Guide to Cash Balance Pension Plans

Guide to Cash Balance Pension Plans

A cash balance pension plan is a defined benefit plan that offers employees a stated amount at retirement. The amount of money an employee receives can be determined by their years of service with the company and their salary. Employers may offer a cash balance retirement plan alongside a 401(k) or in place of one.

If you have a cash balance plan at work, it’s important to know how to make the most of it when preparing for retirement. Read on to learn more about what a cash balance pension plan is and their pros and cons.

What Are Cash Balance Pension Plans?

A cash balance retirement plan is a defined benefit plan that incorporates certain features of defined contribution plans. Defined benefit plans offer employees a certain amount of money in retirement, based on the number of years they work for a particular employer and their highest earnings. Defined contribution plans, on the other hand, offer a benefit that’s based on employee contributions and employer matching contributions, if those are offered.

In a cash balance plan, the benefit amount is determined based on a formula that uses pay and interest credits. This is characteristic of many employer-sponsored pension plans. Once an employee retires, they can receive the benefit defined by the plan in a lump sum payment.

This lump sum can be rolled over into an individual retirement account (IRA) or another employer’s plan if the employee is changing jobs, rather than retiring. Alternatively, the plan may offer the option to receive payments as an annuity based on their account balance.

How Cash Balance Pension Plans Work

Cash balance pension plans are qualified retirement plans, meaning they’re employer-sponsored and eligible for preferential tax treatment under the Internal Revenue Code. In a typical cash balance retirement plan arrangement, each employee has an account that’s funded by contributions from the employer. There are two types of contributions:

•   Pay credit: This is a set percentage of the employee’s compensation that’s paid into the account each year.

•   Interest credit: This is an interest payment that’s paid out based on an underlying index rate, which may be fixed or variable.

Fluctuations in the value of a cash pension plan’s investments don’t affect the amount of benefits paid out to employees. This means that only the employer bears the investment risk.

Here’s an example of how a cash balance pension works: Say you have a cash balance retirement plan at work. Your employer offers a 5% annual pay credit. If you make $120,000 a year, this credit would be worth $6,000 a year. The plan also earns an interest credit of 5% a year, which is a fixed rate.

Your account balance would increase year over year, based on the underlying pay credits and interest credits posted to the account. The formula for calculating your balance would look like this:

Annual Benefit = (Compensation x Pay Credit) + (Account Balance x Interest Credit)

Now, say your beginning account balance is $100,000. Here’s how much you’d have if you apply this formula:

($120,000 x 0.05) + ($100,000 x 1.05) = $111,000

Cash balance plans are designed to provide a guaranteed source of income in retirement, either as a lump sum or annuity payments. The balance that you’re eligible to receive from one of these plans is determined by the number of years you work, your wages, the pay credit, and the interest credit.

Cash Balance Plan vs 401k

Cash balance plans and 401k plans offer two different retirement plan options. It’s possible to have both of these plans through your employer or only one.

In terms of how they’re described, a cash balance pension is a defined benefit plan while a 401k plan is a defined contribution plan. Here’s an overview of how they compare:

Cash Balance Plan

401k

Funded By Employer contributions Employee contributions (employer matching contributions are optional)
Investment Options Employers choose plan investments and shoulder all of the risk Employees can select their own investments, based on what’s offered by the plan, and shoulder all of the risk
Returns Account balance at retirement is determined by years of service, earnings, pay credit, and interest credit Account balance at retirement is determined by contribution amounts and investment returns on those contributions
Distributions Cash balance plans must offer employees the option of receiving a lifetime annuity; can also be a lump sum distribution Qualified withdrawals may begin at age 59 ½; plans may offer in-service loans and/or hardship withdrawals

Pros & Cons of Cash Balance Pension Plans

A cash balance retirement plan can offer both advantages and disadvantages when planning your retirement strategy. If you have one of these plans available at work, you may be wondering whether it’s worth it in terms of the income you may be able to enjoy once you retire.

Here’s more on the pros and cons associated with cash balance pension plans to consider when you’re choosing a retirement plan.

Pros of Cash Balance Pension Plans

A cash balance plan can offer some advantages to retirement savers, starting with a guaranteed benefit. The amount of money you can get from a cash balance pension isn’t dependent on market returns, so there’s little risk to you in terms of incurring losses. As long as you’re still working for your employer and earning wages, you’ll continue getting pay credits and interest credits toward your balance.

From a tax perspective, employers may appreciate the tax-deductible nature of cash balance plan contributions. As the employee, you’ll pay taxes on distributions but tax is deferred until you withdraw money from the plan.

As for contribution limits, cash balance plans allow for higher limits compared to a 401k or a similar plan. For 2022, the maximum annual benefit allowed for one of these plans is $245,000.

When you’re ready to retire, you can choose from a lump sum payment or a lifetime annuity. A lifetime annuity may be preferable if you’re looking to get guaranteed income for the entirety of your retirement. You also have some reassurance that you’ll get your money, as cash balance pension plans are guaranteed by the Pension Benefit Guaranty Corporation (PBGC). A 401k plan, on the other hand, is not.

Cons of Cash Balance Pension Plans

Cash balance pension plans do have a few drawbacks to keep in mind. For one, the rate of return may not be as high as what you could get by investing in a 401k. Again, however, you’re not assuming any risk with a cash balance plan so there’s a certain trade-off you’re making.

It’s also important to consider accessibility, taxation, and fees when it comes to cash balance pension plans. If you need to borrow money in a pinch, for example, you may be able to take a loan from your 401k or qualify for a hardship withdrawal. Those options aren’t available with a cash balance plan. And again, any money you take from a cash balance plan would be considered part of your taxable income for retirement.

Pros Cons

•   Guaranteed benefits with no risk

•   Tax-deferred growth

•   Flexible distribution options

•   Higher contribution limits

•   Guaranteed by the PBGC

•   Investing in a 401k may generate higher returns

•   No option for loans or hardship withdrawals

•   Distributions are taxable

Investing for Retirement With SoFi

A cash balance retirement plan is one way to invest for retirement. It can offer a stated amount at retirement that’s based on your earnings and years of service. You can opt to receive the funds as either a lump sum or an annuity. Your employer may offer these plans alongside a 401k or in place of one, and there are pros and cons to each option to weigh.

If you don’t have access to either one at work, you can still start saving for retirement with an IRA. You can set aside money on a tax-advantaged basis and grow wealth for the long-term. If you’re ready to open an IRA, compare your retirement account options with SoFi today.

FAQ

Is a cash balance plan worth it?

A cash balance plan can be a nice addition to your retirement strategy if you’re looking for a source of guaranteed income. Cash balance plans can amplify your savings if you’re also contributing to a 401k at work or an IRA.

Is a cash balance plan the same as a pension?

A cash balance plan is a type of defined benefit plan or pension plan, in which your benefit amount is based on your earnings and years of service. This is different from a 401k plan, in which your benefit amount is determined by how much you (and your employer) contribute and the returns on those contributions.

Can you withdraw from a cash balance plan?

You can withdraw money from a cash balance plan in a lump sum or a lifetime annuity once you retire. You also have the option to roll cash balance plan funds over to an IRA or to a new employer’s qualified plan if you change jobs.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. 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 pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
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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Retirement Planning for Independent Contractors

Retirement Planning for Independent Contractors

There are several retirement plans for independent contractors, consultants, and freelancers that can help you build up a nest egg for retirement, including a SEP IRA, traditional or Roth IRA, and solo 401(k).

While you may have to do some research to determine the best options for your needs, there’s a benefit to having the freedom to invest your money the way you want, without being constrained by an employer-sponsored plan. That said, since you can’t count on the convenience of a larger company plan, it’s important to be proactive.

Fortunately, these accounts are easy to understand — and these days they’re typically straightforward to set up. Here are some retirement savings options and how they can help you, as a contractor or freelancer, plan for a well-funded future.

Types of Retirement Plans for Independent Contractors

There are a number of tax-advantaged independent contractor retirement plans worth considering — even one that could be considered an independent contractor 401k! However, there is no one-size-fits-all solution, so it’s wise to weigh all of your options.

Bear in mind: Once you’ve set up your chosen retirement plan — e.g. an IRA for independent contractors or another option — you’ll need to select the investments that will populate your account. In other words, you’ll build a tax-advantaged portfolio that may include mutual funds, exchange-traded funds (ETFs), target funds or other investments.

All retirement plans come with rules and restrictions. If you need additional guidance, speak with a financial planner who can answer your questions.

Roth IRA

What is the best IRA for independent contractors? There are two types of individual retirement accounts or IRAs that are suitable for independent contractors, consultants, and freelancers: a Roth IRA and a traditional IRA. These accounts have some similarities: Both types of IRAs require you to have earned income. Also, you can’t contribute more than your taxable income. So, if you make $5,000 per year, you can only contribute this amount.

In terms of contribution limits: For 2021 and 2022, both types of IRA let you contribute up to $6,000 per year, plus an extra $1,000 if you’re over 50 years old (often called the catch-up contribution).

Now for some differences:

Tax treatment

With Roth IRAs, you pay income taxes on the money you deposit (so contributions are considered after-tax). Your money grows tax free. And you don’t have to pay income taxes on the money you withdraw in retirement; Roth withdrawals are tax free.

Early withdrawal rules

If you need to take a distribution before retirement, Roth IRA contributions can be withdrawn at any time without tax or penalty, for any reason at any age. However, this only applies to the funds you contributed, i.e. your actual deposits, not any earnings.

Investment earnings on those contributions can typically be withdrawn, tax-free and without penalty, once the investor reaches the age of 59 ½, as long as the account has been open for at least a five-year period.

Income limits

Also, Roth IRAs come with certain income limits, meaning you must make less than a certain amount to be eligible to contribute to a Roth. For example, for folks that file their taxes as a single head of household, you must have an adjusted gross income (AGI) less than $129,000 in 2022 to contribute the full amount. Folks married and filing jointly must have an AGI of less than $204,000 to contribute the full amount.

If your AGI is higher (e.g. up to $144,000 for single filers; up to $214,000 for married filing jointly), you may be able to contribute a reduced amount. Be sure to consult IRS rules.

Required Minimum Distributions (RMDs)

In most cases, you do not have to take required minimum distributions on money in a Roth IRA account. However, for inherited Roths, IRA withdrawal rules mandate that you do take RMDs.

Traditional IRA

A traditional IRA is quite different from a Roth IRA in terms of its tax treatment, income limits, and withdrawal rules.

Tax treatment

First, the money you save in a traditional IRA is considered pre-tax, meaning your contributions are tax deductible. However, when you take distributions in retirement, a.k.a. withdrawals, you will have to pay ordinary income taxes on that money (unlike a Roth, where withdrawals are tax free).

Early withdrawal rules

Also, if you decide to take a distribution from your IRA before you reach age 59 ½, which qualifies as an early withdrawal, you will have to pay a 10% penalty in addition to any taxes you owe. However, in some cases you may be able to withdraw or borrow money without paying a 10% penalty.

Required Minimum Distributions (RMDs)

Although you can take withdrawals from your IRA any time after age 59 ½, you are required to start taking withdrawals the year you turn 72. This is similar to the RMD rules for 401ks. After that, you have to take distributions each year, based on your life expectancy. If you don’t take the RMD, you’ll owe a 50% penalty on the amount that you did not withdraw.

Because RMDs can be complicated, and the penalty for any mixups or mistakes can be high, you may want to consult a professional.

Simplified Employee Pension or SEP IRA

For independent contractors who want or intend to save more than the contribution limits for traditional and Roth IRAs above, a SEP IRA could be ideal. A SEP IRA plan is less expensive to set up, and can also work for companies with a few employees.

Similar to a traditional IRA, contributions to a SEP IRA are tax-deductible, and when you take distributions in retirement, you must pay ordinary income on the total distribution amount.

But the amount you can save is a big selling point: With a SEP IRA, you can contribute up to 25% of the net profits of your business per year or $61,000, whichever is less. Like other retirement plans for independent contractors, a SEP IRA sets a compensation limit of $305,000 for contributions.

As with a traditional IRA, you pay a 10% penalty for any withdrawals you make prior to age 59 ½, unless one of the usual exceptions applies — death, disability, medical expenses, and so on. It’s easy to open a SEP with most financial institutions — including SoFi Invest®.

In more good news: Contributing to a SEP IRA doesn’t prevent you from also saving in a Roth IRA, as long as your income is under the Roth income limits.

To establish a SEP IRA, you must choose a financial institution that can act as a trustee and keep the plan assets safe. Your financial insulation should be able to walk you through the next steps.

Savings Incentive Match Plan for Employees or SIMPLE IRA

A Savings Incentive Match Plan for Employees, also known as a SIMPLE IRA, is intended for businesses with fewer than 100 employees.

If you’re your own boss and self-employed, you can set one up for yourself.

SIMPLE IRAs are relatively easy to put in place, since they have no filing requirements for employers. Employers cannot offer another retirement plan in addition to offering a SIMPLE IRA.

The business is not solely responsible for all contributions with a SIMPLE IRA. The employees can also contribute a portion of their salary to their accounts.

The employer’s contribution

When an employer sets up a SIMPLE IRA plan they are required to contribute to it for their employees. There are two options:

•   The employer can make matching contributions of up to 3% of an employee’s compensation

•   They can make a nonelective contribution of 2% for each eligible employee, up to an annual limit of $305,000 in 2022.

If the employer chooses the latter, they must contribute to their employees’ accounts, even if the employees don’t contribute themselves (i.e. the contributions are nonelective). Contributions to employee accounts are tax deductible.

The employee contribution

In 2022, eligible employees can make SIMPLE IRA contribution limits up to $14,000. Those over age 50 can contribute an extra $3,000 in catch-up contributions (for a total of $17,000).

Like other retirement plans for independent contractors, there is a 10% early withdrawal penalty if you take money out of your account before you reach age 59 ½. If you take out money within the first two years of opening the plan, the penalty increases to 25%.

Solo 401k

Wondering if there’s an independent contractor 401k? Effectively yes: Solo 401k plans are similar to employer-sponsored 401ks, except they are intended for one participant. Usually, these plans are limited to independent contractors. However, their spouses might qualify for participation if they work part-time for you.

In 2022, you can contribute up to $61,000 per year with a catch-up contribution of $6,500 if you’re 50 or older. However, with a solo 401k, you will be treated as the employee and employer. Therefore, you can contribute up to $20,500 as an employee. As the employer, you can contribute up to 25% of your adjusted gross income to $61,000.

As long as you net profits as an independent contractor and don’t have other employees you are likely eligible for a solo 401(k).

Choosing the Right Plan for You

All independent contractors have different financial goals and situations. Therefore, different plans may be more suitable than others.

When it comes to getting your retirement on track, it’s important to weigh the various benefits and drawbacks of each type of plan.

For example, a solo 401k has higher potential tax savings and contributions limits than an IRA since you can contribute significantly more to this account. Also, solo 401ks come with features you may find with employer-sponsored 401k plans, such as the ability to take loans ($50,000 or 50% of your account balance, whichever is less) Also, you have a Roth option which gives you the option to pay your taxes now instead of during retirement.

On the other hand, if you plan to grow your business in the future and add employees, a SEP IRA may make the most sense. Switching from a solo 401k to a SEP can be a big headache. So starting with a SEP IRA may be the best solution for employee growth. SEP IRAs let you add employees. However, SEP rules state that you must contribute an equal percentage to their retirement accounts like yours. So, this is an extra consideration when planning for the future.

Also, speaking with a financial professional can help you pinpoint the best solution for the long haul.

Investing for Retirement With SoFi

There are many different retirement plans for independent contractors. However, it’s up to you to determine what makes the most sense for your needs and long-term goals. You may want to review contribution limits, eligibility requirements, and distributions rules to find the most suitable plan for your retirement savings — whether that’s a traditional IRA, Roth IRA, SIMPLE IRA, SEP IRA, or solo 401k.

Traditional and Roth IRAs have lower contribution limits than the other plans, but they may be simpler to manage. SIMPLE and SEP IRAs allow you to save more of your pre-tax income (and thus reduce your taxable income) — and these accounts can be used if you have additional employees besides yourself. A solo 401k is one you managed as an independent contractor, but it can offer features that are similar to a company plan.

Whichever route you choose, don’t wait. As an independent contractor, consultant, freelancer, or small business owner, your future is in your hands. Fortunately, it’s easy to open an Active Invest account with SoFi Invest®, and start to grow your retirement savings with a Roth, SEP, or traditional IRA account. With SoFi Invest, you can access a wide range of investment options, as well as member features, and a comprehensive array of planning and investment tools.

Also: SoFi members have complimentary access to financial professionals who can help answer your questions. Take the next step toward a secure future today.

FAQ

Can independent contractors have a 401k?

Yes. Independent contractors can open a solo 401k, designed for individuals instead of companies. This account offers a lot of the same benefits and flexibility as an employer-sponsored 401k, such as a Roth option and the ability to take out a loan.

How do independent contractors save for retirement?

Independent contractors don’t have the convenience of relying on an employer-sponsored plan. Fortunately, there are several good options for saving for retirement when you’re an independent contractor, consultant, or freelancer: including SEP IRAs, traditional IRAs, Roth IRAs, or solo 401(k)s. There can be substantial tax benefits for independent contractors who use one or more of these plans, so it’s wise to be proactive.

What is the best retirement plan for 1099 employees?

The best retirement plan for a 1099 employee depends on your unique situation and financial goals. For example, a solo 401k might be suitable for someone who wants to contribute a significant amount and capitalize on a higher tax advantage. Whereas a SEP IRA might be better for someone who wants to add employees to their business down the line.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. 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 pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.

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Calculating Margin for Stock Trading

Calculating Margin for Stock Trading

Margin allows you to buy securities with borrowed funds. Traders find several margin balances when they open a margin trading account. It can be overwhelming trying to calculate and understand each one, but having a grasp on these figures can help you control risk and manage your profit and losses.

A stock margin calculator can help you know your margin requirements and balances. Learn more about how to calculate margin in a stock trading account.

How to Calculate Margins on Trades

Margin requirement calculators can help you track your margin levels and determine how much interest you might owe. Since trading on margin involves borrowing money, you owe margin interest that accrues daily.

A stock margin calculator also allows you to see the impact financial transactions can have on your margin balances and margin requirements. You can see how the numbers change by plugging in hypothetical buys, sells, deposits, and withdrawals.

With a margin loan, you can borrow money from your broker for any purpose, but you will owe interest on the loan based on the borrowing rate. Of course, you will also need the greater of either the $2k minimum margin requirement or 50% of the security’s purchase price in your account to buy on margin. For example, if you were to purchase 10 shares of a stock trading at $30, 50% is $1,500. However, since that is less than $2,000, you’ll need to deposit $2,000 in order to purchase the 10 shares on margin. Conversely, if you wanted to purchase 10 shares of a stock selling for $50, 50% is $2,500. In this case you would need to deposit $2,500, not $2,000, in order to make your purchase on margin.

Calculating Initial Margin

Initial margin refers to the percentage of the purchase price of a security on which the trader must use their own money — typically, at least 50%. This margin rate is set by Federal Reserve Board Regulation T. Some brokers might have stricter initial margin requirements, forcing traders to have a larger percentage of cash to establish positions.

An initial margin requirement is a straightforward calculation. It is the number of shares multiplied by the stock price multiplied by the margin rate.

Initial margin requirement = number of shares x stock price x margin rate

For example, let’s say you want to buy 100 shares of XYZ stock priced at $90 per share, with a 50% initial margin requirement. When you enter the long stock trade, the margin requirement is 100 x $90 x 50% = $4,500. The value of the long stock position is $9,000, so you only need $4,500 of equity to open that $9,000 stake.

In that example, you would need $4,500 to purchase 100 shares of XYZ stock — that is the initial margin requirement. The maximum loan value is 100 shares x $90 x 50% = $4,500. Your margin excess is $4,500.

Calculating Maintenance Margin

Once you own shares, there is a maintenance margin requirement which is often less than the initial margin amount. Maintenance margin is the minimum amount of equity a trader needs to keep in their account to continue to hold positions. Reg T sets this amount at 25%, but many brokerage firms have stricter maintenance margin rates to protect themselves against investors defaulting on their margin loans. Maintenance margin varies by stock; highly volatile stocks often feature higher margin requirements.

To calculate a maintenance margin, we’ll continue the example from above, using the same formula:

Maintenance margin requirement = number of shares x stock price x margin rate

Let’s assume XYZ stock is a fully marginable stock with a 25% requirement. You only need $2,250 of equity to continue to own the position. The formula is: 100 shares x $90 per share x 25% = $2,250.

If the stock price fell, however, you would face a margin call since your equity percentage would drop below 25%. Your margin loan would swell above 75%.

Calculating Margin on Short Stock

Here is a short stock margin calculation example. It’s worth noting that selling stocks short comes with its own set of risks since there is no limit on how high a stock value can go.

Let’s say you short sell 100 shares of XYZ stock at $90 per share. The margin requirement is 150%. Since you receive 100% cash from selling the shares, the additional margin requirement is 50% on top of that 100%.

The margin calculation is: 100 shares x $90 x 150% = $13,500.

Maintaining Adequate Margin

You are responsible for always keeping a minimum margin balance — that is the equity in your account. Let’s dive into what happens when your position value fluctuates.

Suppose you bought 1,000 XYZ shares at $10 per share and it has a 50% initial margin requirement. That $10,000 position requires $5,000 of equity. The maximum loan value is $5,000, or 50% of the purchase value.

Assuming a 25% maintenance margin, your equity must remain at or above 25% of the position value. Once the position is established, the maximum loan value is 1,000 shares x $10 x 75% = $7,500.

Now suppose the stock price rises to $15. The position value is now $15,000 and your equity has risen to $10,000. The maximum loan percentage is still 75%, but that equates to $11,250 — which means your equity must be at or above $3,750. You have excess margin of $6,250.

Now let’s say the stock price drops sharply to $6 per share. Your equity is $1,000 and you are borrowing $5,000. The maximum loan value is now: 1,000 shares x $6 x 75% = $4,500.

Since the loan balance is greater than the maximum loan value, you must resolve the shortfall immediately. The account requires a deposit of cash or marginable securities by the close of business that day.

Calculating Maximum Trade Size from Margin Excess

In this example, assume you have $6,000 of margin excess and seek to purchase the maximum number of shares of a stock with a 30% margin requirement. The stock price is $20.

Your stock margin calculator shows: $6,000 / 30% = $20,000.

At $20,000, you can buy 1,000 shares: $20,000 / $20.

Calculating Maximum Trade Value at Different Margin Rates for $10,000 Excess Margin

Here is a breakdown of maximum trade values at different margin rates for $10,000 of excess margin. You can employ a margin requirement calculator to easily determine margin levels.

25% Maintenance margin: $10,000 / 25% = $40,000
30% Marginable equities: $10,000 / 30% = $33,333
50% Initial margin: $10,000 / 50% = $20,000
75% Marginable equities: $10,000 / 75% = $13,333

It’s important to remember that different brokers will have different margin requirements. Moreover, margin rates vary by security.

Margin Calls

An online stock margin calculator can keep track of your margin balances to help avoid margin calls.

A margin call happens when the value of your margin account falls below the broker’s requirements. The brokerage firm will demand that you satisfy the call by depositing more cash or securities. You can also meet the call by selling your existing holdings. The broker can execute a forced sale if you do not act quickly enough.

The Takeaway

A stock margin calculator can help you know your margin balances when trading with borrowed funds. With changing stock prices and when holding multiple positions, account margin levels can vary minute by minute. Knowing how to calculate margin in stock trading is important in order to carefully manage your risk.

You can get started trading today on the SoFi Invest® online brokerage — and trade stocks, exchange-traded funds (ETFs), and IPOs.

Find out how to get started with SoFi Invest.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. 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 pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
*Borrow at 2.5% through 5/31/22 and 5% starting 6/1/22. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
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.
Third-Party Brand Mentions: No brands or products 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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What Is Excess Margin & How Do You Use It?

What Is Excess Margin & How Do You Use It?

The excess margin in a trading account indicates how much available funds it contains above the required minimum amounts. Knowing your excess margin helps determine how many securities you can trade on margin, as well as how much you can withdraw from your account to use for other purposes.

What Is Excess Margin?

Excess margin is a trading account‘s equity above the legal minimum required for a margin account, or the amount of equity above the broker’s maintenance margin requirement.

Excess margin is generated from cash or securities a trader deposits in a margin account above required levels. Excess margin can be used as collateral for margin loans, or it may be withdrawn from the account. It is important to monitor your excess margin ratio so you can keep your account in good standing.

Special Memorandum Account

A special memorandum account (SMA) is where excess margin generated from a margin trading account is held. Trading margin is also called free margin, usable margin, or available margin. Excess margin, on the other hand, is only the margin above the required minimum.

Understanding Trading Margin Excess

Trading margin excess tells you how much buying power you have, but no trader should feel compelled to use all of it just because it is there. Excess cash margin can be thought of as funds left over after you have taken positions during the trading day. You can use excess margin to buy new positions or add to an existing holding.

Understanding how to trade excess margin requires a grasp of how margin accounts work. A margin account allows you to borrow from a broker if you meet initial margin requirements. You will need the greater of either the $2k minimum margin requirement or 50% of the security’s purchase price in your account to buy on margin. For example, if you were to purchase 10 shares of a stock trading at $30, 50% is $1,500. Since that is less than $2,000, you’ll need to deposit $2,000 in order to purchase the 10 shares on margin. On the other hand, if you wanted to purchase 10 shares of a stock selling for $50, 50% is $2,500 — and you would need to deposit $2,500, not $2,000, in order to make your purchase on margin.

In the United States, Regulation T set by the Federal Reserve states that a trader with a margin account can borrow up to 50% of the purchase price of a stock (assuming the stock is fully marginable). There are also maintenance margin requirements set at 25% by the Financial Industry Regulatory Authority (FINRA) — your equity relative to your account value must not fall below that threshold. Finally, a broker might set stricter margin requirements than the governing authorities.

The value of assets in a margin account that exceeds these requirements is the excess margin deposit. Since you are trading with leverage, the maintenance margin excess amount indicates how much is left that you can borrow against — it is not actual cash remaining in your account. According to FINRA , maintenance margin excess is the amount by which the equity in the margin account exceeds the required margin.

Risks and Benefits of Excess Margin

An account is in good standing as long as it has margin levels above those set by regulators and the broker. There are dangers with trading excess margin securities, though. Since you trade with leverage in a margin account, there is the risk that your account value could drop dramatically if the market goes against you. Your account can be in good standing one day, but then face a margin call the next day.

If your account violates margin requirements, you will be faced with a margin call. To meet the call, you must deposit cash, deposit marginable securities, or liquidate securities you own. If you do not meet the call, your broker can perform a forced sale. In extreme cases, your account’s trading privileges can be suspended. Silver Thursday is an extreme example of when margin works against traders.

On the upside, there is potential to make larger profits by trading on margin. Returns are amplified by leverage. You can also benefit from declining share prices by short selling (it’s worth noting that margin requirements are different for short selling — 30% in most cases). There are other benefits when trading on margin so long as you maintain excess margin. You can use your margin account for loans by borrowing against your assets, often at a competitive interest rate. Margin trading also lets you diversify a concentrated portfolio.

Excess Margin Risks vs Benefits

Risks

Benefits

Trading with leverage can amplify losses Trading with leverage can amplify returns
A broker can perform a forced sale if you face a margin call Excess margin tells you how much money you can use for new purchases or to withdraw from the account
You can lose more than what you put in during extreme events You can hold a diversified portfolio and short positions

What Is an Excess Margin Deposit?

An excess margin deposit is the collateral held in a margin account that is above required margin levels. When the value of your excess margin deposit drops under the required margin amount, you might face a margin call. An excess margin deposit is calculated as the difference between an account’s value and its minimum maintenance requirement. Required margin levels are often higher for equity and options trading accounts versus futures trading accounts.

Managing excess margin securities is important when trading. If you trade positions without understanding risk, then you are more likely to eventually get hit with a margin call. A way to manage excess margin is to trade securities and positions sizes that fit your risk and return preferences.

Excess Margin Deposit Example

An example helps illustrate what excess margin is. Let’s say your margin trading account has $50,000 of unmargined securities. The Reg T requirement dictates that your initial margin is $25,000 (a 50% margin requirement), so excess initial margin is $25,000. Assuming a 25% maintenance margin requirement, $12,500 of equity must be kept after opening the account.

With $25,000 of equity, there is $12,500 of excess margin above the 25% maintenance margin requirement. You can buy more securities with that amount or withdraw it to use for other purposes.

If the account value drops to $45,000, then your equity has fallen to $20,000 ($45,000 of stocks minus the $25,000 loan). Assuming the account has a 25% maintenance requirement, the account would need to have equity of at least $11,250 (25% of $45,000). With $20,000 of equity, the account meets the requirements and is in good standing.

The Takeaway

Excess margin is your margin trading account’s equity above all margin requirements. It is a balance that tells you how much more securities you can buy on margin. The excess cash margin also indicates how much you can pull from the account to use for other purposes.

Interested in trading? You can get started today with SoFi Invest®. With SoFi active investing, you can buy and sell stocks, exchange-traded funds (ETFs), and IPOs.

Find out how to get started with SoFi Invest.

FAQ

What happens if you go over margin?

If you go over margin, you might be faced with a margin call. A margin call happens when your excess margin deposit falls below zero. Satisfying a margin call involves depositing more cash or securities or liquidating existing holdings to bring the account’s excess margin ratio back within proper limits.

What is excess intraday margin?

Excess intraday margin is the amount of funds in a margin trading account above the intraday margin requirement. It is a balance that tells you how much money is in the account above an intraday margin requirement. Intraday margin is also referred to as day trading margin if you engage in pattern day trading. Note: There are different requirements for a pattern day trader.

Can margin trading put you in debt?

In extreme circumstances, trading excess margin securities can put you in debt due to positions losing value and margin interest being owed. Margin calls issued by brokers help to reduce this risk since the calls require the trader to deposit more funds into the account or liquidate existing holdings. If the trader does not act, the broker might automatically sell securities. If the trader has borrowed too much and market movements are drastically against the trader, equity can turn negative.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. 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 pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
*Borrow at 2.5% through 5/31/22 and 5% starting 6/1/22. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
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.
Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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What is 401k Plan Benchmarking?

What Is 401(k) Plan Benchmarking?

Benchmarking a 401(k) retirement plan refers to how a company assesses their plan’s design, fees, and services to ensure they meet industry and ERISA standards.

Benchmarking 401k plans is important for a few reasons. First, the company offering the plan needs to be confident that they are acting in the best interests of employees who participate in the 401k plan. And because acting in the best interests of plan participants is part of an employer’s fiduciary duty, benchmarking can help reduce an employer’s liability if fiduciary standards aren’t met.

If your company’s plan isn’t meeting industry benchmarks, it may be wise to change plan providers. You can start by learning how benchmarking works and why it’s important.

How 401(k) Benchmarking Works

While a 401k is a convenient and popular way for participants to invest for retirement, the company offering the plan has many responsibilities to make sure that its plan is competitive. That is where 401k benchmarking comes into play.

An annual checkup is typically performed whereby a company assesses its plan’s design, evaluates fees, and reviews all the services offered by the plan provider. The 401k plan benchmarking process helps ensure that the retirement plan reduces the risk of violating ERISA rules. For the firm, a yearly review can help reduce an employer’s liability and it can save the firm money.

ERISA, the Employee Retirement Income Security Act, requires that the plan sponsor verifies that the 401k plan has reasonable fees. ERISA is a federal law that mandates minimum standards that retirement plans must meet. It helps protect plan participants and beneficiaries.

The Importance of 401(k) Plan Benchmarking

It is important that an employer keep its 401k plan up to today’s standards. Making sure the plan is optimal compared to industry averages is a key piece of retirement benchmarking. It’s also imperative that your employees have a quality plan to help them save and invest for retirement. Most retirement plan sponsors conduct some form of benchmarking planning, and making that a regular event — annually or even quarterly — is important so that the employer continuously complies with ERISA guidelines.

Employers have a fiduciary responsibility to ensure that fees are reasonable for services provided. ERISA also states that the primary responsibility of the plan fiduciaries is to act in the best interest of their plan participants. 401k benchmarking facilitates the due diligence process and reduces a firm’s liability.

How to Benchmark Your 401(k) Plan: 3 Steps

So how exactly do you go about benchmarking 401k plans? There are three key steps that plan sponsors should take so that their liability is reduced, and the employees get the best service for their money. Moreover, 401k benchmarking can help improve your service provider to make your plan better.

1. Assess Your 401(k) Plan Design

It’s hard to know if your retirement plan’s design is optimal. Two gauges used to figure its quality are plan asset growth and the average account balance. If workers are continuously contributing and investments are performing adequately compared to market indexes, then those are signs that the plan is well designed.

Benchmarking can also help assess if a Roth feature should be added. Another plan feature might be to adjust the company matching contribution or vesting schedule. Optimizing these pieces of the plan can help retain workers while meeting ERISA requirements.

2. Evaluate Your 401(k) Plan Fees

A 401k plan has investment, administrative, and transaction fees. Benchmarking 401k plan fees helps ensure total costs are reasonable. It can be useful to take an “all-in” approach when assessing plan fees. That method can better compare service providers since different providers might have different terms for various fees. But simply selecting the cheapest plan does not account for the quality and depth of services a plan renders. Additional benchmarking is needed to gauge a retirement plan’s quality. Here are the three primary types of 401k plan fees to assess:

•   Administrative: Fees related to customer service, recordkeeping, and any legal services.

•   Investment: Amounts charged to plan participants and expenses related to investment funds.

•   Transaction: Fees involved with money movements such as loans, withdrawals, and advisory costs.

3. Evaluate Your 401(k) Provider’s Services

There are many variables to analyze when it comes to 401k benchmarking of services. A lot can depend on what your employees prefer. Reviewing the sponsor’s service model, technology, and execution of duties is important.

Also, think about it from the point of view of the plan participants: Is there good customer service available? What about the quality of investment guidance? Evaluating services is a key piece of 401k plan benchmarking. A solid service offering helps employees make the most out of investing in a 401k account.

Investing for Retirement With SoFi

Investing for retirement is more important than ever as individuals live longer and pension plans (a.k.a. defined benefit plans that offer a steady payout) are becoming a relic of the past. With today’s technology, and clear rules outlined by ERISA, workers can take advantage of inexpensive, high-quality 401k plans to help them save and invest for the long term.

For the company offering the plan, establishing a retirement benchmarking process is crucial to keeping pace with the best 401k plans. Reviewing a plan’s design, costs, and services helps workers have confidence that their employer is working in their best interests. Benchmarking can also protect employers.

If your company already has a 401k plan that you contribute to as an employee, you might consider other ways to invest for retirement. You can learn more about various options — for example, investing in an IRA with SoFi. You can help grow your retirement savings with a SoFi IRA by opening a Roth or traditional IRA.

FAQ

What does it mean to benchmark a 401k?

401k benchmarking is the process of reviewing and evaluating a firm’s retirement plan to insure that it meets industry and ERISA standards. It is a due diligence process to ensure that the plan provider is living up to their duty as fiduciaries.

In addition, with a changing investing and retirement planning landscape, it’s important to keep a 401k plan up to date. Benchmarking a 401k plan includes looking at the plan’s design, various service providers, the investment lineup, and fees.

How should you structure your 401k?

A 401k should be structured so that it addresses several key points.

•   Determining who is eligible for the plan is one place to start, by setting a minimum age or length of employment.

•   Automatic enrollment with auto-escalation features can be good features to include.

•   Offering a Roth option is another consideration for your 401k plan.

•   Another important piece of your plan that employees must know about is how the company matching contribution works, if there is one.

•   Last, structuring a vesting schedule can vary by plan — and the vesting process you choose may help attract or retain workers.

How do I check my 401k performance?

You can use online tools that measure investment performance. A vendor can help conduct 401k benchmarking processes, such as identifying and selecting plan funds, but some might not come cheap. Employers should make sure that their investment lineup has quality funds with reasonable expense ratios so that participants can achieve a decent rate of return. 401k fee benchmarking can help ensure that is the case.

The average rate of return for 401k plans from 2015 to 2020 was 9.5%, according to data from retirement and financial service provider, Mid Atlantic Capital Group. Employers have a fiduciary responsibility to pay only reasonable fees within its 401k plan.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. 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 pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.

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