Solo 401(k) vs SEP IRA: Key Differences and Considerations

Solo 401(k) vs SEP IRA: An In-Depth Comparison for Self-Employed Retirement Planning

Self-employment has its perks, but an employer-sponsored retirement plan isn’t one of them. Opening a solo 401(k) or a Simplified Employee Pension Individual Retirement Account (SEP IRA) allows the self-employed to save for retirement while enjoying some tax advantages.

So, which is better for you? The answer can depend largely on whether your business has employees or operates as a sole proprietorship and which plan yields more benefits, in terms of contribution limits and tax breaks.

Weighing the features of a solo 401(k) vs. SEP IRA can make it easier to decide which one is more suited to your retirement savings needs.

Understanding the Basics

A solo 401(k) is similar to a traditional 401(k), in terms of annual contribution limits and tax treatment. A SEP IRA follows the same tax rules as traditional IRAs. SEP IRAs, however, typically allow a higher annual contribution limit than a regular IRA.

What Is a Solo 401(k)?

A solo 401(k) covers a business owner who has no employees or employs only their spouse. Simply, a Solo 401(k) allows you to save money for retirement from your self-employment or business income on a tax-advantaged basis.

These plans follow the same IRS rules and requirements as any other 401(k). There are specific solo 401(k) contribution limits to follow, along with rules regarding withdrawals and taxation. Regulations also govern when you can take a loan from a solo 401(k) plan.

A number of online brokerages offer solo 401(k) plans for self-employed individuals, including those who freelance or perform gig work. You can open a retirement account online and start investing, no employer other than yourself needed.

If you use a solo 401(k) to save for retirement, you’ll also need to follow some reporting requirements. Generally, the IRS requires solo 401(k) plan owners to file a Form 5500-EZ if it has $250,000 or more in assets at the end of the year.

What Is a SEP IRA?

A SEP IRA is another option to consider if you’re looking for retirement plans for the self-employed. This tax-advantaged plan is available to any size business, including sole proprietorships with no employees. SEP IRAs work much like traditional IRAs, with regard to the tax treatment of withdrawals. They do, however, allow you to contribute more money toward retirement each year above the standard traditional IRA contribution limit. That means you could enjoy a bigger tax break when it’s time to deduct contributions.

If you have employees, you can make retirement plan contributions to a SEP IRA on their behalf. SEP IRA contribution limits are, for the most part, the same for both employers and employees. If you’re interested in a SEP, you can set up an IRA for yourself or for yourself and your employees through an online brokerage.

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Diving Deeper: Pros and Cons of Each Plan

As you debate between a solo 401(k) vs. a SEP IRA as ways to build wealth for retirement, it’s helpful to learn more about how these plans work, including their benefits and drawbacks.

Advantages of Solo 401(k)s

In terms of differences, there are some things that set solo 401(k) plans apart from SEP IRAs.

With a solo 401(k), you can choose a traditional or Roth. You can deduct your contributions in the year you make them with a traditional solo 401(k), but you’ll pay taxes on your distributions in retirement. With a Roth solo 401(k) you pay taxes on your contributions in the year you make them, and in retirement, your distributions are tax free. You can choose the plan that gives you the best tax advantage.

Another benefit of a solo 401(k) is that those age 50 and older can make catch-up contributions to this plan. In addition, you may be able to take a loan from a solo 401(k) if the plan permits it.

Advantages of SEP IRAs

One of the benefits of a SEP IRA is that contributions are tax deductible and you can make them at any time until your taxes are due in mid-April of the following year.

The plan is also easy to set up and maintain.

If you have employees, you can establish a SEP IRA for yourself as well as your eligible employees. You can then make retirement plan contributions to a SEP IRA on your employees’ behalf. (All contributions to a SEP are made by the employer only, though employees own their accounts.)

SEP IRA contribution limits are, for the most part, the same for both employers and employees. This means that you need to make the same percentage of contribution for each employee that you make for yourself. That means if you contribute 15% of your compensation for yourself, you must contribute 15% of each employee’s compensation (subject to contribution limits).

A SEP IRA also offers flexibility. You don’t have to contribute to it every year.

However, under SEP IRA rules, no catch-up contributions are allowed. There’s no Roth option with a SEP IRA either.

Eligibility and Contribution Limits

Here’s what you need to know about who is eligible for a SEP IRA vs. a Solo 401(k), along with the contribution limits for both plans for 2023.

Who Qualifies for a Solo 401(k) or SEP IRA?

Self-employed individuals and business owners with no employees (aside from their spouse) can open and contribute to a solo 401(k). There are no income restrictions on these plans.

SEP IRAs are available to self-employed individuals or business owners with employees. A SEP IRA might be best for those with just a few employees because IRS rules dictate that if you have one of these plans, you must contribute to a SEP IRA on behalf of your eligible employees (to be eligible, the employees must be 21 or older, they must have worked for you for three of the past five years, and they must have earned at least $750 in the tax year).

Plus, the amount you contribute to your employees’ plan must be the same percentage that you contribute to your own plan.

Contribution Comparison

With a solo 401(k), there are rules regarding contributions, including contribution limits. For 2023, you can contribute up to $66,000, plus an additional catch-up contribution of $7,500 for those age 50 and older. In 2024, you can contribute up to $69,000, plus an extra catch-up contribution of $7,500 for those age 50 and older.

For the purposes of a solo 401(k) you play two roles — employer and employee. As an employee, you can contribute the lesser of 100% of your compensation or up to $22,500 in 2023 and up to $23,000 in 2024. If you’re 50 or older, you can contribute the $7,500 catch-up contribution in 2023 and 2024 as well. As an employer, you can make an additional contribution of 25% of your compensation (up to $330,000 of compensation in 2023 and $345,000 in 2024) or net self-employment income.

The contribution limits for a SEP IRA are the lesser of 25% of your compensation or $66,000 in 2023 and $69,000 in 2024. As mentioned earlier, there are no catch-up contributions with this plan.

And remember, per the IRS, if you have a SEP IRA, you must contribute to the plan on behalf of your eligible employees. The amount you contribute to your employees’ plan must be the same percentage that you contribute to your own plan.

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Key Differences That Could Influence Your Decision

When you’re deciding between a solo 401(k) vs. a SEP IRA, consider the differences between the two plans carefully. These differences include:

Roth Options and Tax Benefits

With a solo 401(k), you can choose between a traditional and Roth solo 401(k), depending on which option’s tax benefits make the most sense for you. If you expect to be in a higher tax bracket when you retire, a Roth may be more advantageous since you can pay taxes on your contributions upfront and get distributions tax-free in retirement.

On the other hand, if you anticipate being in a lower tax bracket at retirement, a traditional solo 401(k) that lets you take deductions on your contributions now and pay tax on distributions in retirement could be your best option.

Loan Options and Investment Flexibility

You may also be able to take a loan from a solo 401(k) if your plan permits it. Solo 401(k) loans follow the same rules as traditional 401(k) loans.

If you need to take money from a SEP IRA before age 59 ½, however, you may pay an early withdrawal penalty and owe income tax on the withdrawal.

Both solo 401(k)s and SEP IRA offer more investment options than workplace 401(k)s. So you can choose the investment options that best suit your needs.

The Impact of Having Employees

Whether you have employees or not will help determine which type of plan is best for you.

A solo 401(k) is designed for business owners with no employees except for a spouse.

A SEP IRA is for those who are self-employed or small business owners. A SEP IRA may be best for those who have just a few employees since, as discussed above, you must contribute to a SEP IRA on behalf of all eligible employees and you must contribute the same percentage of compensation as you contribute for yourself.

The Financial Implications for Your Business

The plan you choose, solo 401(k) vs. SEP IRA, does have financial and tax implications that you’ll want to consider carefully. Here’s a quick comparison of the two plans.

Solo 401(k) vs SEP IRA at a Glance

Both solo 401(k) plans and SEP IRAs make it possible to save for retirement as a self-employed person or business owner when you don’t have access to an employer’s 401(k). And both can potentially offer a tax break if you’re able to deduct contributions each year.

Here’s a rundown of the main differences between a 401(k) vs. SEP IRA.

Solo 401(k)

SEP IRA

Tax-Deductible Contributions Yes, for traditional solo 401(k) plans Yes
Employer Contributions Allowed Yes Yes
Employee Contributions Allowed Yes No
Withdrawals Taxed in Retirement Yes, for traditional solo 401(k) plans Yes
Roth Contributions Allowed Yes No
Catch-Up Contributions Allowed Yes No
Loans Allowed Yes No

How These Plans Affect Your Bottom Line

Both solo 401(k)s and SEP IRAs are tax-advantaged accounts that can help you save for retirement. With a SEP IRA, contributions are tax deductible, including contributions made on employees’ behalf, which offers a tax advantage. Solo 401(k)s give you the option of choosing a traditional or Roth option so that you can pay tax on your contributions upfront and not in retirement (traditional), or defer them until you retire (Roth).

Making the Choice Between SEP IRA and Solo 401(k): Which Is Right for You?

An important part of planning for your retirement is understanding your long-term goals. Whether you choose to open a solo 401(k) or make SEP IRA contributions can depend on how your business is structured, how much you want to save for retirement, and what kind of tax advantages you hope to enjoy along the way.

When to Choose a Solo 401(k)

If you’re self-employed and have no employees (or if your only employee is your spouse), you may want to consider a solo 401(k). A solo 401(k) could allow you to save more for retirement on a tax-advantaged basis compared to a SEP IRA. A solo 401(k) allows catch-up contributions if you are 50 or older, and you can also take loans from a solo 401(k).

Just be aware that a solo 401(k) can be more work to set up and maintain than a SEP IRA.

When to Choose a SEP IRA

If you’re looking for a plan that’s easy to set up and maintain, a SEP IRA may be right for you. And if you have a few employees, a SEP IRA can be used to cover them as well as your spouse. However, you will need to cover the same percentage of contribution for your employees as you do for yourself.

Remember that a SEP IRA does not allow catch-up contributions, nor can you take loans from it.

Step-by-Step Guide to Opening Your Account

You can typically set up a SEP IRA with any financial institution that offers other retirement plans, including an online bank or brokerage. The institution you choose will guide you through the set-up process and it’s generally quick and easy.

Once you establish and fund your account, you can choose the investment options that best suit your needs and those of any eligible employees you may have. You will need to set up an account for each of these employees.

To open a Solo 401(k), you’ll need an Employee Identification Number (EIN). You can get an EIN through the IRS website. Once you have an EIN, you can choose the financial institution you want to work with, typically a brokerage or online brokerage. Next, you’ll fill out the necessary paperwork, and once the account is open you’ll fund it. You can do this through direct deposit or a check. Then you can set up your contributions.

Additional Considerations for Retirement Planning

Besides choosing a SEP IRA or a solo 401(k), there are a few other factors to consider when planning for retirement. They include:

Rollover Process

At some point, you may want to roll over whichever retirement plan you choose — or roll assets from another retirement plan into your current plan. A SEP IRA allows for either option. You can generally roll a SEP IRA into another IRA or other qualified plan, although there may be some restrictions depending on the type of plan it is. You can also roll assets from another retirement plan you have into your SEP.

A solo 401(k) can also be set up to allow rollovers. You can roll other retirement accounts, including a traditional 401(k) or a SEP IRA, into your solo 401(k). You can also roll a solo 401(k) into a traditional 401(k), as long as that plan allows rollovers.

Can You have Both a SEP IRA and a Solo 401(k)?

It is possible to have both a SEP IRA and a solo 401(k). However, how much you can contribute to them depends on certain factors, including how your SEP was set up. In general, when you contribute to both plans at the same time, there is a limit to how much you can contribute. Generally, your total contributions to both are aggregated and cannot exceed more than $66,000 in 2023 and $69,000 in 2024.

Preparing for Retirement Beyond Plans

Choosing retirement plans is just one important step in laying the groundwork for your future. You should also figure out at what age you can retire, how much money you’ll need for retirement, and the typical retirement expenses you should be ready for.

Working on building your retirement savings is an important goal. In addition to opening and contributing to retirement plans, other smart strategies include creating a budget and sticking to it, paying down any debt you have, and simplifying your lifestyle and cutting unnecessary spending. You may even want to consider getting a side hustle to bring in extra income.

The Takeaway

Saving for retirement is something that you can’t afford to put off. And the sooner you start, the better so that your money has time to grow. Whether you choose a solo 401(k), SEP IRA, or another savings plan, it’s important to take the first step toward building retirement wealth.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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Guide to Wealth Advisors & What They Do

Key Points

•   Wealth management advisors are professionals who offer personalized financial advice and services to individuals with significant assets.

•   These professionals assist clients with various aspects of their financial lives, including investment management, retirement planning, tax strategies, and estate planning.

•   Expertise in multiple areas, such as finance, accounting, and law, enables wealth management advisors to provide comprehensive guidance.

•   By closely collaborating with clients, wealth management advisors gain an understanding of their goals, risk tolerance, and financial situation to develop tailored strategies.

•   Engaging the services of a wealth management advisor grants individuals access to specialized knowledge, ongoing support, and a holistic approach to managing their wealth.

What Is a Wealth Advisor?

Wealth advisors are a subset of the greater financial advisor world, and they typically (but not exclusively) help high-net worth individuals or families manage their assets, and plan for the future.

There are many firms that offer wealth advisory services, including individual wealth management advisors running independent firms. And while their services often mirror or closely resemble those offered by others in the space — such as financial advisors or financial planners — the key difference is that a wealth advisor tends to offer those with high net worth holistic wealth management services.

Wealth advisors, or wealth management advisors, usually work with wealthy people or families with at least $1 million in liquid assets (i.e. not including property, businesses, trusts, and so on). Wealth management can be expensive, because the services are comprehensive, including but not limited to retirement planning, tax planning, estate planning, and investment management.

Wealth Manager vs Financial Advisor

Wealth manager, financial advisor, investment advisor, financial planner — there are many terms and titles in the financial services sector. Because of that, it can be helpful to know which specific type of financial service provider you’re looking for when you’re in need of guidance and advice.

Differences in certifications and licenses are one of the reasons there are so many terms and titles used to describe people who provide advice related to personal finances. So, it pays to do a little research to determine who would work best for you and your specific financial situation.

Wealth Manager vs Financial Advisor

Wealth Manager

Financial Advisor

Subset of financial advising Advise on financial plans or strategies
Usually work with high-earners or high-net-worth individuals Often sell products to earn commissions
Role is more comprehensive, and includes estate planning, tax consulting, and retirement planning Two common types: Financial Planners and Investment Advisors

What Do Wealth Advisors Do?

Wealth management is a subset of financial advising. Wealth managers tend to focus on managing the assets of high earners. A wealth manager’s role is generally far more comprehensive than offering just investment advice. While investment advisors and financial planners focus on one piece of your financial situation, wealth managers combine several areas of financial guidance.

It may be helpful to think of them as a quarterback with a team of professionals behind them, who can provide highly customized services and products.

They might place your assets in markets to enhance returns and shift them out when risk exceeds your comfort levels. Once the parameters are set, and the wealth manager understands your individual needs, you can focus your energy elsewhere.

They are able to provide financial advice that addresses the entirety of a person’s financial life, including investment management, accounting and tax strategy consulting, estate planning, retirement planning, and more. They work closely with you to establish a plan to grow and maintain wealth.

While wealth management is often thought of as a service only for the affluent, there are opportunities to get great advice, service, and solutions from a wealth advisor at very reasonable costs.

There are three areas a wealth advisor can help you:

Investment Management and Risk Management

A wealth advisor will work with you to assess your tolerance for risk and then provide an investment strategy to help you reach your financial goals. For example, if you’re beginning to plan for retirement early in your career, you may be more apt to take on risk than someone who may be nearing the end of their career and is much closer to retiring.

Part of any investment plan also includes managing risk over time. This includes having adequate insurance for your financial investments, and diversifying your portfolio to minimize risk.

💡 Learn more about investment risk.

Tax and Estate Planning

Wealth managers do not offer tax advice, but they can often coordinate with your attorney or accountant to strategize and minimize the taxes you owe by planning for tax efficiency.

Many wealth advisors can also help with estate planning strategies. Estate planning often involves more than just wills. For instance, there are advantages for setting up trusts, especially if you have dependents that will need caring for. Working with a wealth manager for estate planning can help get your affairs in order, and help avoid any surprises or legal snags for your family down the road.

Real Estate

If you own investment property, this is where the wealth manager vs financial advisor debate will be quite impactful. Wealth advisors usually have more experience and skills to help you manage portfolios with valuable real estate. Millions of Americans invest in real estate in one way or another — often by purchasing property, or shares of REITs — and choosing an advisor who can help with financial planning and real estate might make sense.

What Do Financial Advisors Do?

Financial advisor is the broadest of the terms. The phrase can describe anyone who advises you on a financial plan, investments, or tax strategy implications.

How much do these professionals cost? Be aware that some financial advisors are incentivized to recommend certain investments based on the fees they can earn. So, your first step should be to understand which type of financial advisor you’re looking for, as well as what the advisor charges.

Many young investors might not have a good understanding of what financial advisors do. But the two most common types are financial planners and investment advisors.

Financial Planners

It may be easiest to think of financial planners as “lifestyle planners.” They’re most suitable for helping you set up a budget, plan for tax time, save for retirement, or to plan your child’s college education. They should have completed professional requirements for their Certified Financial Planner™ practitioner designation.

Some, usually in larger companies, earn their keep by selling you financial products, rather than just advice or guidance. Those can include insurance, stocks, mutual funds, and more.

Fee-only financial planners don’t sell products, however, as they’re paid for their advice — per hour, or at a certain rate. Fee-based planners may charge a fee but also may earn a commission from certain products, like mutual funds.

It’s always wise to ask how any advisor is being compensated, as taxes and fees quickly eat into profits.

Investment Advisors

Investment advisors also encompass a range of financial professionals. Probably the biggest difference between a financial advisor and an investment advisor is that a Registered Investment Advisor has a fiduciary responsibility to put his or her client’s interests first. And as the name implies, they must register with the SEC, and are subject to various oversight and record keeping rules, among other obligations.

You can even look up individual advisors and review their credentials through a relatively simple internet search. Some financial planners are also Registered Investment Advisors (RIAs).

If you’re unsure of your advisor’s intentions, it’s always best to ask about their priorities before you start working with them. With an investment broker, for example, you’d want to know whether he or she has a fiduciary responsibility.

How Much Does a Wealth Advisor Cost?

As noted, wealth advisors may charge their clients on a fee-only basis, or as a percentage based on the total asset management load. Ultimately, what clients end up paying will vary drastically based on how much they’re actually putting under management — so, the more a wealth advisor is managing, the more a client might pay.

Fees can vary widely, and as noted above, some advisors are compensated in more than one way. For fee-only or flat-fee wealth advisors, the fees generally land somewhere between $7,500 and can be as high as $55,000 per year.

The typical wealth advisor charging on a percentage basis will likely levy a fee between 0.6% and 1.2%.

The point is that it’s up to the client to ascertain how their advisors charge for their services so they know what they’re paying, and what they’re paying for exactly.

Pros and Cons of Having a Wealth Advisor

Whether the expenses of hiring a wealth advisor, along with the hassle of finding the right person, may prove to be worth it in the end, there are no guarantees. As such, there are pros and cons to hiring a wealth advisor.

On the upside, wealth advisors can shoulder some of the burden of financial decision making, and properly manage one’s assets — which, if you have a lot to manage, can become like a full-time job in and of itself.

Wealth advisors can also act as a sounding board for clients to bounce ideas or strategies off of, offer support during difficult times (death in the family, etc.), and have plans and contingencies in place in case things don’t go to script.

As for some of the potential cons, it’s hard to overlook the expense. If you have a substantial amount of wealth, a 1% management fee can easily amount to tens of thousands of dollars every year.

For some people, it may be worth looking into automated investing platforms rather than hiring a professional. Automated investing, or robo advisors as they’re sometimes called, can be a low-cost way to manage a pre-set portfolio of exchange-traded funds (ETFs). These services are more limited however, and may be more suited to investors with fairly straightforward goals and situations.

It’s also important to note that not all wealth advisors act as fiduciaries, and may be looking to benefit themselves more than you as a client.

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4 Tips for Choosing a Wealth Advisor

If you’re interested in working with a wealth management advisor, it’s important to research options carefully before making a decision. Meeting with different financial professionals can give you an opportunity to ask questions about their background, experience and services, as well as the fees they charge.

These tips can help with selecting an advisor that meets your needs and goals as well as your budget.

1. Determine the Type of Wealth Advisor for You

Again, wealth management advisors aren’t identical when it comes to the types of clients they work with and the advisory services they offer. So, it’s important to consider which one is best suited for helping to guide money decisions.

A wealth management advisor can help you with financial-market investment guidance, some may specialize in taxes, real estate investments, or estate planning. Clarifying what you need and want from an advisor, based on where you are financially and where you want to end up, can help winnow your choices.

It is also important to know who the typical clientele of the wealth management advisor you are considering is. For instance, some advisors may prefer to work with clients who have a certain level of assets.

2. Research Their Credentials

It’s never a bad idea to do some background research on a professional you’re planning to hire, and the same logic applies to choosing a wealth management advisor. Specifically, that means looking at things such as:

•   How many years of experience they have

•   What types of clients they typically work with

•   What professional certifications or licenses they hold, if any

•   Whether they’ve ever been the subject of any disciplinary or legal action

There are several tools you can use to research a financial advisor’s background. The regulatory body known as FINRA, for instance, has a BrokerCheck Tool that allows you to explore the backgrounds of investment advisors who are registered with the Securities and Exchange Commission (SEC).

You can also look at registration information from the SEC, and your state’s securities agency.

3. How Much You Can Afford to Pay?

Not every advisor’s fee schedule will work with your budget, so it’s critical to know the distinction between fee-based and fee-only to understand how advisors structure their fees and what you’ll pay for their services.

You should be able to get a sense of what an advisor charges by reviewing their client brochure. A brochure is essentially a condensed version of Form ADV (which is used by advisors to register with federal and state securities authorities), which details the services an advisor offers, their fees, where they operate, any potential conflicts of interest that exist and past disciplinary or legal actions they were subject to, if any. You may be able to find both their Form ADV and their client brochure on an advisor’s website but they’re also required to furnish you with a copy upon request.

It may also be helpful to cast a wider net and look beyond traditional advisors. Using an online platform like SoFi Invest, for example, allows you to benefit from professional investment guidance without paying commissions, or advisory fees, but other fees apply.

4. Which Questions to Ask

Before committing to a wealth management advisor, take the time to interview them first. This vetting process can help with making a final decision about whether you want to pursue a professional relationship.

During this process, you should ask questions about their background and services. Specifically, consider posing these questions to any advisor you’re thinking of working with:

•   How long have you been a financial professional?

•   What certifications do you hold?

•   Which financial advisory services do you offer?

•   How are you paid for those services?

•   Are you a fiduciary financial advisor?

•   What type of client do you typically work with?

•   What is your approach to or strategy for financial planning?

•   How do you typically communicate with clients?

•   Will I work with anyone besides you? (To determine if the advisor is part of a financial services firm.)

•   Do you have any potential conflicts of interest?

•   Are there any past legal or disciplinary actions on your record?

Do I Need a Wealth Management Advisor?

There’s no right or wrong answer as to whether you need a wealth management advisor — it really comes down to whether you feel hiring one would ultimately be worth the expense, and take the burden of managing your assets and finances off of your shoulders.

Since wealth advisors tend to work with wealthier clientele, they often do provide those clients a valuable service.

That said, if you’re in a lower income bracket or don’t have a vast array of assets to stay on top of, another type of financial advisor may prove to be more beneficial. It really comes down to your specific situation, goals, time horizon, and budget. You can also check out SoFi’s Wealth Investing Guide to try and gauge your needs too.

The Takeaway

Wealth management advisors can help you navigate unforeseen hurdles and ease your investing worries. Plus, they can be a great asset when defining your financial goals, among many other things.

Hiring a wealth management advisor has its upsides, like having someone to discuss strategy with, and to help you keep a cool head and make wise financial decisions during trying times. But they can have their downsides, too, and can be expensive.

With all of that in mind, if you’re ready to prioritize investing and want some guidance, consider opening a SoFi Invest® brokerage account. SoFi offers an Active Investing platform, where investors can trade stocks and ETFs. For a limited time, funding an account gives you the opportunity to win up to $1,000 in the stock of your choice. All you have to do is open and fund a SoFi Invest account.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

Is a wealth advisor worth it?

A wealth advisor is worth it if the client feels that the amount they’re spending on the advisor’s service is getting them what they want. While a wealth advisor may not be worth it for everyone, depending on how wealthy you are, an advisor’s services could be invaluable.

What is the difference between a wealth advisor and a financial advisor?

A wealth advisor is a type of financial advisor, but one who tends to work with wealthier or high-earning clients, and who work to provide custom solutions to their clients’ wealth management issues. They’re more specialized, in many ways, than a financial advisor.

How rich do you need to be to have a financial advisor?

There’s not necessarily a minimum net worth needed to work with a financial advisor, but as a general guideline, once you have around $50,000 in assets, it may be a good idea to get in touch with one and explore the services they offer.


SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Claw Promotion: Customer must fund their Active Invest account with at least $10 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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What Is Compliance Testing for 401k?

What Is Compliance Testing for 401(k)?

To maintain the tax-advantages of a 401(k) or 403(b) retirement plan, employers must follow the rules established by the Employment Retirement Income Security Act (ERISA) of 1974, including nondiscrimination testing.

401(k) compliance testing ensures that companies administer their 401(k) plans in a fair and equal manner that benefits all employees, rather than just executives and owners. In other words, a 401(k) plan can’t favor one group of employees over another.

Companies must test their plans yearly and address any compliance flaws surfaced by the tests. Often a third-party plan administrator or recordkeeper helps plan sponsors carry out the tests.

Understanding nondiscrimination tests for retirement plans is important both as an employer and as an employee.

401(k) Compliance Testing Explained

Compliance testing is a process that determines whether a company is fairly administering its 401(k) plan under ERISA rules. ERISA mandates nondiscrimination testing for retirement plans to demonstrate that they don’t favor highly compensated employees or key employees, such as company owners. 401(k) compliance testing is the responsibility of the company that offers the plan.

How 401(k) Compliance Testing Works

Companies apply three different compliance tests to the plan each year. These tests look at how much income employees defer into the plan, how much the employer 401(k) match adds up to, and what percentage of assets in the plan belong to key employees and highly compensated employees versus what belongs to non-highly compensated employees.

There are three nondiscrimination testing standards employers must apply to qualified retirement plans.

•   The Actual Deferral Percentage (ADP) Test: Analyzes how much income employees defer into the plan

•   The Actual Contribution Percentage (ACP): Analyzes employers contributions to the plan on behalf of employees

•   Top-Heavy Test: Anayzes how participation by key employees compares to participation by other employees

The Actual Deferral Percentage (ADP) Test

The Actual Deferral Percentage (ADP) test counts elective deferrals of highly compensated employees and non-highly compensated employees. This includes both pre-tax and Roth deferrals but not catch-up contributions made to the plan. This 401(k) compliance testing measures engagement in the plan based on how much of their salary each group defers into it on a yearly basis.

To run the test, employers average the deferral percentages of both highly compensated employees and non-highly compensated employees to determine the ADP for each group. Then the employer divides each plan participant’s elective deferrals by their compensation to get their Actual Deferral Ratio (ADR). The average ADR for all eligible employees of each group represents the ADP for that group.

A company passes the Actual Deferral Percentage test if the ADP for the eligible highly compensated employees doesn’t exceed the greater of:

•   125% of the ADP for the group of non-highly compensated employees

OR

•   The lesser of 200% of the ADP for the group of non-highly compensated employees or the ADP for those employees plus 2%

The Actual Contribution Percentage (ACP) Test

Plans that make matching contributions to their employees’ 401(k) must also administer the Actual Contribution Percentage (ACP) test. Companies calculate this the same way as the ADP test but they substitute each participant’s matching and after-tax contributions for elective deferrals when doing the math.

This test reveals how much the employer contributes to each participant’s plan as a percentage, based on their W-2 income. Companies pass the Actual Contribution Percentage test if the ACP for the eligible highly compensated employees doesn’t exceed the greater of:

•   125% of the ACP for the group of non-highly compensated employees

OR

•   The lesser of 200% of the ACP for the group of non-highly compensated employees or the ACP for those employees plus 2%

Companies may run both the ADP and ACP tests using prior year or current-year contributions.

Top-Heavy Test

The Top-Heavy test targets key employees within an organization who contribute to qualified retirement plans. The IRS defines a key employee as any current, former or deceased employee who at any time during the plan year was:

•   An officer making over $215,000 for 2023 and over $220,000 for 2024

•   A 5% owner of the business OR

•   An employee owning more than 1% of the business and making over $150,000 for the plan year

Anyone who doesn’t fit these standards is a non-key employee. Top-heavy ensures that lower-paid employees receive a minimum benefit if the plan is too top-heavy.

Under IRS rules, a plan is top heavy if on the last day of the prior plan year the total value of plan accounts for key employees is more than 60% of the total value of plan assets. If the plan is top heavy the employer must contribute up to 3% of compensation for all non-key employees still employed on the last day of the plan year. This is designed to bring plan assets back into a fair balance.

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Why 401(k) Compliance Testing Is Necessary

401(k) compliance testing ensures that investing for retirement is as fair as possible for all participants in the plan, and that the plan continues to receive favorable tax treatment from the IRS. The compliance testing rules prevent employers from favoring highly compensated employees or key employees over non-highly compensated employees and non-key employees.

If a company fails a 401(k) compliance test, then they have to remedy that under IRS rules or risk the plan losing its tax-advantaged status. This is a strong incentive to fix any issues with non-compliant plans as it can cost employers valuable tax benefits.

Nondiscrimination testing can help employers determine participation across different groups of their workers. It can also shed light on what employees are deferring each year, in accordance with annual 401k plan contribution limits.

Highly Compensated Employees

The IRS defines highly compensated employees for the purposes of ADP and ACP nondiscrimination tests. Someone is a highly compensated employee if they:

•   Owned more than 5% of the interest in the business at any time during the year or the preceding year, regardless of how much compensation they earned or received,

OR

•   Received compensation from the business of more than $150,000 in 2023 and $155,000 in 2024 or $135,000 (if the preceding is 2022) and was in the top 20% of employees when ranked by compensation

If an employee doesn’t meet at least one of these conditions, they’re considered non-highly compensated. This distinction is important when compliance testing 401(k) plans, as the categorization into can impact ADP and ACP testing outcomes.

Non-Highly Compensated Employees

Non-highly compensated employees are any employees who don’t meet the compensation or ownership tests, as established by the IRS for designated highly compensated employees. So in other words, a non-highly compensated employee would own less than 5% of the interest in the company or have compensation below the guidelines outlined above.

Again, it’s important to understand who is a non-highly compensated employee when applying nondiscrimination tests. Employers who misidentify their employees run the risk of falling out of 401(k) compliance. Likewise, as an employee, it’s important to understand which category you fall into and how that might affect the amount you’re able to contribute and/or receive in matching contributions each year.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

How to Fix a Non-Compliant 401(k)

The IRS offers solutions for employers who determine that their 401(k) is not compliant, based on the results of the ADP, ACP or Top-Heavy tests. When a plan fails the ADP or ACP test, the IRS recommends the following:

•   Refunding contributions made by highly compensated employees in order to bring average contribution rates in alignment with testing standards

•   Making qualified nonelective contributions on behalf of non-highly compensated employees in order to bring their average contributions up in order to pass test

Employers can also choose to do a combination of both to pass both the ADP and ACP tests. In the case of the Top-Heavy test, the employer must make qualified nonelective contributions of up to 3% of compensation for non-highly compensated employees.

Companies can also avoid future noncompliance issues by opting to make safe harbor contributions. Safe harbor plans do not have to conduct ADP and ACP testing, and they can also be exempt from the Top-Heavy test if they’re not profit sharing plans. Under safe harbor rules, employers can do one of the following:

•   Match each eligible employee’s contribution on a dollar-for-dollar basis up to 3% of the employee’s compensation and 50 cents on the dollar for contributions that exceed 3% but not 5% of their compensation.

•   Make a nonelective contribution equal to 3% of compensation to each eligible employee’s account.

Safe harbor rules can relieve some of the burden of yearly 401(k) testing while offering tax benefits to both employers and employees.

The Takeaway

A 401(k) is a key way for employees to help save for retirement and reach their retirement goals. It’s important for employers to conduct IRS-mandated 401(k) compliance testing in order to ensure that their 401(k) plans are administered in a fair and equal manner that benefits all employees.

If you don’t have a 401(k) at work, however, or you’re hoping to supplement your 401(k) savings, you may want to consider opening an Individual Retirement Account (IRA) to help save for retirement. Since IRAs are not employer-sponsored, they’re not subject to 401(k) compliance testing, though they do have to follow IRS rules regarding annual contribution limits and distributions.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Easily manage your retirement savings with a SoFi IRA.

FAQ

What is top-heavy testing for 401(k)?

Top-heavy testing for 401(k) plans determine what percentage of plan assets are held by key employees versus non-key employees. If an employer’s plan fails the top-heavy test, they must make qualified, nonelective contributions on behalf of non-key employees in order to bring the plan into compliance.

What happens if you fail 401(k) testing?

If an employer-sponsored plan fails 401(k) compliance testing, the IRS requires the plan to make adjustments in order to become compliant. This can involve refunding contributions made by highly-compensated employees, making qualified nonelective contributions on behalf of non-highly compensated employees or a combination of the two.

What is a highly compensated employee for 401(k) purposes?

The IRS defines a highly compensated employee using two tests based on compensation and company ownership. An employee is highly compensated if they have a 5% or more ownership interest in the business or their income exceeds a specific limit for the year. Income limits are set by the IRS and updated periodically.


Photo credit: iStock/tumsasedgars

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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How Do You Cash Out Stocks? Guide to Selling Stocks

Buying stocks can be fairly straightforward, whether online or through a financial advisor. But, when it’s time to sell shares, some beginning investors struggle with how to turn their stocks back into cash. After all, money invested in stocks is not immediately cash.

Investors may want to sell stocks for a wide variety of reasons. They might wish to reinvest the cash into another asset with an eye toward long-term gains. Or they could choose to withdraw funds from the stock market to cover short-term, daily expenses with cash earned from the sale.

So, how might investors go about cashing out stocks? And, what factors might individuals curious about how to cash out stocks bear in mind? Here’s an overview of the how and when of selling stocks.

Key Points

•   Stocks can be cashed out by selling them through a broker on a stock exchange.

•   Selling stocks can provide cash for major expenses or to reinvest in other assets.

•   Steps to cash out stocks include determining investment goals, accessing a brokerage account, placing a sell order, waiting for the sale to be completed, and receiving the proceeds.

•   Motivations for selling stocks include accessing cash for expenses, cashing out profits, preventing significant losses, day trading, and offloading low-performing stocks.

•   Types of sell orders include market orders, limit orders, stop orders, and trailing sell stop orders.

Can You Cash Out Stocks?

Investors can cash out stocks by selling them on a stock exchange through a broker. Stocks are relatively liquid assets, meaning they can be converted into cash quickly, especially compared to investments like real estate or jewelry. However, until an investor sells a stock, their money stays tied up in the market.

What Happens When You Sell a Stock?

When you sell a stock for a higher price than you paid, the proceeds from the sale will include your original investment plus your gains and minus any fees. If you sold your stock at a lower price than you paid, the proceeds will include your original investment minus your losses and any fees.

How to Cash Out Your Stocks: 5 Steps

There are several steps involved in selling stocks, including the following:

1.    Determine your investment goals: Consider why you want to sell your stocks and whether it aligns with your overall investment goals.

2.    Access your brokerage account: You need to access or log in to your brokerage account to sell your stocks.

3.    Place an order to sell your stocks: Once you’re logged into your brokerage account, you can place a sell order (like the orders outlined below) to sell your stocks. You can choose to sell at a specific price or through a market order, which will sell the stocks at the current market price.

4.    Wait for the sale to be completed: After placing an order to sell your stocks, you will need to wait for the sale to be completed. This can take anywhere from a few seconds to several days, depending on market conditions and the type of order you have placed.

5.    Receive the proceeds from the sale: After the sale is completed, the proceeds from the sale will be deposited into your brokerage account or sent to you in the form of a check.

Motivations for Selling Stocks

Some investors watch their portfolios closely, selling stocks regularly to cash out profits or avoid significant losses.

However, one common reason investors decide to sell stocks is that they need the cash from the investments to pay for living expenses. While different investors might sell for various reasons, it can be helpful to understand the motivation that drives the desire to sell.

So, why might investors want to cash out stocks? Some common reasons could include the following:

Motivation for Selling Stocks

Accessing Cash for Life Expenses

If investors know they’ll need cash for a major life expense, such as buying a car or home, they may choose to cash out some stocks. Selling shares might ensure there’s enough cash around to cover big expenses.

One benefit to having cash on hand instead of having money invested in stocks is that cash is not subject to the ups and downs of the stock market. However, the value of cash is impacted over time by inflation.

Some investors might also opt to move money out of stocks into potentially more secure investments, such as bonds or a money market account, until they’re ready to pay for that large expense. This way, their money still earns interest while at a lower risk of losing value.

Cashing Out Profits

If it appears as though a recession is coming or investors have seen significant gains in their portfolio, they might choose to cash out to lock in the profits.

However, attempting to time the stock market to avoid losses during unstable economic conditions is risky. What seems to be a trend in the market one day may or may not indicate how the markets may perform in the future.

Investors may want to ask themselves whether they’re interested in cashing out based on an emotional reaction (fear of recent market ups and downs, for instance) or a need for profits.

Preventing Significant Losses

The goal of investing in stocks is to earn profits, not take losses. Still, there are some instances in which it could make sense to sell at a loss.

For example, an investor may sell specific stock holdings to prevent the likelihood of deeper losses in the future. Another scenario that might drive an investor to want to sell stocks is an industry-wide hardship, where numerous companies in one sector of the economy experience financial calamity at the same time. Industry-wide hardships may negatively impact the value of specific stock holdings.

In other instances, a company might reduce or eliminate shareholder dividends. Earning dividends may be a prime reason an investor bought the stock in the first place, so they decide to sell the stock because it’s no longer part of their investment strategy.

Day Trading

Day trading is one way of selling stocks, but it can carry significant risks. Day trades are the purchasing and selling (or vice versa) of the same stock on the same day. Here, traders are attempting to gain profit through short-term trades — typically through the use of technical or market analyses, which can require an in-depth knowledge of the intricacies of trading.

If it were possible to clearly predict future stock movements, everyone might want in on the stock market. But, stocks are volatile. Rather than guessing based on company news and technical indicators, traders who wish to make shorter term trades might choose to set a price goal. For instance, if they buy shares at $10 each, they could set a goal to sell them when they reach $18 per share.

Offloading Low Performing Stocks

Even if investors conduct thorough research on a company before buying a stock, they may later realize it wasn’t a boon for their portfolio. If a purchased stock continues to decline in value over time, investors may opt to offload the low-performing stock.

Also, some investors sell low-performing stocks at the end of the year for tax-loss harvesting, where investors sell investments at a loss to reduce their overall tax burden.

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Understanding Types of Sell Orders

Once an investor has decided to cash out a stock, there are several options for how to sell. Each comes with different amounts of control over the sale. Here’s an overview of the most common types of sell orders:

Understanding Types of Sell Orders

Market Orders

When placing a market order, an investor agrees to sell their shares at the current market price per share. The sell order will be placed immediately or when the market reopens if the order is placed after hours.

One upside of market orders is that the trade can usually be executed quickly. A downside is that the investor has no control over the selling price.

Limit Orders

With a limit order, however, an investor can set the minimum price they are willing to sell their shares for. The sell order only gets executed if and when the stock reaches that price or higher.

For example, if you want to sell a stock currently trading at $50 per share and place a sell limit order at $55, the order will only be filled if the stock price rises to $55 or above.

The upside of limit orders is that investors can control the selling price (and potentially get a higher price than the current market rate). But, one possible downside is that their order won’t go through instantly and, potentially, might never go through (if the stock doesn’t reach the selected price).

Stop Orders or Stop-Loss Orders

A stop-loss order is placed with a brokerage to automatically sell a security when it reaches a specific price, known as the stop price. The reason investors set stop orders is to prevent incurring significant losses if a stock plummets in value.

For example, if you own a stock currently trading at $50 per share and place a stop-loss order at $40, the order will be triggered, and the stock will be sold if the price falls to $40 or below.

The upside of stop orders is that they can help protect against significant losses if the stock price drops unexpectedly. However, stop-loss orders do not guarantee a specific price, and the actual sale price may differ from the stop price due to market fluctuations.

Trailing Sell Stop Orders

Investors may also choose to place a trailing sell stop order, which allows you to set a stop price for a security that adjusts automatically as the price of the security moves in your favor.

With a trailing sell stop order, you can set the initial stop price at a certain percentage or dollar amount below the market price. The stop price will then adjust automatically as the market price of the security increases so that the stop price remains a fixed percentage or dollar amount below the market price. If the market price of the security then falls and reaches the stop price, the order will be triggered, and the security will be sold.

Trailing sell stop orders may allow traders to benefit from gains when a stock’s price rises while still protecting themselves from potential losses.

Factors to Assess When Cashing Out Stocks

There are several factors that you should consider when cashing out stocks:

•   Capital gains taxes: Cashing out stocks may result in capital gains, which are subject to taxes. It is important to consider the tax implications of cashing out stocks. Not all stock holdings are taxed similarly, which could impact an investor’s decision to sell or not to sell.

•   Investment goals: Consider why you are cashing out stocks and whether it aligns with your overall investment goals. If you are cashing out stocks to meet a short-term financial need, selling may be necessary even if the stock price is not optimal. However, if you are cashing out stocks as part of a long-term investment strategy, it may be worth holding onto the stocks, even if they’ve declined in price, because they may still appreciate over time.

•   Fees and commissions: Brokerage firms generally charge investment fees and commissions for executing trades, which can impact the overall profit or loss on the sale of your stocks. Considering these fees and commissions is important when deciding whether to cash out stocks.

Pros and Cons of Reinvesting Profits

Investors may choose to sell stocks to gain or spend cash. But, individuals may want to reinvest earnings from the stocks sold into other assets. If investors decide to reinvest their profits, they need to consider the advantages and disadvantages of doing so.

Pros

Cons

Benefit from compound growth Lose out on opportunity to use profits for other financial needs
Diversify your portfolio Capital gains taxes
Hedge against inflation Exposure to market risk

Pros

•   Compound growth: Reinvesting stock profits allows you to compound your returns on your investments, which can significantly increase your overall returns over time.

•   Diversification: Reinvesting stock profits can help you diversify your portfolio and reduce risk by investing in various stocks rather than holding a lot of cash.

•   Hedge against inflation: Cash is subject to inflation, which makes cash savings lose value over time. Over a long-term period, cash tends to lose value, whereas the stock market tends to grow. By reinvesting rather than holding on to cash, investors may be less likely to lose money due to inflation.

💡 Recommended: 5 Tips to Hedge Against Inflation

Cons

•   Opportunity cost: Reinvesting stock profits means that you are not using the proceeds from the sale of your stocks to meet other financial goals or needs, such as paying off debt or saving for a down payment on a house.

•   Taxes: Reinvesting stock profits may result in capital gains tax, which can reduce the overall returns on your investments.

•   Market risk: The value of your investments can fluctuate due to market conditions, and reinvesting stock profits means you are exposed to the risks of the stock market.

Platforms for Buying and Selling Stocks

People just getting started with building a portfolio of stocks have several options. Options might include online platforms or traditional phone-in and in-person traders, including:

Online Brokerage Accounts

There are numerous online brokerage accounts and digital apps where investors can buy and sell stocks to build a portfolio. Online brokerage accounts and apps can be a convenient investment method, allowing users to sell from anywhere. Unlike many traditional brokerage firms, many trading apps don’t charge a commission on trades.

Opening a brokerage account will require identity verification and connection with a bank account for deposits and withdrawals.

Financial Advisors

Investors can also make stock trades over the phone or in person by working with a financial advisor. Sell orders placed through these individuals generally get executed within 24 hours, so it can be a slower method to cash out stocks. Before the arrival of web-driven trading, most stocks were bought and sold through traditional investment brokers or financial advisors.

The Takeaway

Before selling any stocks, investors might opt to evaluate their short- and long-term financial goals. Then, they could devise a plan to pursue those objectives, which may lead to cashing out stock holdings. However, knowing when to sell a stock can take time and effort. Rather than trying to time the market and sell stocks to lock in immediate profits and avoid future losses, individuals may want to invest for the long term.

Understanding how to navigate the stock market and decide when to cash out your stocks can be complicated. But that doesn’t mean the investing process needs to be confusing. By opening a SoFi Invest® online brokerage account, you can buy and sell stocks, exchange-traded funds (ETFs), fractional shares, and more with a few clicks of a button with no commissions. You can track your favorite stocks, stay up to date on the latest market news, and access educational resources, all in the SoFi app.

Take a step toward reaching your financial goals with SoFi Invest.

FAQ

How long does it take to cash out stocks?

The time it takes to cash out stocks can vary depending on the type of order you place and market conditions. Generally, it can take anywhere from a few seconds to several days for a sale of stocks to be completed.

Do you get money when you sell stock?

Yes, you will receive money when you sell stock. The proceeds from the stock sale will be deposited into your brokerage account or sent to you in the form of a check. The amount of money you receive will depend on the price you sell the stock and any fees or commissions charged by the brokerage firm.

Can I withdraw money from stocks?

To access cash from stocks, you need to sell your holdings and use the proceeds from the sale to withdraw cash from your brokerage account.


SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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Safe Harbor 401(k) Plan: What Is It? Is It for You?

Safe harbor 401(k) plans enable companies to avoid the annual IRS testing that comes with traditional 401(k) plans. With a safe harbor 401(k), an employer makes mandatory contributions to all employees’ retirement accounts, and those funds vest immediately.

Often a perk used to attract top talent, safe harbor 401(k) plans are a way for highly compensated employees, like company executives and owners, to save more than a traditional 401(k) plan would normally allow.

Keep reading to learn more about safe harbor rules, why companies use these plans, along with the benefits, drawbacks, and relevant deadlines.

Key Points

•   Like a traditional 401(k), a safe harbor 401(k) lets employees deposit tax-deferred funds from their paychecks into a retirement savings account.

•   Employers are required to contribute to employees’ safe harbor 401(k) accounts.

•   Employer contributions in a safe harbor 401(k) vest immediately. There is no waiting period.

•   Highly-paid employees can contribute more to a safe harbor 401(k) than a traditional 40(k).

•   Safe harbor 401(k) plans allow companies to skip the annual nondiscrimination regulatory testing required by the IRS for traditional 401(k)s.

What Is a Safe Harbor 401(k) Plan?

A 401(k) safe harbor plan is similar to a traditional 401(k) plan — but with a twist. In both cases, eligible employees can use the plan to contribute pre-tax funds to a retirement account and employers may contribute matching funds.

But with a traditional 401(k) retirement plan, companies must submit to annual nondiscrimination regulatory testing by the IRS to ensure that the company plan doesn’t treat highly compensated employees (HCEs) — generally defined as earning at least $150,000 in the 2023 tax year and $155,000 in the 2024 tax year and being in the company’s top 20% in pay, or owning more than 5% of the business — more favorably than others. The testing process is complex and can be a burden for some companies.

An alternative is to set up a safe harbor 401(k) plan with a safe harbor match. This allows a company to skip the annual IRS testing — and avoid imposing restrictions on employee saving — by providing the same 401(k) contributions to all employees, regardless of title, salary, or even years spent at the company. And those funds must vest immediately.

This is an important benefit, because in many cases, employer contributions to traditional 401(k) plans vest over time, requiring employees to stay with the company for some years in order to get the full value of the employer match. Often, if you leave before the employer contributions or match have vested, you may forfeit them.

For smaller companies, it may be worth making the extra safe harbor match contributions in order to avoid the time and expense of the IRS’s annual nondiscrimination testing. For larger companies, giving all employees the same percentage contribution could be expensive. But the upside is that highly paid employees can then make much larger 401(k) contributions without running afoul of IRS rules, a real perk for company leaders. In addition, 401(k) safe harbor plans are typically less expensive to set up than traditional plans.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

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*Offer lasts through Tax Day, 4/15/24. Only offers made via ACH are eligible for the match. ACATs, wires, and rollovers are not included.

Traditional 401(k) vs Safe Harbor 401(k) Plans

While safe harbor 401(k)s and traditional 401(k) plans are similar in many ways, there are some important differences that employers should be aware of.

For instance, with traditional 401(k) plans, contributions from highly compensated employees can’t comprise more than 2% of the average of all other employee contributions, in addition to other restrictions. However, with safe harbor 401(k) plans, those limits don’t apply.

Comparing Plan Features and Benefits

Here is a side-by-side comparison of a safe harbor 401(k) vs. a traditional 401(k)

Safe Harbor 401(k) Traditional 401(k)
Employer contributions are required. Employer contributions are optional.
Employer contributions are vested immediately. Employer contributions may vest over time.
Highly-paid employees can contribute up to the $22,500 maximum in tax year 2023 and up to $23,000 in 2024. Highly-paid employees can be limited in how much they can contribute.
Companies do not have to do annual nondiscrimination testing. Companies must do annual nondiscrimination testing.

Choosing the Right Plan for Your Business

A safe harbor plan may be beneficial for some smaller companies that can’t afford the expense of nondiscrimination testing. In addition, the plan is simpler with less administrative tasks.

A company might also choose a safe harbor 401(k) if it has some key high-earning employees that make up a large share of the workforce.

However, if your company is able to easily manage the nondiscrimination testing process, you may want to opt for a traditional 401(k). A traditional 401(k) could also be a good option for business owners who want to try to retain employees over the long-term. They could set up a vesting schedule for employer contributions that requires employees to be with the company for three years before becoming fully vested, for instance.

Setting Up a Safe Harbor 401(k) Plan

For employers interested in using a safe harbor 401(k), there are some general rules and guidelines they will need to follow.

Requirements, Contribution Formulas, and Deadlines

To fulfill the safe harbor 401(k) requirements, the employer must make qualifying 401(k) contributions (a.k.a. the safe harbor match) that vest immediately. The company contributes to employees’ retirement accounts in one of three ways:

•   Non-elective: The company contributes the equivalent of 3% of each employee’s annual salary to a company 401(k) plan, regardless of whether the employee contributes.

•   Basic: The company offers 100% matching for the first 3% of an employee’s 401(k) plan contributions, plus a 50% match for up to 5% of an employee’s contributions.

•   Enhanced: The company offers a 100% company match for all employee 401(k) contributions, up to 4% of a staffer’s annual salary.

Companies that opt for a safe harbor 401(k) plan have to adhere to strict compliance filing deadlines. These are the dates worth knowing.

October 1: That’s the deadline for filing for a safe harbor 401(k) for the current calendar year. This deadline meets the government criteria of a company needing to have a safe harbor 401(k) in operation for at least three months in a 12 month period, for the first year operating a safe harbor plan.

December 1: By this date, all companies — whether they’re rolling out a brand new safe harbor plan or are administering an existing one — must issue a formal notice to employees that a safe harbor 401(k) will be offered to company staffers.

January 1: The date that all safe harbor 401(k) plans are activated. For companies that currently have no 401(k) plan at all, they can roll out either a traditional 401(k) plan or a safe harbor 401(k) plan at any point in the year, for that calendar year.

Advantages of Implementing a Safe Harbor 401(k) Plan

Safe harbor 401(k)s offer some distinct upsides for business owners and employees alike.

Benefits for Employers and Employees

By creating a safe harbor 401(k) plan, a business owner can potentially attract and maintain highly skilled employees. Employees are attracted to higher retirement plan contributions and the ability to optimize retirement plan contribution amounts, ensuring more money for long-term retirement savings.

Plus, a safe harbor 401(k) plan can also help business owners save money on the compliance end of the spectrum. For example, companies save on regulatory costs by avoiding the costs of preparing for a nondiscrimination test (and the staff hours and training that goes with it).

There are some additional upsides to offering a safe harbor 401(k) retirement plan, for higher paid employees and regular staff too.

•   Playing catch up. If a company owner, or high-level managers, historically haven’t stowed enough money away in a company retirement plan, a safe harbor 401(k) plan can help them catch up. The same may be true, although to a lesser degree, for regular employees.

•   The spread of profit. Suppose a company has a steady and robust revenue stream and is managed efficiently. In that case, company owners may feel comfortable “spreading the wealth” with not only high-profile talent but rank-and-file employees, too.

•   Encourage retirement savings. If a company is seeing weak contribution activity from its rank-and-file employees, it may feel more comfortable going the safe harbor route and at least guaranteeing minimum 401(k) contributions to employees while rewarding higher-value employees with more lucrative 401(k) plan contributions.

Disadvantages of Safe Harbor Plans

Safe harbor 401(k) plans have their downsides, too. Here are some drawbacks to consider.

Financial Implications for Employers

The matching contribution requirements for safe harbor 401(k)s can add up to a hefty expense, depending on employee salaries. And because employees are vested immediately, there’s no incentive to stay with the company for a certain period.

In addition, if a company introduces a safe harbor 401(k) plan, it must commit to it for one calendar year, no matter how the plan is performing internally. Even after a year, 401(k) plan providers (which administer and manage the retirement plans) may charge a termination fee if a company decides to pull the plug on its safe harbor plan after one year.

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Safe Harbor 401(k) Contribution Limits and Match Types

There are some different rules for employer contribution limits and matching with a safe harbor 401(k) vs. a traditional 401(k).

Understanding Contribution Limits

Just like traditional 401(k) plans, the maximum employee contribution limit for a safe harbor plan is $22,500 in 2023 and $23,000 in 2024. If you are over 50, you would be eligible for an additional $7,500 catch-up contribution, if your plan allows it.

But in a safe harbor plan, a company owner can reserve the maximum $22,500 (in 2023) and $23,000 in 2024 for their plan contribution and also boost contribution payments to valued team members up to an individual profit-sharing maximum amount of 100% of their compensation, or $66,000 in 2023 ($73,500 for those over age 50) — whichever is less. In 2024, that number is $69,000 (76,500 for those over age 50).

Regular employees are allowed the standard maximum contribution limit of $22,500 in 2023 and $23,000 in 2024, plus anyone over age 50 can contribute an extra “catch-up” amount of $7,500. Those are the same maximum contribution ceilings as regular 401(k) plans.

Different Types of Employer Matching Contributions

As mentioned earlier, with a safe harbor 401(k), an employer must make qualifying 401(k) contributions that vest immediately in one of these ways:

•   Non-elective: The company contributes the equivalent of 3% of each employee’s annual salary to a company 401(k) plan.

•   Basic: The company matches 100% for the first 3% of an employee’s 401(k) plan contributions, plus a 50% match for the following 2% of their contributions.

•   Enhanced: The company provides a 100% company match for all employee 401(k) contributions, up to 4% of a staffer’s annual salary.

IRS Compliance Testing and Safe Harbor Provisions

To help understand the benefit of safe harbor plans, it helps to see what employers with traditional 401(k) plans face in terms of following IRS rules and submitting to the annual nondiscrimination tests.

Navigating Non-Discrimination Testing

Each year, a company must conduct Actual Deferral Percentage (ADP), Actual Contribution Percentage (ACP), and Top Heavy tests to confirm there is no compensation discrimination.

If the company fails one of the tests, it could mean considerable administrative hassle, plus the expense of making corrections, and potentially even refunding 401(k) contributions.

Before explaining the details of each test, here’s a refresher on how the IRS defines highly compensated employees (HCEs) and non-highly compensated employees (NHCEs).

To be a HCE:

•   The employee must own more than 5% of the company at any time during the current or preceding year (directly or through family attribution).

•   The employee is paid over $150,000 in compensation from the employer for 2023 and $155,000 in 2024. The plan can limit these employees to the top 20% of employees who make the most money.

Employees who don’t fit these criteria are considered non-highly compensated. The nondiscrimination tests are designed to assess whether top employees are saving substantially more than the rank-and-file staffers.

•   The Actual Deferral Percentage (ADP) test measures how much income highly paid employees contribute to their 401(k), versus staff employees.

•   The Actual Contribution Percentage (ACP) test compares employer retirement contributions to HCEs versus the contributions to everyone else.

According to the IRS, the terms of the ADP test — which compares the amounts different employees are saving in their 401(k)s — are met if the ADP for highly compensated employees (HCE) doesn’t exceed the greater of:

•   125% of the deferral percentage for ordinary, i.e., non-highly compensated employees (NHCEs)

Or the lesser of:

•   200% of the deferral percentage for the NHCEs

•   or the deferral percentage for the NHCEs plus 2%.

The ACP test is met if the deferral percentage for highly compensated employees doesn’t exceed the greater of:

•   125% of the deferral percentage for the NHCEs,

Or the lesser of:

•   200% of the deferral percentage for the group of NHCEs

•   or the deferral percentage for the NHCEs plus 2%.

Last, the top-heavy test measures the value of the assets in all company 401(k) accounts, total. If the 401(k) balances of “key employees” account for more than 60% of total plan assets, the 401(k) would fail the top heavy test. The IRS defines key employees somewhat differently than highly compensated employees, although both groups are similar in that they earn more than ordinary staff.

As you can see, maintaining a traditional 401(k) plan, and meeting these requirements each year, can be a burden for some companies. Fortunately, by setting up a safe harbor 401(k) plan, a company can avoid the annual nondiscrimination tests and still provide a 401(k) savings plan for employees.

The Takeaway

Companies that don’t want the regulatory obligations of a traditional 401(k) plan, and would like to prioritize talent acquisition and employee retention may want to consider safe harbor 401(k) plans.

However, a business owner needs to weigh the pros and cons of a safe harbor 401(k) plan because, in some cases, it can be expensive for a company to maintain.

But no matter what type of 401(k) an employer decides to go with, having a retirement plan in place, with different savings and investment options, can help employees — and business owners themselves — save for the future.

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FAQ

Is a safe harbor 401(k) worth it?

Whether a safe harbor 401(k) is worth it depends on the goals of the business owner. A safe harbor 401(k) allows a company to skip the expense of nondiscrimination testing. And by creating a safe harbor 401(k) plan, a business owner may be able to attract and maintain highly skilled employees because of the higher contributions. However, the matching employer contribution requirements can add up to a high expense. A business owner needs to weigh the pros and cons of these plans.

Can I cash out my safe harbor 401(k)?

You can withdraw safe harbor 401(k) funds without penalty at age 59 ½ or if you leave your job. However, hardship withdrawals for immediate and heavy financial need may be allowed in certain circumstances. You can learn more at irs.gov.

Why would a company use a safe harbor 401(k)?

A company might use a safe harbor 401(k) to avoid the expense of nondiscrimination testing and to simplify the administration of a 401(k) plan. They might also use a safe harbor 401(k) to help attract and keep highly skilled employees.

What is an example of a safe harbor 401(k) match?

If an employer with a safe harbor 401(k) chooses to offer non-elective matching contributions, that means they contribute at least 3% of each employee’s annual salary. So if an employee makes $70,000 a year, for example, the employer would contribute $2,100 to their safe harbor 401(k) account.


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