A Traditional IRA and a SEP IRA are both phenomenally good ways to save for retirement while reaping huge tax advantages.
Both accounts can be funded with what’s called pre-tax contributions, meaning that you won’t pay income tax on whatever amount of money the government allows you to contribute. Say you make $50,000 and deposit $5,000 into either a SEP or Traditional IRA. Uncle Sam will only tax $45,000 of your income. And both Traditional and SEP IRAs are considered tax-deferred accounts, meaning that you will have to pay taxes on your contributions and investment gains when you withdraw them in your retirement.
Both accounts also require that you wait until you’re 70 ½ to withdraw your funds unless you want to be assessed brutal penalties. (The government won’t penalize you if you withdraw the money early to spend on a handful of approved uses, like a first home purchase or higher education.) Both types of accounts require the holders to withdraw minimum annual distributions after reaching age 70 ½.
The big difference is who’s eligible to open the accounts and how much the IRS permits account holders to contribute. Traditional IRAs are available to the masses. Anyone can open one and deposit up to $5,500 dollars a year of tax-deferred loot, and those over 50 can deposit up to $6,500. The SEP IRA’s a little more exclusive; only the self-employed or small business owners are eligible to open one. Since they’re designed to be like a 401(k) for workers in the gig economy, SEPs allow for a much higher maximum annual contribution. SEP holders can contribute $54,000 tax-deferred per year, or 25% of your income– whichever figure is lower. Small business owners are also allowed to contribute up to 25% of the annual salary of their employees into SEPs.