Ask an Advisor: Can I Open a Roth IRA and Still Max Out My SEP IRA?

I am the president (and only employee) of my LLC. I currently have a SEP IRA, and I contribute the maximum amount annually. Would it be advantageous to also have a Roth IRA that I contribute to as well? What if I could not contribute the maximum amounts to the SEP and the Roth, should I contribute equally to both, or fully to one and less to another? – Victoria

Contributing to a Roth IRA in addition to your SEP IRA could increase your overall retirement savings and give you more tax diversification. Whether you should do so ultimately depends on how much you need to save and how the tax benefits of each account fit your situation. If you can’t maximize both accounts, the best way to split your contributions will largely depend on your current tax rate and the tax rate you expect to face in retirement.

If you have similar questions on how to plan and save for retirement, connect with an advisor for free and see how they can potentially help.

Can You Contribute to Both a SEP IRA and a Roth IRA?

Unlike maxing out a traditional IRA, contributing to a SEP IRA does not prevent you from contributing to a Roth IRA. The contribution limits are separate.

As the business owner, your SEP IRA contributions are employer contributions. A Roth IRA, on the other hand, is an individual retirement account that you fund personally. Assuming you meet the Roth IRA income requirements, you can contribute to a Roth IRA even if you are already contributing the maximum to a SEP.

Should You Contribute to a SEP IRA and a Roth IRA?

I wouldn’t say you should contribute to a SEP and Roth IRA simply because you are allowed to. The more important question is whether you need to save more to meet your retirement goals.

Suppose, for example, that maxing out your SEP IRA each year already puts you on track to retire comfortably. You may decide that additional savings are better directed toward other goals or simply spent and enjoyed today. Saving for retirement is important, but maximizing every available retirement account isn’t always necessary.

This is part of the reason why planning is important. A financial plan can help you determine how much you actually need to save and where additional dollars may be better used. (And if you need help creating a financial plan, connect with a financial advisor today.)

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If You Can’t Maximize Both, Consider the Tax Tradeoff

If you determine that you do need to save more but don’t have enough available cash flow to maximize both accounts, I wouldn’t automatically split your contributions equally between the SEP and Roth IRA. Instead, think about the tax treatment of each account.

SEP IRA contributions are generally deductible to the business, reducing taxable income today. The money then grows tax-deferred, and withdrawals from the SEP IRA are taxable as ordinary income in retirement.

A Roth IRA reverses that. You personally don’t receive a tax deduction for your contribution, but qualified withdrawals in retirement are tax-free.

If you’re currently in a relatively high tax bracket and expect to be in a lower tax bracket in retirement, prioritizing deductible SEP contributions may make more sense. On the other hand, if you’re currently in a relatively low tax bracket and expect your tax rate to be higher in the future, Roth contributions may be better. Incurring a tax liability today at a lower rate in exchange for tax-free qualified withdrawals later can work in your favor.

(Retirement planning can be complex, which is why it can help to have a professional in your corner. Match with a financial advisor for free.)

For example, suppose your marginal federal income tax rate is 12% today. Assume also that you’re a diligent saver and expect to be in the 22% bracket in retirement. Giving up a 12% deduction today to get tax-free qualified withdrawals later could be a good trade. Reverse those numbers, and the SEP contribution probably becomes more appealing.

Of course, nobody knows exactly what tax rates will be decades from now, but you can make informed estimates. I would approach the decision like this:

Determine how much you actually need to save each year to stay on track for retirement.
Then, consider your current marginal tax rate and the rate you reasonably expect to face in retirement. If the deduction is especially valuable today, you may want to lean more heavily on the SEP. If you’re in a relatively low tax bracket now, Roth contributions may deserve greater priority.
Finally, consider whether you value having both taxable and tax-free sources of retirement income. Even when maximizing the SEP looks best from a purely current-year tax perspective, putting some money into a Roth can give you additional flexibility later.

There’s no rule that says the contributions need to be equal. A 50/50 split may be appropriate, another allocation may work better, or it may make sense to fully fund one account before contributing to the other. The right allocation depends on what you’re trying to accomplish and your specific tax situation.

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Bottom Line

Yes, you can contribute to a Roth IRA in addition to your SEP IRA, as long as you meet the Roth IRA income eligibility rules. Doing so can increase your total retirement savings while giving you a mix of tax-deferred and potentially tax-free assets.

But I wouldn’t assume that maxing out both accounts is automatically the best choice. Start by determining how much you actually need to save to reach your retirement goals. If you don’t need to max out both accounts, or can’t afford to do so, consider the value of the SEP deduction today relative to the potential benefit of tax-free Roth withdrawals later.

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Plan for retirement expenses, not just a savings target. Estimating costs for housing, healthcare, taxes and everyday spending can help you determine how much income your savings may need to provide.

Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.

Please note that Brandon is not an employee of SmartAsset and is not a participant in SmartAsset AMP. He has been compensated for this article. Some reader-submitted questions are edited for clarity or brevity.