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Dividends: What They Are and How They Work

A dividend is when a company periodically gives its shareholders a payment in cash, additional shares of stock, or property. The size of that dividend payment depends on the company’s dividend yield and how many shares you own.

Not all companies pay dividends, but many investors look to buy stock in companies that pay them as a way to generate regular income in addition to stock price appreciation. A dividend investing strategy is one way many investors look to make money from stocks and build wealth.

Key Points

•   Dividends are payments made by companies to shareholders, either in cash, additional shares of stock, or property.

•   Dividend payments are based on the company’s dividend yield and the number of shares owned by the investor.

•   Dividends can be paid out in cash or additional stock, and they usually follow a fixed schedule.

•   Companies are not required to pay dividends, and dividend payments are not always guaranteed.

•   Dividend stocks can provide regular passive income, offer dividend reinvestment plans, and may have tax advantages.

What Is a Dividend?

A dividend payment is a portion of a company’s earnings paid out to the shareholders. For every share of stock an investor owns, they get paid an amount of the company’s profits.

The total amount an investor receives in a dividend payment is based on the number of shares they own. For example, if a stock pays a quarterly dividend of $1 per share and the investor owns 50 shares, they would receive a dividend of $50 each quarter.

Companies can pay out dividends in cash, called a cash dividend, or additional stock, known as a stock dividend.

Generally, dividend payouts happen on a fixed schedule. Most dividend-paying companies will pay out their dividends quarterly. However, some companies pay out dividends annually, semi-annually (twice a year), or monthly.

Occasionally, companies will pay out dividends at random times, possibly due to a windfall in cash from a business unit sale. These payouts are known as special dividends or extra dividends.

A company is not required to pay out a dividend. There are no established rules for dividends; it’s entirely up to the company to decide if and when they pay them. Some companies pay dividends regularly, and others never do.

Even if companies pay dividends regularly, they are not always guaranteed. A company can skip or delay dividend payments as needed. For example, a company may withhold a dividend if they had a quarter with negative profits. However, such a move may spook the market, resulting in a drop in share price as investors sell the struggling company.

Types of Dividends

As noted, the most common types of dividends are cash dividends and stock dividends.

Cash dividends are dividends paid out in the form of cash to shareholders. Cash dividends are the most common form of dividend. Stock dividends are, likewise, more or less what they sound like: Dividends paid out in the form of additional stock. Generally, shareholders receive additional common stock.

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How Are Dividends Paid Out?

There are four critical dates investors need to keep in mind to determine when dividends are paid and see if they qualify to receive a dividend payment.

•   Declaration Date: The day when a company’s board of directors announces the next dividend payment. The company will inform investors of the date of record and the payable date on the declaration date. The company will notify shareholders of upcoming dividend payments by a press release on the declaration day.

•   Date of Record: The date of record, also known as the record date, is when a company will review its books to determine who its shareholders are and who will be entitled to a dividend payment.

•   Ex-dividend date: The ex-dividend date, typically set one business day before the record date, is an important date for investors. Before the ex-dividend date, investors who own the stock will receive the upcoming dividend payment. However, if you were to buy a stock on or after an ex-dividend date, you are not eligible to receive the future dividend payment.

•   Payable date: This is when the company pays the dividend to shareholders.

Example of Dividend Pay Out

Shareholders who own dividend-paying stocks would calculate their payout using a dividend payout ratio. Effectively, that’s the percentage of the company’s profits that are paid out to shareholders, which is determined by the company.

The formula is as follows: Dividend payout ratio = Dividends paid / net income

As an example, assume a company reported net income of $100,000 and paid out $20,000 in dividends. In this case, the dividend payout ratio would be 20%. Shareholders would either receive a cash payout in their brokerage account, or see their total share holdings increase after the payout.

Why Do Investors Buy Dividend Stocks?

As mentioned, dividend payments and stock price appreciation make up a stock’s total return. But beyond being an integral part of total stock market returns, dividend-paying stocks present unique opportunities for investors in the following ways.

Passive Dividend Income

Many investors look to buy stock in companies that pay dividends to generate a regular passive dividend income. They may be doing this to replace a salary — e.g., in retirement — or supplement their current income. Investors who are following an income-producing strategy tend to favor dividend-paying stocks, government and corporate bonds, and real estate investment trusts (REITs).

Dividend Reinvestment Plans

A dividend reinvestment plan (DRIP) allows investors to reinvest the money earned from dividend payments into more shares, or fractional shares, of that stock. A DRIP can help investors take advantage of compounding returns as they benefit from a growing share price, additional shares of stock, and regular dividend payments. The periodic payments from dividend stocks can be useful when utilizing a dividend reinvestment plan.

Dividend Tax Advantages

Another reason that investors may target dividend stocks is that they may receive favorable tax treatment depending on their financial situation, how long they’ve held the stock, and what kind of account holds the stock.

There are two types of dividends for tax purposes: ordinary and qualified. Ordinary dividends are taxable as ordinary income at your regular income tax rate. However, a dividend is eligible for the lower capital gains tax rate if it meets specific criteria to be a qualified dividend. These criteria are as follows:

•   It must be paid by a U.S. corporation or a qualified foreign corporation.

•   The dividends are not the type listed by the IRS under dividends that are not qualified dividends.

•   You must have held the stock for more than 60 days in the 121-day period that begins 60 days before the ex-dividend date.

Investors can take advantage of the favorable tax treatments of qualified dividends when paying taxes on stocks.

How to Evaluate Dividend Stocks

Evaluating dividend stocks requires some research, like evaluating other types of stocks. There’s analysis to be done, but investors will also want to take special care to look at prospective dividend yields and other variables related to dividends.

In all, investors would likely begin by digging through a stock’s financial reports and earnings data, and then looking at its dividend yield.

Analysis

As noted, investors may want to start their stock evaluations by looking at the data available, including balance sheets, cash flow statements, quarterly and annual earnings reports, and more. They can also crunch some numbers to get a sense of a company’s overall financial performance.

Dividend Yield

A dividend yield is a financial ratio that shows how much a company pays out in dividends relative to its share price. The dividend yield can be a valuable indicator to compare stocks that trade for different dollar amounts and with varying dividend payments.

Here’s how to calculate the dividend yield for a stock:

Dividend Yield = Annual Dividend Per Share ÷ Price Per Share

To use the dividend yield to compare two different stocks, consider two companies that pay a similar $4 annual dividend. A stock of Company A costs $95 per share, and a stock of Company B costs $165.

Using the formula above, we can see that Company A has a higher dividend yield than Company B. Company A has a dividend yield of 4.2% ($4 annual dividend ÷ $95 per share = 4.2%). Company B has a yield of 2.4% ($4 annual dividend ÷ $165 per share = 2.4%).

If investors are looking to invest in a company with a relatively high dividend yield, they may invest in Company A.

While this formula helps compare dividend yields, there may be other factors to consider when deciding on the suitable investment. There are many reasons a company could have a high or low dividend yield, and some insight into dividend yields is necessary for further analysis.

Tax Implication of Dividends

Dividends do, generally, trigger a tax liability for investors. There may be some special considerations at play, so if you have a lot of dividends, it may be beneficial to consult with a financial professional to get a sense of your overall tax liabilities.

But in a broad sense, regular dividends are taxed like ordinary income if they’re reinvested. If an investor receives stock dividends, though, that’s typically not taxable until the investor sells the holdings later on. Further, qualified dividends are usually taxed at lower rates that apply to capital gains – but there may be some variables involved that can change that.

Investors who do receive dividends should receive a tax form, a 1099-DIV, from the payor of the dividends if the annual payout is at least $10.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

The Takeaway

Dividends are a way that companies compensate shareholders just for owning the stock, usually in the form of a cash payment. Many investors look to dividend-paying stocks to take advantage of the regular income the payments provide and the stock price appreciation in total returns.

Additionally, dividend-paying companies can be seen as stable companies, while growth companies, where value comes from stock price appreciation, may be riskier. If your investment risk tolerance is low, investing in dividend-paying companies may be worthwhile.

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

FAQ

Are dividends free money?

In a way, dividends may seem or feel like free money, but in another sense, they’re more like a reward for shareholders for owning a portion of a company.

Where do my dividends go?

Depending on the type of dividend, they’re usually distributed into an investor’s brokerage account in the form of cash or additional stock. The specifics depend on the type of account that dividend-paying stocks are held in, among other things.

How do I know if a stock pays dividends?

Investors can look at the details of stocks through their brokerage or government regulators’ websites. The information isn’t hard to find, typically, and some brokerages allow investors to search specifically for dividend-paying stocks, too.


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Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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

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

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TFSA vs RRSP: What’s the Difference?

TFSA vs RRSP: What’s the Difference?

Both TFSAs and RRSPs are accounts that provide Canadian consumers with a chance to save while enjoying investment earnings and unique tax benefits. While a TFSA acts as a more general savings account, an RRSP is used for retirement savings.

Saving is never a bad idea, so here you can learn the difference between these accounts and how they can play a role in securing your financial future.

Keep reading for a more detailed breakdown of a TFSA vs. RRSP so you can make the right financial move for your needs.

What Is the TFSA?

A Tax-Free Savings Account (TFSA) is a type of registered tax-advantaged savings account to help Canadians earn money on their savings — tax-free. TFSA accounts were created in 2009 by the Canadian government to encourage eligible citizens to contribute to this type of savings account.

Essentially, a TFSA holds qualified investments that can generate capital gains, interest, and dividends, and they’re tax-free. These accounts can be used to build an emergency fund, to save for a down payment on a home, or even to finance a dream vacation.

A TFSA can contain the following types of investments:

•   Cash

•   Stocks

•   Bonds

•   Mutual funds

It’s possible to withdraw the contributions and earnings generated from dividends, interest, and capital gains without having to pay any taxes. Accountholders don’t even have to report withdrawals as income when it’s time to file taxes.

There is a limit to how much someone can contribute to a TFSA on an annual basis. This limit is referred to as a contribution limit, and every year the Canadian government determines what the contribution limit for that year is. If someone doesn’t meet the contribution limit one year, their remaining allowed contributions can be made up for in following years.

To contribute to a TFSA, an individual must be at least 18 years of age and be a Canadian resident with a valid Social Insurance Number (SIN).

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What Is the RRSP?

A Registered Retirement Savings Plan (RRSP) is, as the name indicates, a type of savings plan specifically designed to help boost retirement savings. To obtain one, a Canadian citizen must register with the Canadian federal government for this financial product and can then start saving.

When someone contributes to an RRSP, their contributions are considered to be tax-advantaged. What this means: The funds they contribute to their RRSP are exempt from being taxed the year they make the contribution (which can reduce the total amount of taxes they need to pay for that year). On top of that, the investment income these contributions generate will grow tax-deferred. This means the account holder won’t pay any taxes on the earnings until they withdraw them.

Unlike a TFSA, there isn’t a minimum age requirement to open and contribute to an RRSP. That being said, certain financial institutions may require their customers to be the age of majority in order to contribute. It’s possible to contribute to an RRSP until the year the account holder turns 71 as long as they are a Canadian resident, earned an income, and filed a tax return.

Keep reading for a TFSA vs. RRSP comparison.

Similarities Between a TFSA and an RRSP

How does a TFSA vs. RRSP compare? There are a few similarities between TFSAs and RRSPs that are worth highlighting. Here are the main ways in which they are the same:

•   Only Canadians citizens can contribute

•   Contributions can help reach savings goals

•   Investments can be held in each account type

•   Both accounts offer tax advantages.

Differences Between a TFSA and RRSP

Next, let’s answer this question: What is the difference between an RRSP and a TFSA? Despite the fact that both an RRSP and a TFSA share similar goals (saving money and earning interest on it) and advantages (tax benefits), they have some key differences to be aware of.

•   Intended use. RRSPs are for retirement savings whereas TFSAs can be used to save for any purpose.

•   Age eligibility. To contribute to a TFSA one must be 18 years old, but there isn’t an age requirement to open an RRSP.

•   Contribution limit. The limits are usually set annually and are different for TFSAs and RRSPs. For 2024, the contribution limit for an RRSP is the lesser of either 18% of earned income reported on an individual’s tax return for the previous year or the contribution limit, which is currently $31,560 in US dollars. The limit for a TFSA, which also can vary annually, was most recently $7,000.

•   Taxation on withdrawals. While RRSP withdrawals are taxable (but subject to certain exceptions), TFSA withdrawals can be made at any time tax-free.

•   Taxation on contributions. Contributions made to a TFSA aren’t tax-deductible, but RRSP contributions are.

•   Plan maturity. An RRSP matures at the end of the calendar year that the account holder turns 71. TFSAs don’t have age limits for account maturity.

•   Spousal contributions. There is no form of spousal TFSA available, but someone can contribute to a spousal RRSP.

How Do I Choose Between a TFSA and RRSP?

Choosing between a TFSA and an RRSP depends on someone’s unique savings goals and tax preferences. That being said, if someone’s main goal is saving for retirement, they’ll likely find that an RRSP is the right fit for them. When someone contributes to an RRSP, they can defer paying taxes during their peak earning years. Once they retire and make withdrawals (which they will need to pay taxes on), they will ideally have a lower income (and be in a lower tax bracket) and smaller tax liabilities at that point in their life.

If someone wants to be able to use their savings for a variety of different purposes (perhaps including a medium-term goal like the amount needed for a down payment on a home), they may find that a TFSA offers them more flexibility.
That said, there’s no reason TFSA savings can’t be used for retirement later on. Contributing to a TFSA is a great option for someone who has already maxed out their RRSP contributions for the year, but who wants to continue saving and enjoying tax benefits.

Recommended: What Tax Bracket Do I Fall Under?

Can I Have Both a TFSA and RRSP?

It is indeed possible to have both an RRSP and TFSA and to contribute to them at the same time. Putting money into both of these financial vehicles can be a great way to save. There are no downsides associated with contributing to both an RRSP and TFSA at the same time if a person can afford to do so.

Can I Have Multiple RRSP and TFSA Accounts?

Yes, it’s possible to have more than one TFSA and RRSP open at the same time, but there’s no real benefit here. The same contribution limits apply.

That means that opening more than one version of the same account or plan only leads to having more accounts to manage and incurring more administration and management fees. Just as you don’t want to pay fees on your checking account and other bank accounts, you probably don’t want to burn through cash on fees here.

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Should I Prioritize One Over the Other?

Which type of account someone should prioritize depends on their savings goals. Their preferences regarding the unique tax advantages of each account may also come into play. That being said, if someone is focused on saving for retirement, they’ll likely want to make sure they max out their RRSP contributions first.

The Takeaway

Both RRSP and TFSA accounts are great ways for Canadian citizens to save for financial goals like retiring or financing a wedding. Each account has unique advantages and contribution limits. While an RRSP account is designed to help with stashing away cash for retirement, a TFSA account can be used to save for any type of financial need. Whether you choose one or both of these products, you’ll be on a path towards saving and helping to secure your financial future.

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FAQ

Is it better to invest in TFSA or RRSP?

When it comes to TFSA vs. RRSP, there’s no right answer to whether investing in one is better than the other. Someone focused on saving for retirement may want to prioritize an RRSP, while someone who wants to save for other expenses (like a home or wedding) may find a TFSA more appealing.

Should I max out RRSP or TFSA first?

If someone is focused on saving for retirement, they may want to max out their RRSP first. That being said, this is a personal decision that depends on unique financial goals and tax preferences.

When should you contribute to RRSP vs TFSA?

Typically, the contribution deadline for RRSPs is around March 1st. A Canadian citizen can put funds in a TFSA at any point in a calendar year, and if they don’t max out their account, they will usually be able to contribute the remaining amount in the future.


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SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.


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, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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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Is a Backdoor Roth IRA Right for You?

Backdoor Roth IRAs

Want to contribute to a Roth IRA, but have an income that exceeds the limits? There’s another option. It’s called a backdoor Roth IRA, and it’s a way of converting funds from a traditional IRA to a Roth.

A Roth IRA is an individual retirement account that may provide investors with a tax-free income once they reach retirement. With a Roth IRA, investors save after-tax dollars, and their money generally grows tax-free. Roth IRAs also provide additional flexibility for withdrawals — once the account has been open for five years, contributions can generally be withdrawn without penalty.

But there’s a catch: Investors can only contribute to a Roth IRA if their income falls below a specific limit. If your income is too high for a Roth, you may want to consider a backdoor Roth IRA.

Key Points

•   A backdoor Roth IRA allows high earners to contribute to a Roth IRA by converting funds from a traditional IRA.

•   This strategy involves paying income taxes on pre-tax contributions and earnings at conversion.

•   There are no income limits or caps on the amount that can be converted to a Roth IRA.

•   The process includes opening a traditional IRA, making non-deductible contributions, and then converting these to a Roth IRA.

•   Potential tax implications include moving into a higher tax bracket and owing taxes on pre-tax contributions and earnings.

What Is a Backdoor Roth IRA?

If you aren’t eligible to contribute to a Roth IRA outright because you make too much, you can do so through a technique called a “backdoor Roth IRA.” This strategy involves contributing money to a traditional IRA and then converting it to a Roth IRA.

The government allows individuals to do this as long as, when they convert the account, they pay income tax on any contributions they previously deducted and any profits made. Unlike a standard Roth IRA, there is no income limit for doing the Roth conversion, nor is there a ceiling to how much can be converted.

💡 Quick Tip: How much does it cost to open an IRA account? Often there are no fees to open an IRA, but you typically pay investment costs for the securities in your portfolio.

How Does a Backdoor IRA Work?

This is how a backdoor IRA typically works: An individual opens a traditional IRA and makes non-deductible contributions. They then convert the account into a Roth IRA. The strategy is generally most helpful to those who earn a higher salary and are otherwise ineligible to contribute to a Roth IRA.

Example Scenario

For instance, let’s say a 34-year-old individual whose tax filing status is single and who makes $150,000 a year wants to open a Roth IRA. Their income is too high for them to be eligible for a Roth directly (more on this below), but they can use the “backdoor IRA” strategy. In order to do this, the individual would open a traditional IRA and contribute non-deductible funds to it. They then convert that money to a Roth IRA.

Recommended: Traditional Roth vs. Roth IRA: How to Choose the Right Plan

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Only offers made via ACH are eligible for the match. ACATs, wires, and rollovers are not included.

Income and Contribution Limits

In general, Roth IRAs have income limits. In 2024, a single person whose modified adjusted gross income (MAGI) is more than $161,000, or a married couple filing jointly with a MAGI more than $240,000, cannot contribute to a Roth IRA. For tax year 2023, a single filer whose MAGI is more than $153,000, or a married couple filing jointly with a MAGI over $228,000, cannot contribute to a Roth IRA.

There are also annual contribution limits for Roth IRAs. In 2024, an individual can contribute up to $7,000 in a Roth IRA (or up to $8,000 if they are 50 or older). For tax year 2023, an individual can contribute up to $6,500 in a Roth IRA (or up to $7,500 if they are 50 or older). Traditional IRAs have the same contribution limits as Roth IRAs.

How to Set Up and Execute a Backdoor Roth

Here’s how to initiate and complete a backdoor Roth IRA.

•   Open a Traditional IRA. You could do this with SoFi Invest®, for instance.

•   Make a non-deductible contribution to the Traditional IRA.

•   Open a Roth IRA, complete any paperwork that may be required for the conversion, and transfer the money into the Roth IRA.

Tax Impact of a Backdoor Roth

If you made non-deductible contributions to a traditional IRA that you then converted to a Roth IRA, you won’t owe taxes on the money because you’ve already paid taxes on it. However, if you made deductible contributions, you will need to pay taxes on the funds.

In addition, if some time elapsed between contributing to the traditional IRA and converting the money to a Roth IRA, and the contribution earned a profit, you will owe taxes on those earnings.

You might also owe state taxes on a Roth IRA conversion. Be sure to check the tax rules in your area.

Another thing to be aware of: A conversion can also move people into a higher tax bracket, so individuals may consider waiting to do a conversion when their income is lower than usual.

And finally, if an investor already has traditional IRAs, it may create a situation where the tax consequences outweigh the benefits. If an individual has money deducted in any IRA account, including SEP or SIMPLE IRAs, the government will assume a Roth conversion represents a portion or ratio of all the balances. For example, say the individual contributed $5,000 to an IRA that didn’t deduct and another $5,000 to an account that did deduct. If they converted $5,000 to a Roth IRA, the government would consider half of that conversion, or $2,500, taxable.

The tax rules involved with converting an IRA can be complicated. You may want to consult a tax professional.

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

Is a Backdoor Roth Right for Me?

It depends on your situation. Below are some of the benefits and downsides to a backdoor Roth IRA to help you determine if this strategy might be a good option for you.

Benefits

High earners who don’t qualify to contribute under current Roth IRA rules may opt for a backdoor Roth IRA.

As with a typical Roth IRA, a backdoor Roth may also be a good option when an investor expects their taxes to be lower now than in retirement. Investors who hope to avoid required minimum distributions (RMDs) when they reach age 73 might also consider doing a backdoor Roth.

Downsides

If an individual is eligible to contribute to a Roth IRA, it won’t make sense for them to do a backdoor conversion.

And because a conversion can also move people into a higher tax bracket, you may consider waiting to do a conversion in a year when your income is lower than usual.

For those individuals who already have traditional IRAs, the tax consequences of a backdoor Roth IRA might outweigh the benefits.

Finally, if you plan to use the converted funds within five years, a backdoor Roth may not be the best option. That’s because withdrawals before five years are subject to income tax and a 10% penalty.

Is a Backdoor Roth Still Allowed for 2023? For 2024?

Backdoor IRAs are still allowed for tax year 2023. And at this point, they are still allowed for 2024 as well.

There had been some discussion in previous years of possibly eliminating the backdoor Roth IRA, but as of yet, this has not happened.

The Takeaway

A backdoor Roth IRA may be worth considering if tax-free income during retirement is part of an investor’s financial plan, and the individual earns too much to contribute directly to a Roth.

In general, Roth IRAs may be a good option for younger investors who have low tax rates and people with a high income looking to reduce tax bills in retirement.

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

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FAQ

What are the rules of a backdoor Roth IRA?

The rules of a backdoor Roth IRA include paying taxes on any deductible contributions you make; paying any other taxes you may owe for the conversion, such as state taxes; and waiting five years before withdrawing any earnings from the Roth IRA to avoid paying a penalty.

Is it worth it to do a backdoor Roth IRA?

It depends on your specific situation. A backdoor Roth IRA may be beneficial if you earn too much to contribute to a Roth IRA. It may also be advantageous for those who expect to be in a higher tax bracket in retirement.

What is the 5-year rule for backdoor Roth IRA?

According to the 5-year rule, if you withdraw money from a Roth IRA before the account has been open for at least five years, you are typically subject to a 10% tax on those funds. The five year period begins in the tax year in which you made the backdoor Roth conversion. There are some possible exceptions to this rule, however, including being 59 ½ or older or disabled.

Do you get taxed twice on backdoor Roth?

No. You pay taxes once on a backdoor IRA — when you convert a traditional IRA with deductible contributions and any earnings to a Roth. When you withdraw money from your Roth in retirement, the withdrawals are tax-free because you’ve already paid the taxes.

Can you avoid taxes on a Roth backdoor?

There is no way to avoid paying taxes on a Roth backdoor. However, you may be able to reduce the amount of tax you owe by doing the conversion in a year in which your income is lower.

Can you convert more than $6,000 in a backdoor Roth?

There is no limit to the amount you can convert in a backdoor Roth IRA. The annual contribution limits for IRAs does not apply to conversions. But you may want to split your conversions over several years to help reduce your tax liability.

What time of year should you do a backdoor Roth?

There is no time limit on when you can do a backdoor Roth IRA. However, if you do a backdoor Roth earlier in the year, it could give you more time to come up with any money you need to pay in taxes.


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

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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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
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What Is Dividend Yield?

Dividend yield concerns how much an investor realizes from their investments over the course of a year as a result of dividends. Dividends, which are payouts to investors as a share of a company’s overall profit, can help investors generate bigger returns, and some investors even formulate entire strategies around maximizing dividends.

But it’s important to have a good understanding of dividends, dividend yields, and other related concepts before going too far into the weeds.

What Is Dividend Yield?

A stock’s dividend yield is how much the company annually pays out in dividends to shareholders, relative to its stock price. The dividend yield is a financial ratio (dividend/price) expressed as a percentage, and is distinct from the dividend itself.

Dividend payments are expressed as a dollar amount, and supplement the return a stock produces over the course of a year. For an investor interested in total return, learning how to calculate dividend yield for different companies can help to decide which company may be a better investment.

But bear in mind that a stock’s dividend yield will tend to fluctuate because it’s based on the stock’s price, which rises and falls. That’s why a higher dividend yield may not be a sign of better value.

How Does Dividend Yield Differ From Dividends?

It’s important to really drive home the difference between dividend yield and dividends in general.

Dividends are a portion of a company’s earnings paid to investors and expressed as a dollar amount. Dividends are typically paid out each quarter (although semi-annual and monthly payouts are common). Not all companies pay dividends.

Dividend yield, on the other hand, refers to a stock’s annual dividend payments divided by the stock’s current price, and expressed as a percentage. Dividend yield is one way of assessing a company’s earning potential.

How to Calculate Dividend Yield

Calculating the dividend yield of an investment is useful for investors who want to compare companies and the dividends they pay. For investors looking for investments to help supplement their cash flow, or even to possibly live off dividend income, a higher dividend yield on a stock would be more attractive than a lower one.

What Is the Dividend Yield Formula?

The dividend yield formula is more of a basic calculation than a formula: Dividend yield is calculated by taking the annual dividend paid per share, and dividing it by the stock’s current price:

Annual dividend / stock price = Dividend yield (%)

Dividend Yield Formula

How to Calculate Annual Dividends

Investors can calculate the annual dividend of a given company by looking at its annual report, or its quarterly report, finding the dividend payout per quarter, and multiplying that number by four. For a stock with fluctuating dividend payments, it may make sense to take the four most recent quarterly dividends to arrive at the trailing annual dividend.

It’s important to consider how often dividends are paid out. If dividends are paid monthly vs. quarterly, you want to add up the last 12 months of dividends.

This is especially important because some companies pay uneven dividends, with the higher payouts toward the end of the year, for example. So you wouldn’t want to simply add up the last few dividend payments without checking to make sure the total represents an accurate annual dividend amount.

Example of Dividend Yield

If Company A’s stock trades at $70 today, and the company’s annual dividend is $2 per share, the dividend yield is 2.85% ($2 / $70 = 0.0285).

Compare that to Company B, which is trading at $40, also with an annual dividend of $2 per share. The dividend yield of Company B would be 5% ($2 / $40 = 0.05).

In theory, the higher yield of Company B may look more appealing. But investors can’t determine a stock’s worth by yield alone.

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💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

Dividend Yield: Pros and Cons

Pros

Cons

Can help with company valuation. Dividend yield can indicate a more established, but slower-growing company.
May indicate how much income investors can expect. Higher yield may mask deeper problems.
Yield doesn’t tell investors the type of dividend (ordinary vs. qualified), which can impact taxes.

For investors, there are some advantages and disadvantages to using dividend yield as a metric that helps inform investment choices.

Pros

•   From a valuation perspective, dividend yield can be a useful point of comparison. If a company’s dividend yield is substantially different from its industry peers, or from the company’s own typical levels, that can be an indicator of whether the company is trading at the right valuation.

•   For many investors, the primary reason to invest in dividend stocks is for income. In that respect, dividend yield can be an important metric. But dividend yield can change as the underlying stock price changes. So when using dividend yield as a way to evaluate income, it’s important to be aware of company fundamentals that provide assurance as to company stability and consistency of the dividend payout.

Cons

•   Sometimes a higher dividend yield can indicate slower growth. Companies with higher dividends are often larger, more established businesses. But that could also mean that dividend-generous companies are not growing very quickly because they’re not reinvesting their earnings.

Smaller companies with aggressive growth targets are less likely to offer dividends, but rather spend their excess capital on expansion. Thus, investors focused solely on dividend income could miss out on some faster-growing opportunities.

•   A high dividend yield could indicate a troubled company. Because of how dividend yield is calculated, the yield is higher as the stock price falls, so it’s important to evaluate whether there has been a downward price trend. Often, when a company is in trouble, one of the first things it is likely to reduce or eliminate is that dividend.

•   Investors need to look beyond yield to the type of dividend they might get. An investor might be getting high dividend payouts, but if they’re ordinary dividends vs. qualified dividends they’ll be taxed at a higher rate. Ordinary dividends are taxed as income; qualified dividends are taxed at the lower capital gains rate, which typically ranges from 0% to 20%. If you have tax questions about your investments, be sure to consult with a tax professional.

The Difference Between Dividend Yield and Dividend Rate

As noted earlier, a dividend is a way for a company to distribute some of its earnings among shareholders. Dividends can be paid monthly, quarterly, semi-annually, or even annually (although quarterly payouts tend to be common in the U.S.). Dividends are expressed as dollar amounts. The dividend rate is the annual amount of the company’s dividend per share.

A company that pays $1 per share, quarterly, has an annual dividend rate of $4 per share.

The difference between this straight-up dollar amount and a company’s dividend yield is that the latter is a ratio. The dividend yield is the company’s annual dividend divided by the current stock price, and expressed as a percentage.

What Is a Good Dividend Yield?

dividend yield of sp500 vs dividend aristocrats

Two companies with the same high yields are not created equally. While dividend yield is an important number for investors to know when determining the annual cash flow they can expect from their investments, there are deeper indicators that investors may want to investigate to see if a dividend-paying stock will continue to pay in the future.

A History of Dividend Growth

When researching dividend stocks, one place to start is by asking if the stock has a history of dividend growth. A regularly increasing dividend is an indication of earnings growth and typically a good indicator of a company’s overall financial health.

The Dividend Aristocracy

There is a group of S&P 500 stocks called Dividend Aristocrats, which have increased the dividends they pay for at least 25 consecutive years. Every year the list changes, as companies raise and lower their dividends.

Currently, there are 65 companies that meet the basic criteria of increasing their dividend for a quarter century straight. They include big names in energy, industrial production, real estate, defense contractors, and more. For investors looking for steady dividends, this list may be a good place to start.

Dividend Payout Ratio (DPR)

Investors can calculate the dividend payout ratio by dividing the total dividends paid in a year by the company’s net income. By looking at this ratio over a period of years, investors can learn to differentiate among the dividend stocks in their portfolios.

A company with a relatively low DPR is paying dividends, while still investing heavily in the growth of its business. If a company’s DPR is rising, that’s a sign the company’s leadership likely sees more value in rewarding shareholders than in expanding. If its DPR is shrinking, it’s a sign that management sees an abundance of new opportunities abounding. In extreme cases, where a company’s DPR is 100% or higher, it’s unlikely that the company will be around for much longer.

Other Indicators of Company Health

Other factors to consider include the company’s debt load, credit rating, and the cash it keeps on hand to manage unexpected shocks. And as with every equity investment, it’s important to look at the company’s competitive position in its sector, the growth prospects of that sector as a whole, and how it fits into an investor’s overall plan. Those factors will ultimately determine the company’s ability to continue paying its dividend.

💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

The Takeaway

Dividend yield is a simple calculation: You divide the annual dividend paid per share by the stock’s current price. Dividend yield is expressed as a percentage, versus the dividend (or dividend rate) which is given as a dollar amount. The dividend yield formula can be a valuable tool for investors, and not just ones who are seeking cash flow from their investments.

Dividend yield can help assess a company’s valuation relative to its peers, but there are other factors to consider when researching stocks that pay out dividends. A history of dividend growth and a good dividend payout ratio (DPR), as well as the company’s debt load, cash on hand, and credit rating can help form an overall picture of a company’s health and probability of paying out higher dividends in the future.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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

Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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