Dave explains the differences between IRAs, Roths, and SEPs.

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QUESTION: Monica has an incorporated business.  She’s looking at putting some of her profits into IRAs or SEP IRAs.  Is one better than the other?

ANSWER: A traditional, old-fashioned IRA allows you to put money in and take a tax deduction.  Then your money grows tax-deferred and you don’t pay taxes on it till you pull the money out. 

A Roth IRA is a tax-free growth IRA.  You don’t get a tax deduction when you put the money in, but it grows tax-free. 

For example, if a 30-year-old couple who each put $3,000 in a Roth IRA invest in good growth stock mutual funds, which have averaged 12% since inception, they’ll end up having $5.8 million if they do that to age 70.  They won’t get a tax deduction on the $240,000 they put in over 40 years, but they will not have to pay taxes on the $5.8 million either. 

If they put that in a traditional IRA for 40 years, they will have put in $240,000 for which they’ll get a tax deduction.  They will also have to pay taxes on almost $6 million. 

The SEP IRA is the Simplified Employment Pension plan for small business owners to invest up to 13.8% of their net profit.  It works like a traditional IRA.  You get the tax deduction, but it grows tax deferred. 

You should fully fund the Roth IRA first – which is $8,000 this year for married couples – before you do a SEP.  A SEP is a good plan for small business owners after fully funding the Roth.

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