Annuities vs. SEP

Annuities and SEP IRAs are useful for growing your retirement savings.

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If you work for a small business, your retirement planning options may include a Simplified Employee Pension, or SEP IRA. If you're not covered by a plan through your job or you want to supplement your retirement savings, you could also invest in an annuity. Both SEP IRAs and annuities are designed to provide you with a steady stream of income once you retire, but these plans function in different ways.


A SEP IRA is a type of qualified retirement account that employers can set up for themselves and their employees. These plans are geared toward smaller companies because they're less expensive and easier to manage than a 401(k). The employer sets up a traditional IRA for each eligible employee and makes equal contributions on their behalf. According to IRS guidelines, an eligible employee is anyone who is at least 21 years old, has worked for the employer in at least three of the five previous years and has earned at least $550 in compensation. As of 2013, an employer could contribute up to 25 percent of an employee's annual compensation to a SEP IRA.


An annuity is a financial product that you purchase from an insurance company. You make a lump sum payment or series of payments to set up the annuity, and the insurer promises to pay you a set amount each month once you retire. A lifetime annuity pays you benefits until your death, but you can also choose to receive payments for a fixed period of time. If you're married, you can set up the annuity to continue paying benefits to your spouse after you die. Annuities may be fixed, indexed or variable. A fixed annuity guarantees you a specific rate of return, while indexed and variable annuities are tied to market performance.

SEP IRA Withdrawals

A SEP IRA is always owned and controlled by the employee, which means you can begin taking out the money at any time. However, you'll owe ordinary income tax on your withdrawals. If you take out money before you turn 59 1/2, you'll also get hit with a 10 percent early withdrawal penalty, unless you qualify for an exemption. The IRS allows exemptions for distributions made if you become totally and permanently disabled; distributions made as a series of substantially equal periodic payments; and distributions made to you after a separation from service in the year you turn 55.

Annuity Withdrawals

If you purchased an annuity with after-tax dollars, the gains on your investment are taxable at your regular income tax rate when you take a withdrawal. The taxable portion of your monthly benefit is also subject to federal withholding, unless you specifically opt out. If you start receiving annuity payments before 59 1/2, you'll also get hit with a 10 percent penalty unless an exemption applies.

Annuity Pros and Cons

Annuities can offer you a steady stream of income in retirement and you can purchase one in addition to or independently of an employer's plan. An annuity allows you to enjoy tax-free growth, but you could end up paying more in fees and taxes than you would with other types of retirement vehicles.

SEP IRA Pros and Cons

You can also take advantage of tax-free growth through a SEP IRA, but the tax breaks end there since your employer gets the write-off for contributions. If you're self-employed, you can set up a SEP IRA for yourself and still get the deduction for any money you kick in.