Mar
23
2023
Simple IRA vs. Traditional IRA

Is a SIMPLE IRA the Same as a Traditional IRA?

By | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off on Is a SIMPLE IRA the Same as a Traditional IRA?

One of the most popular retirement accounts is an IRA, or Individual Retirement Account. IRAs allow individuals to put money aside over time to save up for retirement, with tax benefits similar to those of other retirement plans.

Two common IRAs are the SIMPLE IRA and the Traditional IRA, both of which have their own benefits, downsides, and rules around who can open an account. For investors trying to decide which IRA to open, it helps to know the differences between SIMPLE IRAs and Traditional IRAs.

SIMPLE IRA vs Traditional IRA: Side-by-Side Comparison

Although there are many similarities between the two accounts, there are some key differences. This chart details the key attributes of each plan:

SIMPLE IRA Traditional IRA
Offered by employers Yes No
Who it’s for Small-business owners and their employees Individuals
Eligibility Earn at least $5,000 per year Under 70 ½ years old and earned income in the past year
Tax deferred Yes Yes
Tax deductible contributions Yes, for employers and sole proprietors only Yes
Employer contribution Required No
Fee for early withdrawal 10% plus income tax, or 25% if money is withdrawn within two years of an employer making a deposit 10% plus income tax
Contribution limits $15,500 in 2023 $6,500 in 2023
Catch-up contribution $3,500 additional per year for people 50 and over $1,000 additional per year for people 50 and over

SIMPLE IRAs Explained

The SIMPLE IRA, which stands for Savings Incentive Match Plan for Employees, is set up to help small-business owners help both themselves and their employees save for retirement. It’s a retirement plan that small businesses with fewer than 100 employees can offer employees who earn at least $5,000 per year.

A SIMPLE IRA is similar to a Traditional IRA, in that a plan participant can make tax-deferred contributions to their account, so that it grows over time with compound interest. When the individual retires and begins withdrawing money, then they must pay income taxes on the funds.

With a SIMPLE IRA, both the employer and the employee contribute to the employee’s account. Employers are required to contribute in one of two ways: either by matching employee contributions up to 3% of their salary, or by contributing a flat rate of 2% of the employee’s salary, even if the employee doesn’t contribute. With the matching option, the employee must contribute money first.

There are yearly employee contribution limits to a SIMPLE IRA: in 2023, the annual limit is $15,500, with an additional $3,500 in catch-up contributions permitted for people over age 50.

Benefits and Drawbacks of SIMPLE IRAs

It’s important to understand both the benefits and downsides of the SIMPLE IRA to make an informed decision about retirement plans.

SIMPLE IRA Benefits

There are several benefits — for both employers and employees — to choosing a SIMPLE IRA:

•   For employers, it’s easy to set up and manage, with online set-up available through most banks.

•   For employers, management costs are low compared to other retirement plans.

•   For employees, taxes on contributions are deferred until the money is withdrawn.

•   Employers can take tax deductions on contributions. Sole proprietors can deduct both salary and matching contributions.

•   For employees, there is an allowable catch-up contribution for those over 50.

•   For employers, the IRA plan providers send tax information to the IRS, so there is no need to do any reporting.

•   Employers and employees can choose how the money in the account gets invested based on what the plan offers. Options may include mutual funds aimed toward growth or income, international mutual funds, or other assets.

SIMPLE IRA Drawbacks

Although there are multiple benefits to a SIMPLE IRA, there are some downsides as well:

•   Employers must follow strict rules set by the IRS.

•   Other employer-sponsored retirement accounts have higher limits, such as the 401(k), which allows for $22,500 per year, as of 2023. (Check out our IRA calculator to see what you can contribute to each type of IRA.)

•   If account holders withdraw money before they reach age 59 ½, they must pay a 10% fee and income taxes on the withdrawal. That penalty jumps to 25% if money is withdrawn within two years of an employer making a deposit.

•   There is no option for a Roth contribution to a SIMPLE IRA, which would allow account holders to contribute post-tax money and avoid paying taxes later.

What Is a Traditional IRA?

The Traditional IRA is set up by an individual to contribute to their own retirement. Employers are not involved in Traditional IRAs in any way. The main requirements to open an IRA are that the account holder must have earned some income within the past year, and they must be younger than 70 ½ years old at the end of the year.

Pros and Cons of Traditional IRAs

When it comes to benefits and downsides, there’s not too much of a difference between Traditional vs. SIMPLE IRAs, given what an IRA is. That being said, there are a few that are unique to this type of plan.

Traditional IRA Pros

Some of the upsides of a Traditional IRA include:

•   It allows for catch-up contributions for those over age 50.

•   One can choose how the money in the account gets invested based on what the plan offers. Options may include mutual funds aimed toward growth or income, international mutual funds, or other assets.

•   Contributions are tax-deferred, so taxes aren’t paid until funds are withdrawn. If you’re hoping to pay taxes now instead of later, you might weigh a Traditional vs. Roth IRA.

Traditional IRA Cons

Meanwhile, downsides to a Traditional IRA include:

•   They have much lower contribution limits than a 401(k) or a SIMPLE IRA, at $6,500 per year as of 2023.

•   Penalties for early withdrawal are also the same: if you withdraw money before age 59 ½, you’ll pay a 10% fee plus income taxes on the withdrawal.

Is a SIMPLE IRA or Traditional IRA Right for You?

The SIMPLE IRA and Traditional IRA are both individual retirement accounts, but the SIMPLE is set up through one’s employer — typically a small business of 100 people or less. The Traditional IRA is set up by an individual. In other words, whether a SIMPLE IRA is an option for you will depend on if you have an employer that offers it.

There are many similarities in the attributes of the plans, if you’re choosing between a SIMPLE IRA vs. Traditional IRA. However, two major distinctions are that the SIMPLE IRA requires employer contributions (though not necessarily employee contributions) and allows for a higher amount of employee contributions per year.

Is your retirement piggy bank feeling light?

Start saving today with a Roth or Traditional IRA.

Can I Have Both a SIMPLE IRA and a Traditional IRA?

Yes, it is possible for an individual to have both a SIMPLE IRA through their employer and also a Traditional IRA on their own — though they may not be able to deduct all of their Traditional IRA contributions. The IRS sets a cap on deductions per calendar year.

Single people with an AGI (adjusted gross income) of more than $73,000 are restricted to a partial deduction; those with AGI above $83,000 may not take a deduction at all. Married couples filing jointly with an AGI of $116,000 to 136,000 may take a partial deduction; those with AGI above $136,000 may not take a deduction at all.

Can You Convert a SIMPLE IRA to a Traditional IRA?

If you’re hoping to convert a SIMPLE IRA to a Traditional IRA, you’re in luck — you can roll over a SIMPLE IRA into a Traditional IRA. However, you can’t roll over the funds from a SIMPLE IRA to a Traditional IRA within the first two years of opening a SIMPLE IRA. Otherwise, you’ll get hit with a 25% penalty in addition to the regular income tax you must pay on your withdrawal.

Once that two-year period is up, however, you can roll over the money from your SIMPLE IRA — even if you’re still working for that employer. Just note that you can only roll over money from a SIMPLE IRA one time within a 12-month period.

Can You Max Out a Traditional and SIMPLE IRA the Same Year?

While you cannot max out a SIMPLE IRA and another employer-sponsored retirement plan like a 401(k), you can max out both a Traditional IRA and a SIMPLE IRA.

The maximum contribution for a SIMPLE IRA in 2023 is $15,500 (plus $6,500 in catch-up contributions), while the maximum for a Traditional IRA is $3,500 (plus $1,000 in catch-up contributions). This means that you could contribute a total of $19,000 across both plans in a year — or $26,500 if you’re 50 or older.

Are SIMPLE IRAs Most Similar to 401(k) Plans?

There are a lot of similarities between SIMPLE IRAs and 401(k) plans given that they are both employer-sponsored retirement plans. However, while any employer with one or more employees can offer a 401(k), SIMPLE IRAs are reserved for employers with 100 or fewer employees. Additionally, contribution limits are lower with SIMPLE IRAs than with 401(k) plans.

Another key difference between the two is that while employers can opt whether or not to make contributions to employee 401(k), employer contributions are mandatory with SIMPLE IRAs. On the employer side, SIMPLE IRAs generally have fewer account fees and annual tax filing requirements.

Opening an IRA With SoFi

Understanding the differences between retirement accounts like the SIMPLE and Traditional IRA is one more step in creating a personalized retirement plan that works for you and your goals. While a SIMPLE IRA is only an option if your employer offers it, you’ll want to weigh the pros and cons of a SIMPLE IRA vs. Traditional IRA if both are on the table for you. As we’ve covered, the two types of IRAs share many similarities, but a SIMPLE IRA is not the same as a Traditional IRA.

If you’re looking to start saving for retirement now, or add to your investments for the future, SoFi Invest® online retirement accounts offer both Traditional and Roth IRAs that are simple to set up and manage. By opening an IRA with SoFi, you’ll gain access to a broad range of investment options, member services, and a robust suite of planning and investment tools.

Find out how to further your retirement savings goals with SoFi Invest.

FAQ

Can I have both a SIMPLE IRA and a Traditional IRA?

Yes, it is possible to have both. An individual could have a SIMPLE IRA through their employer and a Traditional IRA on their own.

Do you pay taxes on SIMPLE IRA?

Yes, you will pay taxes on a SIMPLE IRA, but not until you withdraw your funds in retirement. You’ll generally have to pay income tax on any amount you withdraw from your SIMPLE IRA in retirement. However, if you make a withdrawal prior to age 59 ½, or if money is withdrawn within two years of an employer making a deposit, you’ll have to pay income taxes then, alongside an additional tax penalty.

Is a SIMPLE IRA better than a Traditional IRA?

When comparing a SIMPLE IRA vs. traditional IRA, it’s important to understand that each has its pros and cons. If your employer offers a SIMPLE IRA, they require employer contributions, and they have higher contributions. At the end of the day, though, both allow you to save for retirement through tax-deferred contributions.

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.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. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
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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Mar
22
2023
What Is a Bitcoin Faucet? How Bitcoin Faucets Work

Guide to Bitcoin and Crypto Faucets

By | Growing Wealth, invest, Investing | Comments Off on Guide to Bitcoin and Crypto Faucets

A crypto faucet allows crypto users and investors earn small cryptocurrency rewards — basically free. Crypto faucets require users to perform small or simple tasks to earn rewards, but investors generally do not need to make a purchase or put up any additional assets in exchange.

The idea of earning free crypto may sound intriguing, but know that crypto faucets have been used in scams in years past. However, when used wisely they can be a way to increase your crypto holdings over the long term.

What Are Crypto Faucets?

Crypto faucets generally take the form of a website or app which gives out tiny amounts of cryptocurrency in exchange for completing simple tasks. The term “faucet” comes from the fact that the rewards are very small — like drops of water dripping from a faucet.

There are numerous types of crypto faucets, like Bitcoin faucets. A Bitcoin faucet, for example, sends small amounts of free or earned Satoshis or “sats” (the smallest unit of Bitcoin) to a user’s wallet. To claim these rewards, users typically have to perform a task such as:

•   Watching product videos

•   Viewing or clicking on advertisements

•   Completing a Captcha

•   Solving a puzzle

•   Playing a game

As payment for these tasks, users could receive a single Satoshi, which is one millionth of one Bitcoin (0.00000001 BTC). While that may sound like a very small drop in the bucket indeed, Bitcoin is still the oldest cryptocurrency (and by far the largest) on the market, and its value could increase over time. (Remember that past performance doesn’t guarantee future results.)

How Do Crypto Faucets Work?

Most crypto faucets are relatively easy to use. Sometimes, using one can be as simple as entering a public key address for your crypto wallet, clicking a few buttons, and receiving the coins or tokens. In general, the more complex the tasks required, the higher the rewards.

Keep in mind that some faucets tend to give out very small rewards — and it is unlikely that users will amass a large amount of crypto from them.

Faucets often have a web-hosted crypto wallet, which stores coins for users up until a certain threshold. To avoid transaction fees eating up most or all of the rewards, many crypto faucets have a minimum threshold that users must reach before they can withdraw the coins to their own wallet.

What Is the Point of Crypto Faucets?

A bit of context is required to fully understand why crypto faucets are a part of the crypto universe.

During the first few years after the creation of Bitcoin 2009, few people had heard of virtual currencies, let alone used them. And those who had couldn’t do much with their coins, as businesses did not accept Bitcoin for payment, and there were no opportunities for trading, because modern crypto exchanges didn’t exist yet.

Gavin Andresen, an early Bitcoin adopter, believed in the future of Bitcoin and devised a way for more people to learn about cryptocurrency. He offered free Bitcoins in exchange for completing Captchas.

In 2010, the first Bitcoin faucet ever created paid out 5 BTC in exchange for the simple task of clicking on images. This was, at a time, when one Bitcoin was worth less than a penny. Today, 5 BTC would be worth well into the six-figures.

As crypto and crypto faucets became more popular, the rewards fell to the smallest denominations possible. Faucets became an integral part of cryptocurrency history, as they helped get crypto into more people’s hands.

Up to $100 in bitcoin2 – just for you.

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Pros and Cons of Crypto Faucets

Crypto faucets have both benefits and drawbacks that investors should make note of:

Pros

 Cons
Free crypto Some faucets could be scams
Easy way to get started learning about crypto Small rewards
Anyone can use faucets Mindless tasks required

Pros of Crypto Faucets

•   The biggest pro of crypto faucets might be the free crypto. There aren’t many other ways to get crypto simply handed to you. Crypto airdrops also involve users receiving free crypto, but those are usually distributed to select users based on certain eligibility requirements.

•   Faucets are an easy way to get started with Bitcoin or other cryptocurrencies. There’s no real investment required beyond getting a crypto wallet and the time required to complete the task in question.

•   Faucets don’t require much knowledge or know-how to get started. Anyone can use them — you don’t need to know how to trade crypto to use a faucet.

Cons of Crypto Faucets

•   The amount of crypto earned is very small. As mentioned earlier, the reward could be as little as one Satoshi from a Bitcoin faucet, which is worth only a tiny fraction of a cent.

•   The tasks that a Bitcoin faucet will require can quickly get monotonous. How long will someone be willing to sit there and repeatedly complete a Captcha, after all?

•   The general risks associated with crypto also apply to faucets. Some can be types of crypto scams, phishing attempts, or ways to steal a user’s funds or identity. Some faucets could infect users’ devices with malware.

The lure of free money can be an effective way for hackers to compromise the devices or identity of potential users. The website or app might be phishing for information or download malware to a user’s device after having them click a link or download a file. Here are a few red flags that a crypto faucet is a scam:

◦   The rewards are too good to be true. If the rewards seem significantly higher than other faucet rewards, they are likely not legitimate.

◦   You’ve received an unsolicited offer. If you’ve received a faucet offer via email or message without asking for it, it could be from a scammer.

◦   Error-heavy messages. Multiple grammatical errors and misspellings could indicate the email is fraudulent.

Bitcoin Faucets

As noted, Bitcoin faucets were the original crypto faucet, as Bitcoin itself was the original cryptocurrency. As such, Bitcoin faucets are likely the most common on the market. Also as mentioned, Bitcoin faucets distribute BTC to users who are willing and able to complete certain tasks or activities.

Other Types of Crypto Faucets

It all began with a Bitcoin faucet many years ago, but today, there are crypto faucets for all types of different cryptocurrencies. Some of the most popular include Litecoin faucets, Ethereum faucets, and Dogecoin faucets.

Litecoin Faucets

A Litecoin faucet functions in the same manner as a Bitcoin faucet. The only difference is that the faucet distributes Litecoin (LTC) rather than Bitcoin (BTC).

To use Litecoin faucets, users will have to first set up a Litecoin wallet. Then it’s just a matter of choosing the highest-paying Litecoin faucet. Some faucets could pay up to 1,000 litoshis (the smallest units of Litecoin).

Ethereum Faucets

An Ethereum faucet is one that distributes ETH, the native token of the Ethereum network.

Ethereum faucets, like some other faucets, may also have referral bonuses. Users who refer their friends could get an extra faucet drip without having to do anything more.

When trying to withdraw funds, however, users could run into an issue: The Ethereum network tends to have very high transaction fees, known as gas fees. So, to send $2 worth of ETH to another wallet could easily cost more than the transaction itself.

Dogecoin Faucets

Dogecoin faucets have been popular since the meme cryptocurrency was first invented back in 2014. These faucets distribute Dogecoin (DOGE). Because DOGE has such a low value, larger portions of coins can come out of faucets.

When one DOGE was worth a fraction of a penny, faucets would distribute between one and five DOGE at a time. Today’s Dogecoin faucets mostly distribute anywhere from 0.1 to 1 DOGE at a time.

The Future of Crypto Faucets

The future of crypto faucets probably looks a lot like the past. These are basically fun apps for people who are new to crypto (as long as you’re careful). It gives individuals a way to get started learning how to interact with the cryptocurrency ecosystem without having to make an initial investment. Some modern or current crypto faucets even allow users to play games, making it a bit more fun to earn rewards.

But, keep in mind: No one keeps clicking on a faucet all day hoping to cash in on big rewards. In terms of today’s value, the typical crypto faucet pays out a tiny fraction of a cent each time, and there are often limits on the number of payouts a user can receive in a given timeframe.

Are There Any Real Crypto Faucets?

Yes, there are numerous real crypto faucets, but it may take a little time for users to do some research to make sure they’re not falling for a scam or some sort of fake faucet. A simple internet search for a desired, certain cryptocurrency faucet is likely to yield a list of results.

But again: It’s up to you, the user, to take a little time and make sure you don’t see any red flags that could indicate a faucet is a scam.

Other Ways to Make Money With Crypto

Crypto faucets are an option for earning crypto, or adding additional holdings to your portfolio. But, as mentioned, it’s a slow, tedious process. Here are some other ways to make money with crypto.

Investing

Investing is likely the most common or popular way that people make money with crypto, which more or less entails buying at one price, and selling it at a higher price. There are numerous ways to invest in crypto, however (even through retirement accounts), and the risks involved are significant — even more significant than investing in stocks.

Mining/Staking

You can also mine certain cryptocurrencies, like Bitcoin, or stake others, to earn even more crypto. Whether you can mine or stake crypto will depend on the specific cryptocurrency, but know that an increasing number of cryptos are moving to a proof-of-stake system (which allows for staking), as it’s generally more efficient and less resource-intensive.

Play to Earn

You can also try your hand at any number of play-to-earn crypto games, of which there are many. These games reward players or participants with tokens or NFTs for playing, which may or may not have value — they allow the player to participate in the in-game economy, though.

If any of these methods don’t strike your fancy, there are numerous ways to earn passive crypto income, too, such as lending, cloud mining, and running lightning nodes.

Buying Crypto With SoFi

Crypto faucets can give new users their first foray into the crypto world. They reward users with small amounts of crypto, though the actual amounts are often miniscule. Crypto faucets take advantage of the divisibility of cryptocurrencies, or their ability to be divided into many smaller units — and the potential for growth over time (although with crypto there is also considerable volatility).

There are numerous types of crypto faucets, such as Bitcoin faucets or Litecoin faucets. There are also many scams out there using the guise of crypto faucets in order to take advantage of unsuspecting users — which is important to keep in mind.

There are easier and more effective ways to get started investing in cryptocurrency. One of them is to open an account on the SoFi Invest® online brokerage platform. Beginners and experienced investors alike can use the Invest platform to buy and sell Bitcoin and several other top cryptocurrencies.

Trade crypto and get up to $100 in bitcoin! (Offer is available through 12/31/23; terms apply.)

FAQ

Are there any crypto faucets?

Yes, there are many crypto faucets out there. You should be able to find them through simple internet searches, but you’ll want to make sure you’re finding a faucet for the specific cryptocurrency you hope to accumulate through rewards.

Are crypto faucets legit?

Many crypto faucets are legit, but there are numerous scams out there — so, faucet users should proceed with caution.

Is using a crypto faucet profitable?

Crypto faucets are not really profitable. Though they do offer users “free” rewards in the form of tiny amounts of crypto, those amounts are often so tiny that they carry next to no value.

How can I get 1 Bitcoin for free?

It’s not likely that you’ll find anyone or anywhere that’s willing to give you a free Bitcoin as of 2023, given that a single Bitcoin’s value is more than $20,000, as of March 14, 2023.

Photo credit: iStock/Fabian19

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.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. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
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.
2Terms and conditions apply. Earn a bonus (as described below) when you open a new SoFi Digital Assets LLC account and buy at least $50 worth of any cryptocurrency within 7 days. The offer only applies to new crypto accounts, is limited to one per person, and expires on December 31, 2023. Once conditions are met and the account is opened, you will receive your bonus within 7 days. SoFi reserves the right to change or terminate the offer at any time without notice.

First Trade Amount Bonus Payout
Low High
$50 $99.99 $10
$100 $499.99 $15
$500 $4,999.99 $50
$5,000+ $100

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Mar
22
2023
401(k) Catch-Up Contributions: What Are They & How Do They Work?

401(k) Catch-Up Contributions: What Are They & How Do They Work?

By | invest, Investing, Preparing for Retirement | Comments Off on 401(k) Catch-Up Contributions: What Are They & How Do They Work?

Retirement savers age 50 and older get to put extra tax-advantaged money into their 401(k) accounts beyond the standard annual contribution limits. Those additional savings are known as “catch-up contributions.”

If you have a 401(k) at work, taking advantage of catch-up contributions is key to making the most of your plan, especially as retirement approaches. Here’s a closer look at how 401(k) catch-up limits work.

What Is 401(k) Catch-Up?

A 401(k) is a type of defined contribution plan. This means the amount you can withdraw in retirement depends on how much you contribute during your working years, along with any employer matching contributions you may receive, as well as how those funds grow over time.

There are limits on how much employees can contribute to their 401(k) plan each year as well as limits on the total amount that employers can contribute. The regular employee contribution limit is $22,500 for 2023. This is the maximum amount you can defer from your paychecks into your plan — unless you’re eligible to make catch-up contributions.

Under Internal Revenue Code Section 414(v), a catch-up contribution is defined as a contribution in excess of the annual elective salary deferral limit. As of 2023, the 401(k) catch-up contribution limit is $7,500.

That means if you’re eligible to make these contributions, you would need to put a total of $30,000 in your 401(k) in 2023 to max out the account. That doesn’t include anything your employer matches.

Congress authorized catch-up contributions for retirement plans as part of the Economic Growth and Tax Relief Reconciliation Act of 2001( EGTRRA). The legislation aimed to help older savers “catch up” and avoid falling short of their retirement goals, so they can better cover typical retirement expenses and enjoy their golden years.

Originally created as a temporary measure, catch-up contributions became a permanent feature of 401(k) and other retirement plans following the passage of the Pension Protection Act in 2006.

Who Is Eligible for 401(k) Catch-Up?

To make catch-up contributions to a 401(k), you must be age 50 or older and enrolled in a plan that allows catch-up contributions, such as a 401(k).

The clock starts ticking the year you turn 50. So even if you don’t turn 50 until December 31, you could still make 401(k) catch-up contributions for that year, assuming your plan follows a standard calendar year.

Making Catch-Up Contributions

If you know that you’re eligible to make 401(k) catch-up contributions, the next step is coordinating those contributions. This is something with which your plan administrator, benefits coordinator, or human resources director can help.

Assuming you’ve maxed out your 401(k) regular contribution limit, you’d have to decide how much more you want to add for catch-up contributions and adjust your elective salary deferrals accordingly. Remember, the regular deadline for making 401(k) contributions each year is December 31.

It’s possible to make catch-up contributions whether you have a traditional 401(k) or a Roth 401(k), as long as your plan allows them. The main difference between these types of plans is tax treatment.

•   You fund a traditional 401(k) with pre-tax dollars, including anything you save through catch-up contributions. That means you’ll pay ordinary income tax on earnings when you withdraw money in retirement.

•   With a Roth 401(k), regular contributions and catch-up contributions use after-tax dollars. This allows you to withdraw earnings tax-free in retirement, which is a valuable benefit if you anticipate being in a higher tax bracket when you retire.

You can also make catch-up contributions to a solo 401(k), a type of 401(k) used by sole proprietorships or business owners who only employ their spouse. This type of plan observes the same annual contribution limits and catch-up contribution limits as employer-sponsored 401(k) plans. You can choose whether your solo 401(k) follows traditional 401(k) rules or Roth 401(k) rules for tax purposes.

401(k) Catch-Up Contribution Limits

Those aged 50 and older can make catch-up contributions not only to their 401(k) accounts, but also to other types of retirement accounts, including 403(b) plans, 457 plans, SIMPLE IRAs, and traditional or Roth IRAs.

The IRS determines how much to allow for elective salary deferrals, catch-up contributions, and aggregate employer and employee contributions to retirement accounts, periodically adjusting those amounts for inflation. Here’s how the IRS retirement plan contribution limits for 2023 add up:

Retirement Plan Contribution Limits in 2023
Annual Contribution Catch Up Contribution Total Contribution for 50 and older
Traditional, Roth and solo 401(k) plans; 403(b) and 457 plans $22,500 $7,500 $30,000
Defined Contribution Maximum, including employer contributions $66,000 $7,500 $73,500
SIMPLE IRA $15,000 $3,500 $18,500
Traditional and Roth IRA $6,500 $1,000 $7,500

These amounts only include what you contribute to your plan or, in the case of the defined contribution maximum, what your employer contributes as a match. Any earnings realized from your plan investments don’t count toward your annual or catch-up contribution limits.

Also keep in mind that employer contributions may be subject to your company’s vesting schedule, meaning you don’t own them until you’ve reached certain employment milestones.

Recommended: How to Open Your First IRA

Tax Benefits of Making Catch-Up Contributions

Catch-up contributions to 401(k) retirement savings allow you to save more money in a tax-advantaged way. The additional money you can set aside to “catch up” on your 401(k) progress enables you to save on taxes now, as you won’t pay taxes on the amount you contribute until you withdraw it in retirement. These savings can add up if you’re currently in a high tax bracket, offsetting some of the work of saving extra.

The amount you contribute will also grow tax-deferred, and making catch-up contributions can result in a sizable difference in the size of your 401(k) by the time you retire. Let’s say you start maxing out your 401(k) plus catch-up contributions as soon as you turn 50, continuing that until you retire at age 65. That would be 15 years of thousands of extra dollars saved annually.

Those extra savings, thanks to catch-up contributions, could easily cross into six figures of added retirement savings and help compensate for any earlier lags in saving, such as if you were far off from hitting the suggested 401(k) amount by 30.

Roth 401(k) Catch-Up Contributions

The maximum amount you can contribute to a Roth 401(k) is the same as it is for a traditional 401(k): $22,500 and, if you’re 50 or older, $7,500 in catch-up contributions, as of 2023. This means that if you’re age 50 and up, you are able to contribute a total of $30,000 to your Roth 401(k) in 2023.

If your employer offers both traditional and Roth 401(k) plans, you may be able to contribute to both, and some may even match Roth 401(k) contributions. Taking advantage of both types of accounts can allow you to diversify your retirement savings, giving you some money that you can withdraw tax-free and another account that’s grown tax-deferred.

However, if you have both types of 401(k) plans, keep in mind while managing your 401(k) that the contribution limit applies across both accounts. In other words, you can’t the maximum amount to each 401(k) — rather, they’d share that limit.

The Takeaway

Putting money into a 401(k) account through payroll deductions is one of the easiest and most effective ways to save money for your retirement. To determine how much you need to put into that account, it helps to know how much you need to save for retirement. If you start early, you may not need to make catch-up contributions. But if you’re 50 or older, taking advantage of 401(k) catch-up contributions is a great way to turbocharge your tax-advantaged retirement savings.

Of course, you can also add to your retirement savings with an IRA. While a 401(k) has its advantages, including automatic savings and a potential employer match, it’s not the only way to grow retirement wealth. If you’re interested in a traditional, Roth, or SEP IRA, you can easily open a retirement account on the SoFi Invest® brokerage platform. If you’re age 50 or older, those accounts will also provide an opportunity for catch-up contributions.

Help grow your nest egg with a SoFi IRA.

FAQ

How does the 401(k) catch-up work?

401(k) catch-up contributions allow you to increase the amount you are allowed to contribute to your 401(k) plan on an annual basis. Available to those aged 50 and older who are enrolled in an eligible plan, these catch-contributions are intended to help older savers meet their retirement goals.

Who is eligible for 401(k) catch-up?

To make catch-up contributions to a 401(k) plan, you musts be at least 50 years old and enrolled in a plan that allows catch-up contributions.

What is the 401(k) catch-up amount in 2023?

For 2023, the 401(k) catch-up contribution limit is $7,500.

Photo credit: iStock/1001Love

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