Preparing for Retirement Archives | Page 10 of 28

Apr

2022

What Is a Salary Reduction Contribution Plan?

By Mike Zaccardi, CMT, CFA | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

A salary reduction contribution plan allows employees to reduce their taxable income by investing for retirement. So an employee’s salary isn’t really reduced; rather the employer deducts a percentage of their salary and deposits the funds in a retirement savings plan so the money can grow tax deferred.

Common employer-sponsored retirement plans include 401(k)s, 403(b)s, and SIMPLE IRAs. Employee contributions — also called elective deferral contributions — are typically made with pre-tax money, effectively reducing the participant’s taxable income and often lowering their tax bill. Some plans feature an after-tax Roth contribution option, too.

You may already be contributing to a salary reduction plan, although your company may not call it that. These plans can be a valuable way to boost your retirement savings, and offer you a tax break. Here’s what you need to know.

Salary Reduction Contribution Plans Explained

A salary reduction plan helps workers save and invest for retirement through their employer via several types of retirement accounts. Money is typically deposited in a retirement account such as a 401k, 403b, or SIMPLE IRA on a pre-tax basis through recurring deferrals (a.k.a. contributions) on behalf of the employee.

Employees typically select the percentage they wish to deposit, e.g. 3%, 10%, or more. That percentage is deducted from an employee’s paycheck automatically, and deposited in their retirement account. Sometimes a specific dollar amount is established as the salary reduction contribution amount.

The upshot for the worker is that they can delay paying taxes on the amount of the salary reduction for many years, until they withdraw money from the account during retirement. Like a traditional 401k or 403b, these accounts can be tax deferred; Roth options are considered after tax (because you deposit after-tax funds, but pay no tax on withdrawals). Retirement contributions can offer decades of compounded investment growth without taxation. Essentially, retirement contributions through an employer’s plan means saving money from your salary.

There are also SIMPLE IRA salary reduction agreements sometimes offered by small businesses with 100 or fewer employees: “SIMPLE” is short for “Savings Incentive Match Plan for Employees.”

A Salary Reduction Simplified Employee Pension Plan (SARSEP), on the other hand, is a simplified employee pension plan established before 1997.

How Salary Reduction Contribution Plans Work

Salary reduction contribution plans are established between a worker and their employer. The two parties agree to have a set percentage or a dollar amount taken from the employee’s salary and deposited into a tax-advantaged retirement plan. That money can then be invested in stock or bond mutual funds, or other investments offered by the plan.

With pre-tax contributions, the employee has a reduced paycheck but captures current-year tax savings. With after-tax contributions, as in a Roth account, taxes are paid today while the account can potentially grow tax-free through retirement; withdrawals from a Roth account are tax free.

Example of a Salary Reduction Contribution Plan

Here’s an example of how a salary reduction plan contribution agreement might work:

Let’s say an employee at a university has a $100,000 salary and wishes to save 10% of their pay in a pre-tax retirement account. The school has a 403b plan in place. The worker contacts their Human Resources department to ask about submitting a salary reduction agreement form. On the form, the worker chooses an amount of their salary to defer into the 403b plan (10%).

Typically they also select investments from a lineup of mutual funds or exchange-traded funds (ETFs).

Come payday, the employee’s paycheck will look different. If the usual biweekly gross earnings amount is $3,846 ($100,000 salary divided by 26 pay periods, per year), then $384.60, or 10% of earnings, is deducted from the employee’s paycheck and deposited into the 403b and invested, assuming the employee has selected their desired investment options.

Depending on other deductions, the employee’s new taxable income might be $3,461.40. The contribution effectively reduced the worker’s salary, potentially lowering their tax bill at the end of the year.

If the worker is in the 22% marginal income tax bracket, the $10,000 annual deferral amounts to an annual federal income tax savings of $2,200 per year.

Bear in mind that withdrawals from the 403b plan are taxable with pre-tax salary reductions. We’ll look at salary reduction plan withdrawal rules later.

Pros & Cons of Salary Reduction Contribution Plans

Although your employer may offer a salary reduction contribution plan like a 401k or SIMPLE IRA salary reduction agreement for retirement, it’s not required to participate. Before deciding whether you want to join your organization’s plan, here are some advantages and disadvantages to consider.

Pros

A salary reduction contribution offers employees the chance to reduce their current-year taxable income. A lower salary defers taxation on the money you save, until retirement. For young workers, that could mean decades of compound investment growth without having to pay taxes along the way.

For those who have the option of choosing a Roth account, taxes are paid in the current year, but withdrawals are tax free (as long as certain criteria are met). Also, contributions to a Roth 401k or Roth 403b plan can grow tax-free through retirement.

What’s more, the employer might offer their own contribution such as a matching feature. Typically, an employer might match employees’ contributions up to a certain amount: e.g. they’ll match 50 cents for every dollar an employee saves, up to 6% of their salary.

Another upside is that lowering one’s salary through automated savings can help an individual live on less money and avoid spending beyond their means — which can help establish long-term savings habits. Thus, contributing to a salary reduction plan can be a step toward creating a financial plan.

Cons

Like many aspects of personal finance, salary reduction contributions can be a balancing act between meeting your obligations today and providing for your future self.

Saving for the future can mean forgoing some pleasure in the present, similar to the concept of delayed gratification. Maybe you decide to postpone a vacation or buying a new car in exchange for a more robust retirement account balance.

Employees should also weigh the likelihood of needing money in the event of an emergency. Taking early withdrawals or borrowing from your 401(k) account can be costly, or may come with penalties, versus having extra cash in a checking or savings account. In most cases if you take out a loan from an employer-sponsored plan, you would have to repay the loan in full if you left your job.

Salary Reduction Contribution Limits

Annual salary reduction contribution limits can change each year. The Internal Revenue Service (IRS) determines the yearly maximum contribution amount. For 2022, the most a worker can contribute to a 401k or 403b is $20,500. For those age 50 and older, an additional $6,500 contribution is permitted.

A SIMPLE IRA salary reduction agreement has different limits. For 2022, a SIMPLE IRA’s annual maximum contribution is $14,000 with a catch-up contribution of up to $3,000 for those age 50 and older.

Salary Reduction Contribution Plan Withdrawal Rules

There are many rules regarding salary reduction contribution plan withdrawals.

At a high level, when an employee withdraws money from a tax-deferred retirement account, they will owe income tax on the money. If you withdraw money before age 59 ½, a 10% early-withdrawal tax might be applied.

There can be some exceptions to these rules, but it’s best to consult with a professional.

Should you withdraw money when you leave your employer? While taking a lump sum is possible under those circumstances, it may not be your best choice: You’d owe taxes on the full amount, and you’d risk spending money that’s meant to support you when you’re older.

The standard rule of thumb is that individuals who are leaving one employer should consider rolling over their retirement account to an IRA, or their new employer’s plan; in that case there are no penalties or taxes owed, and the money is once again secured for the future.

The Takeaway

Salary reduction contribution plans can help workers save money for retirement on a pre-tax or after-tax basis. Steadily putting money to work for your future is a major step toward building a solid long-term financial plan. And in many cases you will reap a tax advantage in the present — or in the future.

That said, there are important pros and cons to weigh when deciding whether you should contribute via a salary reduction plan. You may have another strategy. But if you don’t, you might want to consider opting into your employer’s plan for the benefits it can provide.

An important point to know: Even when you join a salary reduction plan, you can still open up an IRA to boost your savings. It’s easy when you open an online brokerage account with SoFi Invest®. SoFi can help you consider risk and return objectives when planning ahead. And as a SoFi member, you have access to complimentary financial planners who can help guide you along your financial journey.

FAQ

Does a 401k reduce salary?

Not really. Contributions toward a traditional 401k retirement plan are a tax-deductible form of savings, that effectively reduce an individual’s taxable income. In that regard, making retirement contributions on a pre-tax basis can reduce someone’s salary (but you still have the money in your retirement account).

Also, some plans allow for after-tax contributions which also reduce the size of your paycheck, but are not tax deductible.

What does employee salary reduction mean?

Employee salary reduction means that money is automatically deducted from an employee’s paycheck and contributed to a retirement plan. Money moves into a plan such as a 401k, 403b, or a SIMPLE IRA. And the account is in your name, and you decide how to invest the funds.

What is the difference between SEP and SARSEP?

A SEP is known as a Simplified Employee Pension Plan. A SEP plan allows employers to contribute to traditional IRAs (called SEP-IRAs) for their employees. The IRS states that a business of any size, even self-employed, can establish a SEP. These plans are common in the small business world.

A SARSEP, on the other hand, is a simplified employee pension plan established before 1997. A SARSEP includes a salary reduction arrangement. The employee can choose to have the employer contribute a portion of their salary to an IRA or annuity. Per the IRS, a SARSEP may not be established after 1996.

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected] Please read the prospectus carefully prior to investing. Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

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Apr

2022

Should I Put My Bonus Into My 401k? Here’s What You Should Consider

By Paulina Likos | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

If you’re wondering what to do with bonus money, you’re not alone. Investing your bonus money in a tax-advantaged retirement account like a 401(k) has some tangible advantages. Not only will the extra cash help your nest egg to grow, you could also see some potential tax benefits.

Of course, we live in a world of competing financial priorities. You could also pay down debt, spend the money on something you need, save for a near-term goal — or splurge! The array of choices can be exciting — but if a secure future is your top goal, it’s important to consider a 401k bonus deferral.

Here are a few strategies to think about before you make a move.

Receiving a Bonus Check

First, a practical reminder. When you get a bonus check, it may not be in the amount that you expected. This is because bonuses are subject to income tax. Knowing how your bonus is taxed can help you understand how much you’ll end up with so you can determine what to do with the money that’s left. The IRS considers bonuses as supplemental wages rather than regular wages.

Ultimately, your employer decides how to treat tax withholding from your bonus. Employers may withhold 22% of your bonus to go toward federal income taxes. But some employers may add your whole bonus to your regular paycheck, and then tax the larger amount at normal income tax rates. If your bonus puts you in a higher tax bracket for that pay period, you may pay more than you expected in taxes.

Also, your bonus may come lumped in with your paycheck (not as a separate payout), which can be confusing.

Whatever the final amount is, or how it arrives, be sure to set aside the full amount while you weigh your options — otherwise you might be tempted to spend it, as behavioral finance research has shown.

What to Do With Bonus Money

There’s nothing wrong with spending some of your hard-earned bonus from your compensation. One rule of thumb is to set a percentage of every windfall (e.g. 10% or 20%) — whether a bonus or a birthday check — to spend, and save the rest.

To get the most out of a bonus, though, many people opt for a 401k bonus deferral and put some or all of it into their 401k account. The amount of your bonus you decide to put in depends on how much you’ve already contributed, and whether it makes sense from a tax perspective.

Contributing to a 401k

The contribution limit for 401k plans in 2022 is $20,500; for those 50 and older you can add another $6,500, for a total of $27,000. If you haven’t reached the limit yet, allocating some of your bonus into your retirement plan can be a great way to boost your retirement savings.

In the case where you’ve already maxed out your 401k contributions, your bonus can also allow you to invest in an IRA or a non-retirement (i.e. taxable) brokerage account.

Contributing to an IRA

If you’ve maxed out your 401k contributions for the year, you may still be able to open a traditional tax-deferred IRA or a Roth IRA. It depends on your income.

In 2022, the contribution limit for traditional IRAs and Roth IRAs is $6,000; with an additional $1,000 catch-up provision if you’re over 50. But if your income is over $144,000 (for single filers) or $214,000 (for married filing jointly), you aren’t eligible to contribute to a Roth. And while a traditional IRA doesn’t have income limits, the picture changes if you’re covered by a workplace plan like a 401k.

If you’re covered by a workplace retirement plan and your income is too high for a Roth, you likely wouldn’t be eligible to open a traditional, tax-deductible IRA either. You could however open a nondeductible IRA. To understand the difference, you may want to consult with a professional.

Contributing to a Taxable Account

Of course, when you’re weighing what to do with bonus money, you don’t want to leave out this important option: Opening a taxable account.

While employer-sponsored retirement accounts typically have some restrictions on what you can invest in, taxable brokerage accounts allow you to invest in a wider range of investments. So if your 401k is maxed out, and an IRA isn’t an option for you, you can use your bonus to invest in stocks, bonds, exchange-traded funds (ETFs), mutual funds, and more in a taxable account.

Deferred Compensation

You also may be able to save some of your bonus from taxes by deferring compensation. This is when an employee’s compensation is withheld for distribution at a later date in order to provide future tax benefits.

In this scenario, you could set aside some of your compensation or bonus to be paid in the future. When you defer income, you still need to pay taxes later, at the time you receive your deferred income.

Your Bonus and 401k Tax Breaks

Wondering what to do with a bonus? It’s a smart question to ask. In order to maximize the value of your bonus, you want to make sure you reduce your taxes where you can.

One method that’s frequently used to reduce income taxes on a bonus is adding some of it into a tax-deferred retirement account like a 401k or traditional IRA. The amount of money you put into these accounts typically reduces your taxable income in the year that you deposit it.

Here’s how it works. The amount you contribute to a 401k or traditional IRA is tax deductible, meaning you can deduct the amount you save from your taxable income, often lowering your tax bill. (The same is not true for a Roth IRA or a Roth 401k, where you make contributions on an after-tax basis.)

The annual contribution limits for each of these retirement accounts noted above may vary from year to year. Depending on the size of your bonus and how much you’ve already contributed to your retirement account for a particular year, you may be able to either put some or all of your bonus in a tax-deferred retirement account.

It’s important to keep track of how much you have already contributed to your retirement accounts because you don’t want to put too much of your bonus and exceed the contribution limit. In the case where you have reached the contribution limit, you can put some of your bonus into other tax deferred accounts including a traditional IRA or a Roth IRA.

How Investing Your Bonus Can Help Over Time

Investing your bonus can help increase its value over the long-run. As your money grows in value over time, it can be used in many ways: You can stow part of it away for retirement, as an emergency fund, a down payment for a home, to pay outstanding debts, or another financial goal.

While it can be helpful to have some of your bonus in cash, your money is better suited invested in an investment vehicle where it works for you and doesn’t lose value due to inflation. If you start investing your bonus each year in either a tax-deferred retirement account or non-retirement account, this will ensure you are steps closer to enjoying greater financial security in the future.

Investing for Retirement With SoFi

The yearly question of what to do with a bonus is a common one. Just having that windfall allows for many financial opportunities, such as saving for immediate needs — or purchasing things you need now. But it may be wisest to use your bonus to boost your retirement nest egg — for the simple reason that you could stand to gain more financially down the road, while also potentially enjoying tax benefits in the present.

The fact is, most people don’t max out their 401k contributions each year, so if you’re in that boat it might make sense to take some or all of your bonus and fill up the gas tank, so to say. If you have maxed out your 401k, you still have options to save for the future via traditional or Roth IRAs, deferred comp, or investing in a taxable account.

A taxable account might offer you different or complementary investment options that could also round out your portfolio.

Keeping in mind the tax implications of where you invest can also help you allocate this extra money where it fits best with your plan.

If you get a bonus this year, you can help grow your retirement savings with SoFi Invest®. It’s easy to set up an Active Invest account and open a traditional or Roth IRA with SoFi. With either an active or automated approach to investing in these retirement accounts, you can choose from a wide range of investment options and services, such as speaking with financial professionals at no additional cost. Learn more about how to take control of your retirement with SoFi Invest.

FAQ

Is it good to put your bonus into a 401k?

The short answer is yes. It might be wise to put some or all of your bonus in your 401k, depending on how much you’ve contributed to your workplace account already. You want to make sure you don’t exceed the 401k contribution limit.

How can I avoid paying tax on my bonus?

Your bonus will be taxed, but you can lower the amount of your taxable income by depositing some or all of it in a tax-deferred retirement account such as a 401k or IRA. However, this does not mean you will avoid paying taxes completely. Once you withdraw the money from these accounts in retirement, it will be subject to ordinary income tax.

Can I put all of my bonus into a 401k?

Possibly. You can put all of your bonus in your 401k if you haven’t reached the contribution limit for that particular year, and if you won’t surpass it by adding all of your bonus. For 2022, the contribution limit for a 401k is $20,500 if you’re younger than 50 years old; Those over 50 can contribute an additional $6,500 for a total of $27,000.

Mar

2022

Guide to Cash Balance Pension Plans

By Rebecca Lake | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

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

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

What Are Cash Balance Pension Plans?

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

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

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

How Cash Balance Pension Plans Work

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

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

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

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

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

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

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

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

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

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

Cash Balance Plan vs 401k

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

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

	Cash Balance Plan	401k
Funded By	Employer contributions	Employee contributions (employer matching contributions are optional)
Investment Options	Employers choose plan investments and shoulder all of the risk	Employees can select their own investments, based on what’s offered by the plan, and shoulder all of the risk
Returns	Account balance at retirement is determined by years of service, earnings, pay credit, and interest credit	Account balance at retirement is determined by contribution amounts and investment returns on those contributions
Distributions	Cash balance plans must offer employees the option of receiving a lifetime annuity; can also be a lump sum distribution	Qualified withdrawals may begin at age 59 ½; plans may offer in-service loans and/or hardship withdrawals

Pros & Cons of Cash Balance Pension Plans

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

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

Pros of Cash Balance Pension Plans

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

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

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

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

Cons of Cash Balance Pension Plans

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

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

Pros	Cons
• Guaranteed benefits with no risk • Tax-deferred growth • Flexible distribution options • Higher contribution limits • Guaranteed by the PBGC	• Investing in a 401k may generate higher returns • No option for loans or hardship withdrawals • Distributions are taxable

Pros

Cons

• Guaranteed benefits with no risk

• Tax-deferred growth

• Flexible distribution options

• Higher contribution limits

• Guaranteed by the PBGC

• Investing in a 401k may generate higher returns

• No option for loans or hardship withdrawals

• Distributions are taxable

Investing for Retirement With SoFi

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

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

FAQ

Is a cash balance plan worth it?

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

Is a cash balance plan the same as a pension?

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

Can you withdraw from a cash balance plan?

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

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
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.

Photo credit: iStock/sturti
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Mar

2022

Retirement Planning for Independent Contractors

By Ashley Kilroy | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

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

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

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

Types of Retirement Plans for Independent Contractors

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

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

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

Roth IRA

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

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

Now for some differences:

Tax treatment

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

Early withdrawal rules

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

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

Income limits

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

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

Required Minimum Distributions (RMDs)

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

Traditional IRA

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

Tax treatment

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

Early withdrawal rules

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

Required Minimum Distributions (RMDs)

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

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

Simplified Employee Pension or SEP IRA

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

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

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

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

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

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

Savings Incentive Match Plan for Employees or SIMPLE IRA

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

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

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

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

The employer’s contribution

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

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

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

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

The employee contribution

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

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

Solo 401k

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

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

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

Choosing the Right Plan for You

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

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

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

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

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

Investing for Retirement With SoFi

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

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

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

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

FAQ

Can independent contractors have a 401k?

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

How do independent contractors save for retirement?

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

What is the best retirement plan for 1099 employees?

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

Mar

2022

What Is 401(k) Plan Benchmarking?

By Mike Zaccardi, CMT, CFA | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

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

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

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

How 401(k) Benchmarking Works

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

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

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

The Importance of 401(k) Plan Benchmarking

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

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

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

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

1. Assess Your 401(k) Plan Design

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

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

2. Evaluate Your 401(k) Plan Fees

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

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

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

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

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

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

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

Investing for Retirement With SoFi

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

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

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

FAQ

What does it mean to benchmark a 401k?

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

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

How should you structure your 401k?

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

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

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

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

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

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

How do I check my 401k performance?

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

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

Photo credit: iStock/Imagesrouges
SOIN0221012

What Is a Salary Reduction Contribution Plan?

Salary Reduction Contribution Plans Explained

How Salary Reduction Contribution Plans Work

Example of a Salary Reduction Contribution Plan

Pros & Cons of Salary Reduction Contribution Plans

Pros

Cons

Salary Reduction Contribution Limits

Salary Reduction Contribution Plan Withdrawal Rules

The Takeaway

FAQ

Does a 401k reduce salary?

What does employee salary reduction mean?

What is the difference between SEP and SARSEP?

Should I Put My Bonus Into My 401k? Here’s What You Should Consider

Receiving a Bonus Check

What to Do With Bonus Money

Contributing to a 401k

Contributing to an IRA

Contributing to a Taxable Account

Deferred Compensation

Your Bonus and 401k Tax Breaks

How Investing Your Bonus Can Help Over Time

Investing for Retirement With SoFi

FAQ

Is it good to put your bonus into a 401k?

How can I avoid paying tax on my bonus?

Can I put all of my bonus into a 401k?

Guide to Cash Balance Pension Plans

What Are Cash Balance Pension Plans?

How Cash Balance Pension Plans Work

Cash Balance Plan vs 401k

Pros & Cons of Cash Balance Pension Plans

Pros of Cash Balance Pension Plans

Cons of Cash Balance Pension Plans

Investing for Retirement With SoFi

FAQ

Is a cash balance plan worth it?

Is a cash balance plan the same as a pension?

Can you withdraw from a cash balance plan?

Retirement Planning for Independent Contractors

Types of Retirement Plans for Independent Contractors

Roth IRA

Tax treatment

Early withdrawal rules

Income limits

Required Minimum Distributions (RMDs)

Traditional IRA

Tax treatment

Early withdrawal rules

Required Minimum Distributions (RMDs)

Simplified Employee Pension or SEP IRA

Savings Incentive Match Plan for Employees or SIMPLE IRA

The employer’s contribution

The employee contribution

Solo 401k

Choosing the Right Plan for You

Investing for Retirement With SoFi

FAQ

Can independent contractors have a 401k?

How do independent contractors save for retirement?

What is the best retirement plan for 1099 employees?

What Is 401(k) Plan Benchmarking?

How 401(k) Benchmarking Works

The Importance of 401(k) Plan Benchmarking

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

1. Assess Your 401(k) Plan Design

2. Evaluate Your 401(k) Plan Fees

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

Investing for Retirement With SoFi

FAQ

What does it mean to benchmark a 401k?

How should you structure your 401k?

How do I check my 401k performance?

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