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Roth IRA vs. 403(b): What Is Best For You?

While it’s common knowledge that saving for retirement is a good idea, there are many paths to get there. When exploring their options, many people wonder about the 403(b) vs. Roth IRA, and the pros and cons of each.

Both 403(b) and Roth IRA are types of retirement plans. But there are important differences in eligibility, taxation, and other rules that can make one plan more attractive than the other, depending on an individual’s needs and circumstances.

Comparing 403(b) & Roth IRA

When making the decision between a Roth IRA vs. 403(b), it’s helpful to have a full understanding of both types of accounts in order to make an informed choice.

What is a 403(b)?

Similar to a 401(k), a 403(b) retirement plan is sponsored by an individual’s employer. Under such programs, an individual may contribute a portion of their salary and may also receive contributions from their employer. However, while 401(k)s are offered by for-profit businesses, 403(b)s are only available to:

•  Employees of public schools, including public colleges and universities
•  Churches
•  Tax-exempt 501(c)(3) charitable organizations

As with all types of requirement plans, the differences are often in the details. The IRS has rules governing 403(b)s and there may also be differences between various employers’ plans. As the IRS requires companies to fully document their plans in writing—including all terms and conditions—it is worth taking some time to review specific plan details.

What is a Roth IRA?

Unlike employer-sponsored retirement plans, Roth IRAs fall under the category of “Individual Retirement Arrangements.” Just as it sounds, this type of retirement savings plan is individually managed—think of it as a personal savings account dedicated specifically to retirement.

A Roth IRA can be set up through a bank, insurance company, and even online IRA accounts. However, unlike a regular savings or investment account, there are many things to learn about opening a Roth IRA, including rules that impact how retirement funds are taxed, how much money an individual can contribute annually, and other important considerations.

One key detail to note is that Roth IRAs are available to individuals with an income below annually established thresholds. Eligibility for contributing to a Roth IRA is capped at the following income levels:

•  In 2020: $139,000 for single filers and $206,000 for married couples filing jointly
•  In 2021: $140,000 for single filers and $208,000 for married couples filing jointly

Another primary difference between Roth IRAs and other types of retirement plans is when an individual is taxed. Generally, taxation on retirement plans is deferred until later funds are withdrawn as distributions (typically upon or after retirement). With Roth IRAs, contributions are taxed when the income is earned and deposited into the individual’s retirement account. The funds are not taxed later, when an investor withdraws contributions or makes a qualified distribution.

Roth 403(b) vs. Roth IRA: Are They the Same Thing?

Simply put, a Roth 403(b) is not the same as a Roth IRA, though both are funded with after-tax dollars.

Like regular 403(b)s, Roth 403(b)s are plans that are run by non-profit employers. An individual may establish a designated Roth account within their 403(b), allowing them to make Roth-style contributions—meaning taxes are not deferred. When an individual contributes to a Roth 403(b), they pay income tax in the year their contribution is earned, and not when the funds of their retirement plan are distributed.

Which is Better: a 403(b) or Roth IRA?

No one plan is universally better than another. Deciding between a 403(b) or Roth IRA, is a personal choice, depending on an individual’s retirement goals.

To make an informed decision about which retirement plan is right for you, it can be helpful to conduct a side-by-side comparison of both plans. This chart breaks down some of the main differences, giving you a better understanding of these types of retirement plans, so that you can weigh the pros and cons of a Roth IRA vs. 403(b).

403(b) Roth IRA

Who can participate? Employees of the following types of organizations:
•  Public school systems, if involved in day-to-day operations
•  Public schools operated by Indian tribal governments
•  Cooperative hospitals and
•  Civilian employees of the Uniformed Services University of the Health Sciences
•  Certain ministers and chaplains
•  Tax-exempt charities established under IRC Section 501(c)(3)
•  Individuals earning less than the following amounts:
•  Single filers earning less than $139,000 for 2020 and $140,000 for 2021
•  Married joint filers claiming less than $206,000 for 2020 and $208,000 for 2021
Are contributions tax deductible? Yes No
Are qualified distributions taxed? Yes No (if not qualified, distribution may be taxable in part)
Annual individual contribution limit $19,500 for 2020 (plus catch-up contributions up to $6,500 for those age 50 and older) The lesser of:
•  $6,000 (individuals 50 and older may contribute $7,000) or
•  Total annual compensation
Are early withdrawals allowed? Depends on individual plan terms and may be subject to a 10% penalty Yes, though account earnings may be subject to 10% penalty if funds are withdrawn before account owner is 59.5 years old.
Plan administered by Employer The individual’s chosen financial institution
Investment options Determined by employer plan Up to the individual, though certain types of investments (collectibles, life insurance) are prohibited
Fees Varies depending on individual plan terms Varies depending on account type/product and financial institution
Portability As with other employee-sponsored plans, individual must roll their account into another fund or cash out when switching employers Yes

Potential Benefits of a 403(b) and a Roth IRA

There are positives to both a 403(b) and a Roth IRA—and because it’s possible for qualified individuals to open a Roth IRA and a 403(b), some people may decide that their best strategy is to use both.

Pros of 403(b)

•  Contributions are automatically deducted by an employer from the individual’s paycheck, which can make it easier to save
•  If an individual earns less money annually in retirement than during their working years, deferring taxes may mean they ultimately pay less
•  Some employers offer contribution matching, meaning for every dollar an employee contributes, they accumulate two towards retirement
•  Greater annual contribution limit
•  Some plans may also allow designated Roth contributions; in such cases, an individual may contribute to both accounts in a given year

Pros of Roth IRAs

•  Individual can invest with any financial institution and have greater flexibility in investment products
•  Withdrawal of contributions are not taxed; withdrawal of earnings are not taxed under certain conditions and/or after age 59.5
•  Account belongs to the owner and is not affected if the individual changes jobs

The Takeaway

It’s never too early to start thinking about saving for retirement. While there can be benefits to participating in an employer-sponsored plan—especially if it offers contribution matching, which many think of as “free money”—the flexibility and control of Roth IRAs can make for an appealing option.

For some people, it’s possible to contribute to a Roth IRA and a 403(bk). That’s just one example of how there are different ways to start saving for retirement, in different combinations of investment vehicles.

Diversifying a retirement portfolio is one way to actively prepare for retirement. SoFi Invest® offers Roth and Traditional IRAs, as well as other investment accounts.

Find out how Sofi Invest can help you plan for retirement.


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 . The umbrella term “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.

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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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”).

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The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.

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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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Required Minimum Distribution (RMD) Rules for 401(k)

While many 401(k) participants are warned of the early withdrawal penalties for 401(k) accounts, fewer people might know about the penalties for not withdrawing enough once you reach age 72. After that year, you’ll need to withdraw a 401(k) required minimum distribution (RMD) every year, or face a tax penalty of up to 50% of the unclaimed distribution.

For defined contribution plans like traditional IRAs, SEP IRAS, SIMPLE IRAS, 401(k) plans, 403(b) plans, 457(b) plans, profit-sharing plans, and other plans in which the money in the account is untaxed, RMDs are a way to ensure taxes get paid on the money.

The age at which RMD starts—72—has gone up recently. In 2019, the Setting Every Community Up for Retirement Enhancement Act (SECURE) changed the required age for RMDs from 70 1/2 to 72. With that change, anyone who reached the age of 70 1/2 before January 1, 2020, should have expected required minimum distributions to kick in that year.

However, when the pandemic hit in early 2020, RMD rules were suspended under the CARES Act. The IRS also allowed for people who had already withdrawn an RMD from their account to pay back the money into their retirement fund. As of now, there have been no further discussions as to whether this moratorium will extend into 2021, so it may be a good idea to pay attention to the news and any policy changes prior to taking out an RMD for 2021.

How Are Required Minimum Distributions Calculated?

Depending on payout options, some retirees choose to roll over their 401(k) into an IRA. But before deciding if that’s the right move, it can be helpful to know the basic 401(k) required minimum distribution rules.

RMDs are calculated in such a way that an individual should have spent their IRA by the time they pass away. While this is obviously not an exact science, this is done by dividing the worth of the portfolio by what is called a “life expectancy factor.”

The IRS has a worksheet for individuals to figure out their RMD, including a chart that maps distribution over projected life expectancy, based on current age. For example, a 75-year-old has a life expectancy factor of 22.9. If that person has a portfolio valued at $500,000, they’d have to withdraw an RMD of $21,834 ($500,000/22.9) from their account that year. Generally speaking, the older a person is, the larger the RMD they’ll need to withdraw. RMDs can be withdrawn in one sum or numerous smaller payments over the course of a year, as long as they add up to the total amount of your total RMD requirement.

If a spouse is the sole beneficiary on the 401(k) account and is more than 10 years younger than the account holder, a different table is used to calculate the RMD. Generally, this means an RMD might be lower, so that there would be money left in the account for the spouse if the account holder were to die.

An investor with multiple IRA accounts would have to calculate the RMD for each of the accounts, but would not have to take that amount out of each account. It’s possible to combine RMDs, withdrawing the funds from just one account.

Individuals can also decide how they want their RMD allocated—for example, some people take a proportional approach to RMD distribution. This means a person with 30% of assets in short-term bonds would choose to have 30% of their RMD come from that investment category.

Deciding how to allocate an RMD gives an investor some flexibility over their finances. That’s why it’s good for an investor to have a sense of when and how much will be required of their RMD. Once they know, they can then come up with a plan for what to do with the funds.

RMD Requirements for IRA Beneficiaries

Some people assume that RMDs are only for people near retirement age. But RMDs are usually required for IRA beneficiaries as well. Beneficiaries also need to consult a beneficiary table to ensure they’re taking out the proper amount from the account each year.

Any beneficiary who inherits an IRA after January 1, 2020, will need to withdraw the entirety of the account within 10 years of inheriting the account, as set forth in the SECURE Act. That timeline shortens to five years if the account is inherited before the original account owner took out distributions (for example, if the account owner died prior to age 72, then the beneficiary will have five years to withdraw from the account).

In certain cases, beneficiaries are categorized as “eligible designated beneficiaries.” These are people including minors, disabled individuals, surviving spouses, and account owners less than 10 years younger than the original account holder. These beneficiaries do not have the same timeline requirements for distribution, and in many cases, can take distributions based on their own expected life expectancy. The exception to this rule is children who were minors at the time of inheritance. Once they turn 18, the clock begins ticking and they must withdraw RMDs according to the designated beneficiary rules.

How a Roth Conversion Affects RMDs

While a 401(k) grows tax-free during the course of an investor’s working years, the RMDs withdrawal is taxed at their current income tax rate. So in some ways, an investor is only delaying a tax bill by growing their 401(k).

One way to offset tax liability is for an investor to consider converting a 401(k) into a Roth IRA in the years preceding mandatory RMDs. This can be done at any point during an investor’s life.

Because a 401(k) invests pre-tax dollars and a Roth IRA invests taxed dollars, an individual will have to pay taxes right away on the 401(k) funds they convert to a Roth. The good news is, upon withdrawing the money after retirement, they don’t have to pay any additional taxes. Paying your tax bill now rather than in the future can make sense for investors who anticipate being in a higher tax bracket during their retirement years than they are currently.

Converting a 401(k) can also be a way for high earners to take advantage of a Roth. Traditional Roth accounts have an income cap (people filing individually need to have a modified adjusted gross income (MAGI) of less than $139,000 to open a Roth) and Roth accounts also limit contributions per year. But these rules don’t apply for Roth conversions (thus they’re sometimes called a “backdoor Roth IRA”).

Once the conversion occurs and a Roth IRA account is opened, an investor needs to follow Roth rules: In general, withdrawals can be taken out after an account owner has had the account for five years and the owner is older than 59 1/2, barring outside circumstances such as death, disability, or first home purchase.

What Should an Investor do With Their RMDs

How you use your RMD depends on your financial goals.

•  Some people may use their RMDs for living expenses, especially if they are in their retirement years.
•  Other people may use their RMDs to fund a brokerage account.
•  It’s also possible to directly transfer your RMD into a taxable account.
•  While an investor will still owe taxes on the RMD, they will then be able to stay invested in the securities in the previous portfolio.
•  Investors also may use part of their RMD to donate to charity.
•  If the funds are directly transferred from the IRA to the charity (instead of writing out a check yourself) the donation will be excluded from taxable income.

Finally, reinvesting RMDs can provide a growth vehicle for retirement income. For example, some investors may look to securities that provide a dividend, so they can create cash flow as well as maintain investments. While there is no “right” way to manage RMDs, coming up with a plan can help ensure that your money continues to work for you, long after it’s out of your original 401(k) account.

The Takeaway

Investors facing RMDs may want to fully understand what the law requires before withdrawing money unnecessarily. As the recent CARES and SECURE acts have made clear, no tax law is set in stone. And even if RMDs seem a long way off, it can be helpful for any investor to consider different avenues for growing that money once they start withdrawing in retirement.

As always, coming up with a financial plan depends on knowing one’s options and exploring next steps to find the best fit for your money. If you’re opening a retirement account such as an IRA or Roth IRA, you can do so at a brokerage, bank, mutual fund house, or other financial services company, like SoFi Invest®.

Find out how SoFi can help you plan for retirement—and whatever comes next.


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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 . The umbrella term “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.

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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.
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 to sell, solicitation to buy or a pre-qualification of any loan product offered by SoFi Lending Corp and/or its affiliates.
For additional disclosures related to the SoFi Invest platforms described above, please visit http://www.sofi.com/legal.
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.
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Should You Use Your 401(k) To Buy Your First Home?

Taking money out of a 401(k) is a financial tactic many home buyers can use to get their arms around their dream house, but the question of whether they should is another story.

When it comes to using money from a 401(k), first-time homebuyers might want to keep a few things in mind. It can be helpful to first assess the rules around early withdrawal from a 401(k) account, including limitations and penalties associated with the transaction.

If you find yourself asking “Can I use my 401(k) to buy a house?” it also might be worth considering other alternatives like withdrawing funds from Roth IRAs, seeking Down Payment Assistance, or seeing if you qualify for other types of home loans.

Reading these pros, cons, and important considerations can help prospective homebuyers make a more informed decision.

Can You Use a 401(k) to Buy a House?

Long story short: Yes, you can use your 401(k) to buy a house. There are two different ways to access the funds:

It’s possible for a first-time homebuyer to take a loan from an existing 401(k) under the condition it will be repaid with interest (though the interest goes back to you).

In some cases it’s also possible for a first-time homebuyer to permanently withdraw funds from a 401(k) account, under the condition that a 10% penalty fee and income tax will be paid upon withdrawal. This criteria is important to fulfill when looking into 401(k) hardship withdrawals.

How Much 401(k) Can Be Used For Home Purchase?

Typically, home buyers who want to use their 401(k) funds to finance a real estate transaction can borrow or withdraw up to 50% of their vested balance or a maximum of $50,000—whichever is less—as long as they’re using the money exclusively to purchase a home.

Potential Drawbacks of Using Your 401(k) to Buy a House

Taking money out of a 401(k) to buy a house is allowed but not always recommended.

First, since one of the immediate limitations to using 401(k) funds is the amount that can be taken, it might not cover the cost of the entire purchase plus closing fees.

Second, homebuyers who borrow from their 401(k) plans can’t make additional contributions to the accounts or receive matching contributions from their employers while paying off the loan. Depending on how much they were regularly contributing, these home buyers could miss out on years of retirement contributions while they’re paying back the funds; that could be enough to make a substantial dent in their overall retirement savings.

Finally, if an individual borrows from their 401(k) to purchase a home and loses employment at their company (whether voluntarily or via layoff), the repayment period shortens and they’ll need to pay back the loan by the end of that year’s tax filing date. If the homebuyer fails to pay off the loan by then, it will typically be subject to a 10% penalty and taxed as income.

What are the Rules & Penalties for Using 401(k) Funds to Buy a House?

This chart outlines some key differences between taking out a 401(k) loan and withdrawing funds from a 401(k).

401(k) loans

401(k) withdrawals

•  Must be repaid with interest in a certain period of time—usually 5 years
•  Penalty-free and tax-free
•  The maximum loan amount is 50% of the vested account balance, or $50,000, whichever is less. (For accounts with a vested account balance of less than $10,000, the maximum loan amount is $10,000.)
•  Interest accrued on the loan goes back into the 401(k), so the borrower is basically paying interest back to themselves
If the borrower doesn’t repay the loan in time, the loan is treated as a regular distribution (aka withdrawal) and subject to an early withdrawal penalty and taxed immediately
•  Do not have to be repaid
•  Subject to income tax on the funds removed and a 10% early withdrawal penalty for people under age 59 ½
•  One can only withdraw enough to cover the immediate expense (a down payment, for example, not future monthly mortgage payments), with a limit of 50% of the vested balance or $50,000—whichever is less
•  Usually allowed only in the case of “financial hardship,” which can include medical expenses, funeral expenses, and primary home-buying expenses

What are the Alternatives to Using a 401(k) to Buy a House?

For some first-time homebuyers, there may be other, more attractive options for securing a down payment than taking money out of a 401(k) to buy a house. These are a few of the alternatives.

Withdrawing Money from a Roth IRA

Using a Roth IRA to buy a first home is one alternative to borrowing from a 401(k) that can be beneficial for some home buyers. Unlike 401(k)s, Roth IRA contributions are made with after-tax dollars. This means at the time of the withdrawal, the funds can be taken out tax-free (if the recipient is 59 ½ or older).

Other reasons why it might make sense to use a Roth IRA to purchase a first home:

•   Roth IRA contributions can be withdrawn without penalty at any time.
•   After the account has been open for five years, Roth IRA account holders who are buying their first home are allowed to withdraw up to $10,000 in investment earnings with no taxes or penalties. (Meaning a person could withdraw the amount of their total contribution plus up to $10,000 in investment earnings.)
•   Roth IRA funds can be used to help with the purchase of a first home not only for the account holders themselves, but for their children, parents, or grandchildren.

One last requirement to note is that time is of the essence when using a Roth IRA to purchase a first home: the funds have to be used within 120 days of the withdrawal.

Low- and No-Down-Payment Home Loans

There are certain low and no-down-payment home loans that first-time homebuyers may qualify for. This could allow them to secure the down payment for a first home without tapping into their retirement savings (either temporarily or permanently):

•   FHA loans are insured by the Federal Housing Administration and allow home buyers to borrow with fewer requirements. Home buyers with a credit score lower than 580 qualify for a loan with 10% down, and those with credit scores higher than 580 can get a loan with only 3.5% down.
•   Conventional 97 loans are Fannie Mae-backed mortgages that allow a loan-to-value ratio of up to 97%, i.e. the home buyer could purchase a house for $400,000 and borrow up to $388,000, leaving only a $12,000 down payment requirement to purchase the house.
•   VA loans are available for U.S. veterans, active duty members, and surviving spouses, and they require no down payment or monthly mortgage insurance payment. They’re provided by private lenders and banks and guaranteed by the United States Department of Veterans Affairs.
•   USDA loans are a type of home buyer assistance program offered by the U.S. Department of Agriculture to buy or possibly build a home in designated rural areas with an up-front guarantee fee and annual fee. Borrowers who qualify for USDA loans require no down payment and receive a fixed interest rate for the lifetime of the loan. Eligibility requirements are based on income, and vary by region.

Other Types of Down Payment Assistance

For home buyers who are ineligible for no-down payment loans, there are a few more alternatives to turn to instead of using a 401(k) to purchase a house:

•   Down Payment Assistance (DPA) programs offer eligible borrowers financial assistance in paying the required down payment and closing costs associated with purchasing a home. They come in the form of grants and second mortgages, are available nationwide, can be interest-free, and sometimes have lower rates than the initial mortgage loan.
•   Certain mortgage lenders provide financial assistance by offering credits to cover all or some of the closing costs and down payment.
•   Gifted money from friends or family members can be used to cover a down payment or closing costs on certain home loans.

The Takeaway

A 401(k) can be used to buy a house, either by taking out a 401(k) loan and repaying it with interest (but no penalties or income tax), or by making a 401(k) withdrawal (which is subject to income tax and a 10% withdrawal fee for people under the age of 59 ½).

But there are other options. Roth IRA withdrawals can be made tax- and penalty-free. Qualified homebuyers can also seek financial help from FHA loans, Conventional 97 loans, VA loans, USDA loans, DPA programs, and gifts from family members or friends.

Regardless of how homebuyers squirrel away the funds for a new home purchase, they can still prepare for a better financial future long after they’ve been handed the keys.

With SoFi Invest® retirement accounts, growing retirement savings is easy, empowering and can even be automated.

Find out how SoFi Invest® can help you meet your retirement goals.



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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 . The umbrella term “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.

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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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”).

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The Active Investing platform is owned by SoFi Securities LLC. 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 http://www.sofi.com/legal.
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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Safe Harbor 401(k) Plan: What Is It? Is it For You?

Safe harbor 401k plans enable companies—usually smaller ones—to sidestep the regulatory oversight that comes with traditional 401k plans. A perk used to attract top talent, safe harbor plans are a way for highly compensated employees to max out their 401k contributions.

With traditional 401k plans, contributions from highly compensated employees—including business owners—can’t comprise more than 2% of the average of all other employee contributions. With a safe harbor 401k plan, there are no such limits.

If you’re wondering about 401k safe harbor plans, it may be because you’re a business owner trying to decide what plan to offer employees, or it may be because your current or prospective employer offers one. Read on for more about what safe harbor 401k plans are and why companies use them, along with the benefits, drawbacks and relevant deadlines.

Safe Harbor 401k Plans Defined

A 401k safe harbor plan is a traditional 401k plan with an incentivizing twist.

With typical 401k retirement plans, any employee, regardless of title, salary, or even years spent at the company, receives the same plan contributions as any other employee or manager at the company. Annual non-discrimination regulatory testing ensures that companies who provide 401k plans to employees treat all employees equally in terms of plan contributions.

A safe harbor 401k allows companies to steer more robust 401k plan contributions to high-level employees and managers, depending on their salaries. Safe harbor 401ks bypass annual non-discrimination testing by adding a mandatory employer contribution at a minimum contribution level.

Having a safe harbor 401k plan frees company decision-makers to shower certain staffers with more plan contribution cash and immediate vesting, both of which could get and keep highly-valued employees in the fold.

Safe Harbor 401k Rules

With a safe harbor 401k, the company contributes to employees’ retirement accounts in one of three ways:

•   Non-elective: The company contributes the equivalent of 3% of each team member’s annual salary to a company 401k plan, regardless of whether the employee contributes.
•   Basic: The company offers 100% matching for the first 3% of an employee’s 401k plan contributions, plus a 50% match for the following 2% of an employee’s contributions.
•   Enhanced: The company offers a 100% company match for all employee 401k contributions, up to 4% of a staffer’s annual salary.

Regulators may also take a close look at a company’s cash flow and corporate finance strategy, and how it will result in a fair and equitable disbursement of funds to the company’s 401k safe harbor plan, and to its employees.

Once that hurdle is cleared, a company owner can reserve the maximum $19,500 (in 2020) for their own plan contribution, and also boost contribution payments to valued team members up to an individual profit-sharing maximum amount of $56,000.

“Regular” (non-favored) employees are allowed the same maximum contribution limit of $19,500, plus anyone over age 50 can contribute an extra “catch-up” amount of $6,500. Those are the same maximum contribution ceilings as regular 401k plans.

Benefits of Offering a Safe Harbor 401k Plan

By creating a safe harbor 401k plan, a business owner can potentially attract and maintain valued employees with higher retirement plan contributions, and also optimize retirement plan contribution amounts for ownership, ensuring more money for long-term retirement savings.

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

There are a number of additional upsides to offering a safe harbor 401k retirement plan.

•   If a company owner, or high-level managers, historically haven’t stowed enough money away in a company retirement plan, a safe harbor 401k plan can help them pay “catch up” fast.
•   If a company has a steady and robust revenue stream, and is managed efficiently, company owners may feel comfortable “spreading the wealth” with not only high-profile talent, but rank-and-file employees, too.
•   If a company is seeing weak contribution activity from its rank-and-file employees, it may feel more comfortable going the safe harbor route and at least guaranteeing minimum 401k contributions to employees, while rewarding higher-value employees with more lucrative 401k plan contributions.

Potential Drawbacks of a Safe Harbor 401k Plan

No doubt, safe harbor 401k plans have their downsides, too.

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

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

Filing Deadlines for a Safe Harbor 401k Plan

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

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

November 1: For companies with a safe harbor plan already in place, November 1st represents the last date a business can change the structure of a safe harbor plan. Regulators stipulate the November 1 deadline date for plan changes so notices can be transmitted to employees by December 1, giving them time to prepare for the next calendar year.

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

January 1: The date that all safe harbor 401k plans are activated.

For companies that currently have no 401k plan at all, they can roll out either a traditional 401k plan or a safe harbor 401k plan at any point in the year, for that calendar year.

The Takeaway

Smaller companies that don’t want the regulatory obligations of a traditional 401k plan and want to prioritize talent acquisition and retention, may choose to consider safe harbor 401k plans.

These plans allow an employer to bestow extra retirement benefits on high-value employees, making an overall compensation package more desirable. But it’s important for a business owner to weigh the pros and cons of a safe harbor 401k plan, because in some cases it can be quite expensive for a company to maintain.

For business owners who aren’t sure what retirement plan is right for their company and their employees, it can be helpful to research other employer-sponsored plans, including SIMPLE (Savings Incentive Match Plan for Employees) IRAs (Individual Retirement Account) or SEP IRAs.

Planning for retirement? Learn how working with a financial planner can help you reach your goals.



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 . The umbrella term “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.

Advisory services are offered through SoFi Wealth, LLC an SEC-registered Investment adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at adviserinfo.sec.gov .
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 to sell, solicitation to buy or a pre-qualification of any loan product offered by SoFi Lending Corp and/or its affiliates.
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.

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Roth IRA 5 Year Rule Explained

There’s a whole lot of lingo packed into the short phrase “Roth IRA 5-Year Rule,” so it may help to unpack it, one step at a time.

First, “IRA” is an acronym for an individual retirement account, an account in which people can invest money for their retirement and also enjoy tax benefits through their contributions. “Roth” is a certain type of IRA, and the 5-year rule is one of the rules that governs what an investor can and can’t do with funds in a Roth IRA.

This rule can apply to Roth IRAs in three broad ways. These include when a person:

•   Withdraws funds from the account.
•   Rolls a traditional IRA account into a Roth.
•   Inherits a Roth IRA account.

Quick Review on Roth IRAs

Numerous financial institutions offer Roth IRAs, including SoFi. Once the account is open, the investor can contribute funds to it each year, up to annual caps, to build a nest egg for retirement years.

For 2020, the maximum IRS contribution limit for Roth IRAs is $6,000 annually. Investors age 50 years or older are allowed to contribute up to $7,000 each year, with the extra $1,000 being a catch-up contribution. There is no upper age limit for contributing to a Roth IRA. But the IRS does limit contributions for certain filing statuses and income thresholds. Employees who contribute to their company-sponsored retirement plan can also contribute to a Roth IRA.

Opening a Roth IRA may be a good choice for some people who expect to be in a higher tax bracket at retirement time than they are now. Because each situation is unique, it is recommended that investors consult with a tax professional to make the best choice.

Contributions to a Roth IRA are made with after-tax income and are not tax deductible. Taxes are paid on an investor’s current income, not on the potentially higher income the investor may be earning at retirement time when they begin taking distributions.

Contributions and Earnings

The generally accepted goal of investing in a Roth IRA is to earn money on the original contributions to create a more substantial retirement account. A Roth IRA typically contains both the original contributions made to it by the investor as well as investment earnings.

Contributions made to a Roth IRA can be withdrawn at any time without tax or penalty, for any reason at any age. Investment earnings on those contributions can typically be withdrawn, tax free and without penalty, when the investor reaches the age of 59½, as long as the account has been in existence for a five-year period.

How does the Roth IRA 5-Year Rule Work?

Because contributions can be withdrawn tax free, this five-year waiting period typically applies to the investment earnings of the account, not to the initial contributions made by the investor.

For example, an investor who contributes $5,000 into a Roth IRA during 2019 earns $400 in interest and wants to withdraw a portion of their money. But this retirement account is less than five years old. It’s possible that the $5,000 contribution could be withdrawn before the account is five years old, because that’s a contribution made out of after-tax income. If, though, part or all of the $400 investment earnings is withdrawn within the initial five-year window of opening the account, this money may be taxed.

If the investor is under the age of 59½ but has had a Roth IRA for at least five years, there are instances when funds can be withdrawn without a penalty or taxes. These include if the investor:

•   Has a qualifying disability.
•   Is buying, building, or rebuilding a first home ($10,000 withdrawal limit)

There are also circumstances under which investors under the age of 59½ may be able to withdraw funds and still avoid a penalty (but may still need to pay income tax). These include when funds are used for:

•   Medical expenses that are more than 7.5% of the person’s adjusted gross income.
•   Medical insurance premiums paid when a person is not employed.
•   Qualified higher education expenses.

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Shortening the Waiting Period

To shorten the actual five-year waiting period, an investor could make a contribution on the day before income taxes are due and have it applied to the previous year. So, if someone made a contribution in April 2017, that contribution could be considered as being made in the 2016 tax year. As long as this doesn’t cause problems with annual contribution caps, the five-year window would effectively expire in 2021 rather than 2022.

If the same investor opens a second Roth IRA—say in 2018—the five-year window still expires (in this example) in 2021. The initial Roth IRA opened by an investor determines the beginning of the 5-year waiting period for all subsequently opened Roth IRAs.

Roth IRA Conversion 5-Year Rule

Some investors who have traditional IRAs may consider rolling them over into a Roth IRA. Typically, the money converted from the traditional IRA to a Roth is taxed as income, so it may make sense to talk to a financial advisor before making this move.

If this conversion is made, then the question becomes how the 5-year rule applies to this Roth IRA. The key date for this part of the 5-year rule is the tax year in which it happened. So, if an investor converted a traditional IRA to a Roth IRA on September 15, 2018, the five-year period would start on January 1, 2018. If the conversion took place on March 10, 2019, the five-year period would start on January 1, 2019. So, unless the conversion took place on January 1 of a certain year, which is unlikely, then the 5-year rule doesn’t literally equate to five full calendar years.

If an investor makes multiple conversions from a traditional IRA to a Roth IRA, perhaps one in 2018 and one in 2019, then each conversion has its own unique five-year window for the rule.

5-Year Rule for Beneficiaries

When the owner of a Roth IRA dies, the balance of the account may be inherited by beneficiaries. These beneficiaries can withdraw money without penalty, whether the money they take was from the principal (contributions made by the original account holder) or investment earnings. If this account was held for fewer than five tax years, however, the earnings portion of the beneficiary withdrawals is subject to taxation.

People who inherit Roth IRAs, unlike the original account holders, must take required minimum distributions. They can do so by withdrawing funds by December 31 of the fifth year after the original holder died or have the withdrawals taken out based upon their own life expectancy. If the five-year withdrawal plan is chosen, the funds can be taken out in partial distributions or in a lump sum. If the account is not emptied by December 31 of that fifth year, the consequence may be a 50% penalty on remaining funds.

Planning for Retirement with SoFi Invest®

Financial planners at SoFi can help guide investors through their retirement funding options. They bring years of expertise to each session, having worked with thousands of clients. As professional fiduciaries, they must keep the investor’s best interests front of center with no ulterior motives. And this no-cost planning can go well beyond saving for retirement, helping investors to meet a broad range of financial goals.

The process is simple and straightforward:

1. Set up a call.
2. Discuss your options and next steps.
3. Arrange a follow-up conversation whenever it’s needed.

You don’t need in-depth know-how to prepare for retirement using a SoFi-managed Roth IRA. Financial advisors can help develop a diversified portfolio and investment plan that works for you.

Consider SoFi Invest for your retirement planning.



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 . The umbrella term “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.

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.
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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