than they will be in when they retire. They can also use the flexibility of withdrawing contributions. If you want to start saving, but fear commitment, the Roth IRA could be a good choice for you. Prepare for retirement with a online Roth IRA from SoFi Invest.

Contribution limits for 2016:  Under age 50: $5,500; age 50 or older: $6,500

Income limits: If you earned below $117,000 as a single filer or $184,000 as a married joint filer, you should be in the clear to make the full contribution. If not, it’s complicated, so we listed the Roth income rules in a chart. You might want to check our calculator or speak with a tax professional for clarity.

How to decide which IRA chart

Simplified Employee Pension (SEP) IRA: A Freelancer’s Best Friend

If you are self-employed as a contractor, a sole proprietor with no employees, or if you earn side income in addition to a regular job, a SEP IRA is a solid option for your retirement savings. The big advantage is much higher contribution levels than other IRAs.

Like a traditional IRA, SEP contributions are tax deductible, but don’t plan on withdrawing money before age 59½, or you’ll face that 10% tax penalty. Contributing to a SEP does not prevent you from contributing to a Roth IRA. Contributing to your employer’s 401(k) (or your spouse doing so) does not prevent you from contributing to a SEP from your freelance income. This is just one of the many retirement options for the self-employed

Best For: Entrepreneurs, contractors, and people who have a side gig, the high contribution allowance makes this option a game changer. You can also open a SEP if you are a small business owner with employees—but you’ll need to contribute for your employees and there might be better pension plan choices. Ask your accountant for help.  

Contribution limit for 2016: You can contribute 18.6% of your net profits up to $53,000—a lot more than with other IRAs. Since the contribution limit is based on those profits, most people wait until after the year ends to fully fund their SEP. You may need the assistance of an accountant to figure out your maximum contribution amount. One final note: If you file an extension for your business taxes, you can make contributions until October 16.

With April 18 looming, don’t delay.

Get started today online investing with SoFi Invest® or schedule time with a financial planner to learn more about opening one of these accounts and investing for your future.

The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
Disclaimer: This information and the IRA Contribution Calculator are intended to serve for educational purposes only. The results generated by the calculator are hypothetical. Those results and this information should not be considered a substitute for personalized investment, planning, tax or legal advice. Individual circumstances are unique and we recommend that you consult with a qualified tax advisor for your specific needs.
SoFi can’t guarantee future financial performance. This information isn’t financial advice. Investment decisions should be based on specific financial needs, goals and risk appetite.
Advisory services offered through SoFi Wealth, LLC, a registered investment advisor.
SoFi doesn’t provide tax or legal advice. Individual circumstances are unique. Consult with a qualified tax advisor or attorney.


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