Can I have a SEP IRA and a Roth IRA?

If you run a business, you should consider setting aside part of the business earnings to save for retirement. The market offers different types of retirement plans for business owners, including a SEP IRA and a Roth IRA. You may consider contributing to either or both retirement plans, but is it allowed? Let's find out.

You can have a SEP IRA and Roth IRA at the same time, as long as you meet their eligibility requirements. You can open a SEP IRA, and use part of the business earnings to fund the retirement plan. Once you max out your SEP IRA contributions, you can open a Roth IRA with a financial institution or brokerage and contribute the surplus funds. You should monitor the contributions you make to both retirement plans to avoid making excess contributions.

What is SEP IRA?

A SEP IRA is similar to a 401(k) plan, but it lacks the administrative hurdles associated with 401(k). This type of IRA appeals to small business owners who want to open a retirement plan for themselves and their employees.

A SEP IRA is funded by employer contributions only; employees cannot contribute to the account. If you are self-employed, you qualify to contribute to your SEP IRA as the employer. A SEP IRA is funded with pre-tax contributions, and the funds are deductible on your tax return. However, you will pay income taxes when you withdraw funds from the SEP IRA.

SEP IRA Eligibility and Contribution Limits

To participate in a SEP IRA, there are certain requirements you must meet. One of these requirements is that you must be 21 years or older. You must have worked in the business for three of the previous five years, and you must have earned at least $650 in the past year in self-employment income or from your employer. However, employers are allowed to be less restrictive, and you may be eligible to enroll in a SEP IRA if you don’t meet all the requirements.

For 2022, you can contribute 25% of the employee's salary, or $61,000, whichever is less. Since a SEP IRA does not accept employee contributions, employees above 50 are not allowed to make catch-up contributions to the account. However, a SEP IRA has a considerably higher contribution limit than a Roth IRA.

If your business has employees, you must contribute a uniform percentage of salary to every employee’s SEP IRA. For example, if you contribute 13% to your SEP IRA, you must make an equal percentage contribution for all eligible employees. If the business earnings are down, the employer may decide not to make SEP IRA contributions, and this must apply to everyone, including the employer.

What is Roth IRA?

A Roth IRA is a tax-advantaged retirement plan that is funded with after-tax dollars. Taxes are taken out on the money going in, and you won’t pay taxes again if you take qualified withdrawals in retirement.

You can withdraw the portion of Roth IRA contributions tax-free before or after retirement. However, different rules apply for Roth IRA earnings, and you must be age 59 ½ or older and held the account for at least five years to make qualified withdrawals from the account.

Roth IRA Eligibility and Contribution Rules

To set up a Roth IRA, you must have an earned income from a job or business. Also, you must meet the income limits for Roth IRAs; you will be ineligible to open a Roth IRA if your annual income exceeds these limits.

For 2022, you can contribute up to $6000, or $7000 if you are above 50. However, the amount you qualify to contribute depends on your income level. To be eligible for a Roth IRA in 2022, your MAGI cannot exceed $144,000 for single filers, $214,000 for married taxpayers.

Can you have both SEP IRA and Roth IRA?

If you are eligible to open and contribute to a SEP IRA and Roth IRA, you can decide to use both retirement plans to save for retirement. 

If you are self-employed, and the business has employees, you can open a SEP IRA to provide a retirement plan to your employees. You will be required to contribute to each employee’s SEP IRA.

For 2022, you can contribute 25% of the employee’s compensation or $61,000 to each employee’s SEP IRA, whichever is less. You must make an equal percentage contribution to all eligible employees

Once you max out your SEP IRA contributions, you can open a Roth IRA to boost your retirement income. However, a Roth IRA has a lower contribution limit i.e. $6,000 for 2022, compared to the $61,000 annual contribution limit for a SEP IRA.

You can also opt to convert a SEP IRA to a Roth IRA to qualify for tax-free distributions in retirement. The conversion will be treated as ordinary income, and you will pay taxes on the amount converted to a Roth IRA.