Feb
01
2022
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Retirement Options For the Self-Employed

By | invest, Investing, Life & Career, Preparing for Retirement | No Comments

Being your own boss is great. You get flexibility and the ability to pursue the things you care about. But as the boss, you also have to deal with all the administrative and financial details an employer might typically take care of—like choosing the right retirement plan.

Though it may require a little more action on your part, there are different kinds of self-employed retirement plans to explore. In fact, some self-employed retirement plans actually have high contribution limits and tax benefits.

And it’s a good thing too, since more people than ever are self-employed or starting their own businesses. According to Fresh Books third annual self-employment report annual self-employment report, 27 million Americans are expected to leave the traditional workforce for self-employment in the next two years.

So what does retirement for self-employed people look like? Well, a little like retirement for the traditionally employed. The general rules of thumb still apply: You can calculate how much you’ll need to save for retirement based on your current age and when you plan to retire.

No matter what your age, it’s a good idea to do the math now, so you can hypothetically see how much money you could be contributing to your retirement and whether you’re on track for your age and retirement goals.

Self-Employed Retirement Plans

In some ways, self-employed retirement plans aren’t too different from regular retirement plans. Certainly, the principles of retirement are the same: set aside money now to use in retirement—ideally providing an income when it’s time to retire.

The most common retirement savings plan, though, is a 401(k), but a 401(k) is, by definition, an employer-sponsored retirement account. For those who are self-employed that’s not an option.

The IRS breaks down a number of retirement plans for the self-employed or for those who run their own businesses, but we’ll lay out the basics here for you to start thinking about.

Traditional or Roth IRA

One of the most popular self-employed retirement plans is an IRA—or an individual retirement account. Anyone can open an IRA either with an online brokerage firm or at a traditional financial institution. And if you’re leaving a regular job where you had an employer-sponsored 401(k), then you can roll it over into an IRA.

If you meet eligibility requirements, you can contribute up to $6,000 annually to an IRA, with an additional $1,000 catch-up contribution allowed for people over 50 years old. (These limits are for 2022—the IRS does adjust them from time to time.)

The main difference between a traditional vs. Roth IRA is when the taxes are paid. In a traditional IRA, the contributions you make to your retirement account are tax-deductible when you make them, and the withdrawals during retirement are taxed at ordinary income rates. With a Roth IRA, there are no tax breaks for your contributions, but you’re not taxed when you withdraw.

Choosing which IRA makes sense for you can depend on a few factors, including what you’re earning now vs. what you expect to be earning when you retire. Additionally, you can only contribute to a Roth IRA if your income is below a certain limit : For 2022, that’s less than $214,000 adjusted gross income (AGI) for a person who is married filing jointly, and less than $144,000 for a person who is filing as single.

Solo 401(k)

A solo 401(k) is a self-employed retirement plan that the IRS also refers to as one-participant 401(k) plans . It works a bit like a regular employer-backed 401(k), except that in this instance you’re the employer and the employee.

For 2022, you can contribute $20,500 (or $27,000 if age 50 or over) in salary deferrals as you would normally contribute to a standard 401(k). Then, as the “employer”, you can also contribute up to 25% of your net earnings, with additional rules for single-member LLCs or sole proprietors. Total contributions cannot exceed a total of $61,000.

From there, it works more or less like a regular 401(k): the contributions are made pre-tax and any withdrawals or distributions after age 59.5 are taxed at the regular rate. You can also set up the plan to allow for potential hardship distributions under specific circumstances, like a medical emergency.

You can not use a solo 401(k) if you have any employees, though you can hire your spouse so they can also contribute to the plan (as an employee; you can match their contributions as the employer). 401(k) contribution limits are per person, not per plan, so if either you or your spouse are enrolled in another 401(k) plan, then the $61,000 limit per person would include contributions to that other 401(k) plan.

A solo 401(k) makes the most sense if you have a highly profitable business and want to save a lot for retirement, or if you want to save a lot some years and less others. You can set up a solo 401(k) with most wealth management firms.

Simplified Employee Pension (or a SEP IRA)

A SEP IRA is an IRA with a simplified and streamlined way for an employer (in this case, you) to make contributions to their employees’ and to their own retirement.

For 2022, the SEP IRA rules and limits are as follows: you can contribute up to $61,000 or 25% of your net earnings, whichever is less. As is the case with a number of these retirement for self-employed options, there is a cap of $305,000 on the compensation that can be used to calculate that cap. You can deduct your contributions from your taxes, and your withdrawals in retirement will be taxed as income.

A key difference in a SEP vs. other self-employment retirement plans is this is designed for those who run a business with employees. You have to contribute an equal percentage of salary for every employee (and you are counted as an employee). That means you can not contribute more to your retirement account than to your employees’ accounts, as a percentage not in absolute dollars. On the plus side, it’s slightly simpler than a solo 401(k) to manage in terms of paperwork and annual reporting.

SIMPLE IRA

A SIMPLE IRA (which stands for Savings Incentive Match Plan for Employees ) is like a SEP IRA except it’s designed for larger businesses. Unlike the SEP plan, the employer isn’t responsible for the whole amount of an employee’s contribution. Individual employees can also contribute to their own retirement as salary deferrals out of their paycheck.

You, as the employer, have to simply match contributions up to 3% or contribute a fixed 2%. This sounds complicated, but the point is it’s designed for larger companies, so that you can manage the contributions to your employees’ retirement plans as well as your own. The trade-off, however, is that the maximum contribution limit is lower.

You can contribute up to $14,000 to your SIMPLE IRA, plus a catch-up contribution of $3,000 if you’re 50 or over. And your total contributions, if you have another retirement employer plan, maxes out at $20,500 annually.

There are a few other restrictions: If you make an early withdrawal before the age of 59 ½ , you’ll likely incur a 10% penalty much like a regular 401(k); do so within the first two years of setting up the SIMPLE account and the penalty jumps to 25%. (There is also a SIMPLE 401(k) that does allow for loan withdrawals, but requires more set-up administrative oversight on the front end.)

Defined Benefit Retirement Plan

Another retirement option you’ve probably heard a lot about is the defined benefit plan, or pension plan. Typically, a defined benefit plan pays out set annual benefits upon retirement, usually based on salary and years of service.

For the self-employed, your defined benefit has to be calculated by an actuary based on the benefit you set, your age, and expected returns. The maximum annual benefit you can set is currently the lesser of $245,000 or 100% of the participant’s average compensation for his or her highest three consecutive calendar years, according to the IRS.
Contributions are tax-deductible and your withdrawals during retirement will be taxed as income. And, if you have employees, then you typically must also offer the plan to them.

Defined benefit plans guarantee you a steady stream of income in retirement and with no set maximum contribution limit, if you’re earning a lot (and expect to keep earning a lot through retirement), they may be a good way to save up money.

These self-employed retirement plans can, however, be complicated and expensive to set up and require ongoing annual administrative work. Not every financial institution even offers defined benefit plans as an option for an individual. You’ll also have to be committed to funding the plan to a certain level each year in order to achieve that defined benefit—and if you have to change or lower the benefit, there may also be fees.

Other Retirement Options for the Self-Employed

While these are the most common self-employed retirement account options and the ones that offer tax benefits for your retirement savings, there are other options self-employed individuals might consider, like a profit-sharing plan if you own your own business.

Plus, don’t forget: You also have Social Security funds in retirement. Full retirement age for Social Security is considered 67 years old.

The IRS does offer what it calls annual check-ups to check on your retirement account and to go through a checklist of potential issues or fixes. However, you may want some additional human guidance, especially if you have specific questions.

The Takeaway

When you’re an entrepreneur or self-employed it can feel like your options are limited in terms of retirement plans, but in fact there are a number of options open, including various IRAs and a solo 401(k).

Looking to open a new retirement account? SoFi Invest® offers traditional, Roth, and SEP IRAs. Plus, you’ll get access to a broad range of investment options, member services, and our robust suite of planning and investment tools.

Find out how to save for retirement with SoFi Invest.

SoFi Invest®
SoFi Invest refers to the two 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 and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA(www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of SoFi Digital Assets, LLC, please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Bank, N.A.

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

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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Feb
01
2022
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How the 4% Retirement Rule Works

By | invest, Investing, Preparing for Retirement | Comments Off on How the 4% Retirement Rule Works

After decades of saving for retirement, many new retirees often find themselves facing a new challenge: Determining how much money they can take out of their retirement account each year, without running the risk of depleting their nest egg too quickly.

One rule of thumb used by some professionals is “the 4% rule.”

What Is the 4% Retirement Rule?

This “rule” suggests that retirees start by withdrawing 4% from their overall nest egg, and adjust that dollar amount each year based on inflation.

Because the withdrawals would at least partly consist of dividends and interest that continue to accrue, the entire amount withdrawn each year would not totally come out of the principal balance.

This post will explore this rule in more depth, including how it originated, misconceptions some people have about the rule, the potential risks associated with it, and whether it’s still a viable strategy today.

Origination of the 4% Rule

Many people think that the 4% rule ensures that a retiree won’t run out of money in their retirement, but Bengen came up with the 4% in rule in 1994, based on an analysis of investment data going back to 1926. Bengen used this historical data to determine the maximum safe withdrawal amount that a retiree could sustainably take out for each rolling 30-year time frame.

Because this withdrawal percentage reflects what has happened in the past, this may or may not accurately predict what will happen now and in the future.

Also, in 2005, Bergen revisited his calculations and expanded his sample portfolio to include small cap stocks. He found that with this additional asset class, he could increase the annual withdrawal amount, so it is now also referred to as the 4.5% rule.

Common 4% Rule Misconceptions

Many mistakenly believe that Bengen’s rule will ensure that a nest egg last all the way through retirement, but Bengen’s calculations, he was not determining a percentage that would help to ensure that someone’s retirement savings would last a lifetime. Instead, he was calculating what withdrawal level would result in retirement funds lasting a minimum of 30 years.

Another common misconception focuses on how to calculate the 4%, with some people believing that the percentage should be calculated each year at the current principal balance. In Bengen’s formula, it should only be calculated once, based on the principal balance of the retirement funds when the person first retires.

So, if the balance was $500,000 at the point of retirement, then the maximum annual withdrawals would be $20,000. If the starting balance was $1 million, then it would be $40,000, and so forth.

Here are two more things to consider: Bengen used sample portfolios that contained 50% stocks and 50% bonds.

Portfolios with different investments of varying percentages would likely have different results, depending on that portfolio’s risk level.

And, because success in this theory is defined as having money left over after 30 years—meaning, any money whatsoever—Bengen’s definition of success may not align with that of a typical retiree. For example, if, after 30 years, a retiree had $10 left in a retirement fund, then the 4% (or 4.5%) rule would be considered a success. Would a retiree who might live five years longer (or more!), without any more money to withdraw, consider this a successful management of funds?

Risks of the 4% Rule

One challenge associated with this rule, as noted above, is that it only addresses 30 years’ worth of time. So, if someone’s life expectancy goes beyond 30 years post-retirement they could find themselves out of money.

Other challenges can exist for retirees who have chosen investments that have higher risks than average ones. In that case, they may need to take a more conservative withdrawal approach, particularly in the years immediately following their retirement because a market downturn could have a bigger impact on the value of those portfolios.

If retirees take a larger withdrawal, especially early on, this lowers the principal in a way that will affect compound interest throughout retirement years. If this happens, then the retiree can’t simply pick up with the 4% rule from that point on. On the other hand, if a retiree spends much less in a given year, the rule doesn’t adjust for that either.

Is the 4% Rule Too Conservative?

Some financial professionals believe that the 4% rule is too conservative, assuming that the United States doesn’t experience a significant economic depression. Because of that, retirees may be too frugal with their retirement funds and not necessarily live life as fully as they could.

Others say, this rule doesn’t take into account any other sources of income retirees may have, such as Social Security, company pensions, or an inheritance.

So, what’s the right withdrawal strategy to take? It depends. The most appropriate withdrawal strategy for any individual will depend on their unique goals and financial picture.

Starting to Invest for Retirement

It’s never too early to start investing for retirement. This can be challenging for young professionals with other financial goals, including things like paying down student loans or saving up for a house downpayment.

Recommended: How Much Should I Have Saved by 30?

But, starting sooner rather than later can make a huge difference in accumulating savings, perhaps hundreds of thousands of dollars of a difference. And whether you follow the 4% rule or not, the more you have saved for retirement, the more you’ll be able to spend in those years.

To get yourself on track for retirement, consider putting your retirement savings in these accounts:

401(k) or other forms of workplace retirement plans

With a workplace plan, employees typically contribute part of a paycheck, using pre-tax dollars, up to $20,500 per year into their retirement account. Those age 50 and older can contribute an additional $6,500. Companies sometimes offer a “match,” which means that the employee’s contribution gets matched up to a certain percent by the employer. This account is tax deferred, meaning no taxes are paid on the funds until they are withdrawn. However, withdrawing these funds early—generally before age 59 ½,—could trigger an additional 10% early distribution tax.

💡 Recommended: How to Start a 401(k) Plan

SEP IRA, SIMPLE IRA or Solo 401(k)

These are retirement plan options for people who are self-employed.

Traditional IRA (individual retirement account)

This is a tax-deferred retirement account, one that’s not tied to the workplace. So, this is also an option used by freelancers and other self-employed people, as well as people who don’t have 401(k) accounts at work. Contribution limits for an IRA for people under age 50 are capped at $6,000 annually; those who are 50 or older can contribute up to $7,000 each year. This account also has a 10% tax penalty for early withdrawal.

Roth IRA

This is another form of retirement account that’s not connected to the workplace, and contribution limits are $6,000 annually. The taxation system for a Roth IRA, however, is different, with income taxes paid in advance on contributed money. But, when retirees withdraw funds, the money is not taxed. Not everyone qualifies for a Roth IRA (there are income limits) but it can be an option for those who are employed by a company as well as those who are self-employed.

Ways to Save for Retirement

If it seems challenging to save for retirement, given your other expenses, a good first step is to create a budget that works for your income and expenses, and includes contributions to a retirement account.

This should be a reasonable budget—meaning that it’s realistic, one that can be adhered to. It makes sense to review this budget regularly, perhaps every few months, and adjust as needed.

In situations where employers offer a 401(k) plan with a contribution match, then it can be a wise move to participate in this program. Matches, remember, are essentially free cash.

Also, consider which expenses you can cut back to make room for higher contributions. Are there online subscriptions or fee-based apps you can cancel? Can you get a better deal on your cell phone plan? Insurance policies?

Can you consolidate your credit cards into a lower-rate personal loan? Once you’ve paid off your credit card balance or personal loan, consider putting the money from those bills into the retirement account?

What about getting a side gig? You can use special skills, such as photography, copyediting, or cooking, to earn extra money that can go toward additional retirement contributions.

The Takeaway

At its core, the 4% rule represents a percentage that retirees are able to withdraw from their savings annually and have them last a minimum of 30 years. For example, someone following this rule could withdraw $20,000 a year from a $500,000 retirement account balance.

However, different people have different dreams for retirement. Some want to travel the world, while others want to spend time with family at home. Some may have other financial responsibilities, like helping a grandchild pay for college. What matters most is that each person plans for the retirement they want to experience.

Given those variations, 4% makes more sense as a guideline than as a hard-and-fast rule for retirees. Having as much flexibility as possible in planning for withdrawals, means saving as much as possible first. A starting place for many people is their workplace 401(k), but that’s not the only place you can save for retirement. Those who don’t have access to a workplace retirement account can open an IRA account online or a plan for the self-employed.

You can start an IRA–or a taxable account–by opening an account on the SoFi Invest® investing platform. Use it to build a portfolio including stocks and exchange-traded funds. You can take a hands-on approach with Active Investing, or a hands-off one with Automated Investing. Plus, fractional shares allow you to start fractional share investing. You can select your favorite companies and invest in them, without needing to commit to buying a whole share.

Interested in investing in your retirement? SoFi offers many options, all with no trading fees.

SoFi Invest®
SoFi Invest refers to the two 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 and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA(www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of SoFi Digital Assets, LLC, please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Bank, N.A.

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.

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

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Jan
31
2022
Profit Sharing 401(k) Plans Guide: Rules, Limits, Basics: Woman with calculator

What is a 401(k) Profit Sharing Plan?

By | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off on What is a 401(k) Profit Sharing Plan?

Like a traditional 401(k) plan, a 401(k) profit share plan is an employee benefit that can provide a vehicle for tax-free retirement savings. But the biggest difference between an employer-sponsored 401(k) and a 401(k) profit share plan is that in a profit share plan, employers have control over how much money—if any—they contribute to the employee’s account from year to year.

In other ways, the 401(k) profit-sharing plan works similarly to a traditional employer-sponsored 401(k). Under a 401(k) profit share plan, as with a regular 401(k) plan, an employee can allocate a portion of pre-tax income into a 401(k) account, up to a maximum of $20,500 per year in 2022.

At year’s end, employers can choose to contribute part of their profits to employee’s plans, tax-deferred. As with a traditional 401(k), maximum total contributions to an account must be the lesser of 100% of the employee’s salary or $61,000 a year per the IRS; that number jumps to $67,500 for older employees who are making catch-up contributions.

How Does 401(k) Profit Sharing Work?

There are several types of 401(k) profit-sharing setups employers can choose from. Each of these distributes funds in slightly different ways.

Pro-Rata Plans

In this common type of plan, all employees receive employer contributions at the same rate. In other words, the employer can make the decision to contribute 3% (or any percentage they choose) of an employees compensation as an employer contribution. The amount an employer can share is capped at 25% of total employee compensation paid to participants in the plan.

New Comparability 401(k) Profit Sharing

In this plan, employers can group employees when outlining a contribution plan. For example, executives could receive a certain percentage of their compensation as contribution, while other employees could receive a different percentage. This might be an option for a small business with several owners that wish to be compensated through a profit-sharing plan.

Age-Weighted Plans

This plan calculates percentage contributions based on retirement age. In other words, older employees will receive a greater percentage of their salary than younger employees, by birth date. This can be a way for employers to retain talent over time.

Integrated Profit Sharing

This type of plan uses Social Security (SS) taxable income levels to calculate the amount the employer shares with employees. Because Social Security benefits are only paid on compensation below a certain threshold, this method allows employers to make up for lost SS compensation to high earners, by giving them a larger cut of the profit sharing.

Boost your retirement contributions with a 1% match.

SoFi IRAs now get a 1% match on every dollar you deposit, up to the annual contribution limits. Open an account today and get started.

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Pros and Cons of 401(k) Profit Sharing

There are benefits and drawbacks for both employers and employees who participate in a profit-sharing 401(k) plan.

Employer Pro: Flexibility of Employer Contributions

Flexibility with plan contribution amounts is one reason profit share plans are popular with employers. An employer can set aside a portion of their pre-tax earnings to share with employees at the end of the year. If the business doesn’t do well, they may not allocate any dollars. But if the business does do well, they can allow employees to benefit from the additional profits.

Employer Pro: Flexibility in Distributions

Profit sharing also gives employers flexibility in how they wish to distribute funds among employees, using the Pro-Rata, New Comparability, Age-Weighted, or Integrated profit sharing strategy.

Employer Pro: Lower Tax Liability

Another advantage of profit share plans is that they allow employers to lower tax liability during profitable years. A traditional employer contribution to a 401k does not have the flexibility of changing the contribution based on profits, so this strategy can help a company maintain financial liquidity during lean years and lower tax liability during profitable years.

Employee Pro: Larger Contribution Potential

Some employees might appreciate that their employer 401(k) contribution is tied to profits, as the compensation might feel like a more direct reflection of the hard work they and others put into the company. When the company succeeds, they feel the love in their contribution amounts.

Additionally, depending on the type of distribution strategy the employer utilizes, certain employees may find a profit-sharing 401(k) plan to be more lucrative than a traditional 401(k) plan. For example, an executive in a company that follows the New Compatibility approach might be pleased with the larger percentage of profits shared, versus more junior staffers.

Employee Con: Inconsistent Contributions

While employers may consider the flexibility in contributions from year to year a positive, it’s possible that employees might find that same attribute of profit sharing 401(k) plans to be a negative. The unpredictability of profit share plans can be disconcerting to some employees who may have come from an employer who had a traditional, consistent match set up.

Employee/Employer Pro: Solo 401(k) Contributions

A profit share strategy can be one way solo business owners can maximize their retirement savings. Once a solo 401(k) is set up with profit sharing, a business owner can put up to $20,500 a year into the account, plus up to 25% of net earnings, up to a total of $61,000. This retirement savings vehicle also provides flexibility from year to year, depending on profits.

Withdrawals and Taxes on 401(k) Profit Share Plans

A 401(k) with a generous profit share plan can grow quite quickly. So what about when you’re ready to take out distributions? A 401(k) withdrawal will have penalties if you withdraw funds before you’re 59 ½ (barring certain circumstances laid out by the IRS) but the money will still be taxable income once you reach retirement age. Additionally, like traditional 401(k) plans, a profit-sharing 401(k) plan has required minimum distribution requirements (RMDs) once an account holder turns 72.

Investors who anticipate being in a high tax bracket during their retirement years may consider different strategies to lower their tax liability in the future. For some, this could include converting the 401(k) into a Roth IRA. This is sometimes called a “backdoor Roth IRA” because rolling over the 401(k) does not subject an investor to the income limitations that cap Roth contributions.

An investor would need to pay taxes on the money they convert into a Roth IRA, but distributions in retirement years would not be taxed the way they would have if they were kept in a 401(k). Any 401(k) owner who qualifies for a Roth IRA can do this, but the additional funds in a 401(k) profit share account can make these moves that much more impactful in the future.

The Takeaway

A 401(k) profit share plan allows employees to contribute pre-tax dollars to their retirement savings, as well as benefit from their employer’s profitability. But because profit share plans can take multiple forms, it’s important for employees to understand what their employer is offering. That way, employees can create a robust retirement savings strategy that works for them.

Another step that could also help you manage your retirement savings is doing a 401(k) rollover, where you move funds from an old account to a rollover IRA.

SoFi makes the rollover process seamless and simple — no need to watch the mail for your 401(k) check. There are no rollover fees or taxes, and you can complete your 401(k) rollover quickly and easily.

Help grow your nest egg with a SoFi IRA.

SoFi Invest®
SoFi Invest refers to the two 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 and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA(www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of SoFi Digital Assets, LLC, please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Bank, N.A.

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

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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Jan
31
2022
Is a Backdoor Roth IRA Right for You?

Is a Backdoor Roth IRA Right for You?

By | Growing Wealth, invest, Investing, Preparing for Retirement, Terminology | No Comments

A Roth IRA is an individual retirement account that may provide investors with a tax-free income once they reach retirement. With a Roth IRA, investors save after-tax dollars, and their money grows tax-free. Roth IRAs also provide additional flexibility for withdrawals—once the account has been open for five years, contributions can be withdrawn at any time, for any reason.

But there’s a catch: Investors can only contribute to a Roth IRA if their income falls below a specific limit. If your contribution is for 2022, that maximum is $129,000 for a single person or $204,000 for a married couple filing jointly (based on modified adjusted gross income). Though, if you make slightly more than that, you may qualify to contribute a reduced amount.

Related: What Is a Roth IRA?

Want to contribute to a Roth IRA, but have an income that exceeds the limits? Good news: There’s another option. It’s called a backdoor Roth IRA.

What is a Backdoor Roth IRA?

If you aren’t eligible to contribute to a Roth IRA outright because you make too much, you can do so through what’s called a “backdoor Roth.” This process involves converting funds in a Traditional IRA into a Roth IRA.

The government allows you to do this as long as investors pay income taxes on any contributions deducted on taxes (and any profits made) when the investor converted the account. Unlike a standard Roth IRA, there is no income limit for doing the conversion, nor is there a ceiling to how much can be converted.

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

Is a Backdoor Roth Worth Doing?

It depends. Use SoFi’s IRA Contribution Calculator to make an informed decision.

High earners who don’t qualify to contribute under current Roth IRA rules may opt for this route. As with a typical Roth IRA, a backdoor Roth may be a good option when an investor expects their taxes to be lower today than in retirement. Investors who hope to avoid required minimum distributions (RMDs) when they reach age 72 might also consider doing a backdoor Roth.

But if someone is eligible to contribute to a Roth IRA, it may not make sense to bother with a backdoor conversion.

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

Related: How Much Can You Put in an IRA This Year?

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

If an investor plans to use the converted funds within five years, a backdoor Roth may not be the best place to park their cash. That’s because withdrawals before five years are subject to income tax and a 10% penalty.

Related: Roth IRA 5-Year Rule Explained

How to Open a Backdoor Roth IRA

If an investor has no other Traditional IRAs, here’s how to make a backdoor Roth IRA happen with SoFi:

•  Open both a Traditional IRA and a Roth IRA with SoFi Invest®.
•  Make a non-deductible contribution to the Traditional IRA by the tax deadline (April 18, 2022 for tax year 2021). The maximum allowable yearly contribution is $6,000 (or $7,000 if you’re 50 or older).
•  SoFi will send you a form to transfer the money into your Roth IRA. Sign and return it.
•  If you choose an automated investing account, once the funds are in your Roth IRA, SoFi will invest them in the portfolio you’ve chosen.

Related: 3 Easy Steps to Starting A Retirement Fund

If you have any questions or want some help as you go through the process, schedule a complimentary appointment with one of our licensed financial advisors. SoFi Invest is all about empowering you and your financial future, and we’re here to help.

The Takeaway

A backdoor Roth IRA may be worth considering if tax-free income during retirement is part of an investor’s financial plan, and they make too much to contribute directly to a Roth. Roth IRAs are a good option for younger investors at low tax rates and people with a high disposable income looking to reduce tax bills on capital gains in retirement.

Learn more about your retirement account options with SoFi.

SoFi Invest®
SoFi Invest refers to the two 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 and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA(www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of SoFi Digital Assets, LLC, please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Bank, N.A.

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

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Jan
30
2022
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Can You Open a Roth IRA For Your Child?

By | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off on Can You Open a Roth IRA For Your Child?

A Roth IRA can be a great retirement investment tool for adults and children. Funded with after-tax dollars, a Roth IRA grows tax-free, so account holders won’t need to pay taxes when they withdraw money in retirement.

Like other individual retirement accounts, a Roth IRA has an early distribution penalty, but that penalty is waived for certain expenses, such as first-time home buying and paying for college. In this way, funding a Roth IRA can allow for more flexibility than a 529 college savings plan or other plan specifically earmarked for education.

That flexibility can make a Roth IRA appealing—especially if you’re a parent who wants to open a Roth IRA for your child. A Roth IRA for minors, called a Custodial Roth IRA, can be opened by any adult—whether a grandparent, parent, or family friend—for a minor who earns income (more on that later).

Here’s everything you need to know about making this investment.

Advantages of Opening a Roth IRA for Your Child

Flexibility in how to use the funds can be one benefit to opening a Custodial Roth IRA as part of an investment plan for your child. A Roth IRA can provide flexibility not only for potential expenses in early adulthood—such as going to college or buying a home—but can be an investment vehicle throughout your child’s lifetime.

Control Over Investments

Another benefit is that a Roth IRA gives you more control over investments than an education-focused 529 college savings plan, and can allow you to create a diversified portfolio made of bonds, stocks, ETFs, or whatever else you may want to add.

Compound Interest

A Roth IRA is a gift that can keep growing, since investors can maximize compound interest to get the most out of their investment.

Here’s how a Roth IRA unlocks the power of compounding: As an example, let’s say you open a Custodial Roth IRA when the child is 10 years old, and contribute $2,000 annually. At a certain point, your child might take over contributing $2,000 annually.

Assuming a 7% rate of return, the account will be worth $928,000 by the time your child is 60 years old—even though the total amount you and your child contributed would be $100,000 total. In comparison, if that same money was put in a taxable savings account over the same time period, the total of the account would be $515,764.

No Required Minimum Distribution (RMD)

Unlike a traditional IRA, there is no required minimum distribution (RMD) on a Roth IRA once the account owner reaches retirement age. A Roth IRA also allows people to continue contributing throughout their lifetime, as long as they’re earning income (with a traditional IRA, you can no longer contribute once you reach 70 ½).

Boost your retirement contributions with a 1% match.

SoFi IRAs now get a 1% match on every dollar you deposit, up to the annual contribution limits. Open an account today and get started.

Only offers made via ACH are eligible for the match. ACATs, wires, and rollovers are not included. Offer ends 12/31/23.

Income Requirements for a Custodial Roth IRA

One reason it may not be immediately intuitive to open a Roth IRA for your child is that a Roth IRA account holder must earn income—but not too much income.

In order to qualify for a Roth IRA, an account holder (in this instance, the child) must make less than $144,000 annually. Individuals who make under $129,000 (filing as single taxpayers) can contribute up to $6,000 per year to a Roth IRA. Those who make between $129,000 and $144,000 are eligible to contribute a reduced amount.

Teens who have jobs “on the books”—lifeguarding, camp counselor—can contribute to a Roth IRA. But they can’t contribute more than their earned income for the year. For example, a teen who makes $2,000 per summer at their lifeguarding job can contribute no more than $2,000 to a Roth IRA.

Of course, this doesn’t mean that a teen has to invest all of their wages. In some cases, parents or grandparents might decide to contribute all or some of the maximum amount the teen is eligible for, and allow the account to grow this way.

Another way that parents can create a Custodial Roth IRA for their child is to hire their child on the books for household tasks that may include shoveling snow, babysitting, housework, or paperwork. Any earned income can then be put into the IRA. If the income comes from self-employment, it makes sense to discuss details with a tax professional, in case any Medicare or Social Security taxes need to be paid.

If you have a business and are hiring your child to do work for your business, make sure their work is business-related (for example, cleaning the office or stuffing envelopes is likely fine; raking leaves may not be unless it is a legitimate business expense).

The IRS also pays attention to the age of your child. Tweens and teens can perform work, but infants and toddlers are likely not doing any work for your business unless there is a legitimate business need for them (such as a clothing designer using an infant to model clothing as marketing material).

How to Open a Roth IRA For Your Child

A Custodial Roth IRA for a minor can be opened by any adult—whether grandparent, parent, or family friend. While the child is a minor, the adult will have sole access to the account; once the child comes of age (the timing of which varies by state), the account will transfer over to the child.

As with any Roth IRA, investment options within the account can include stocks, bonds, ETFs, and mutual funds.

A Roth IRA can be opened with an investment broker or brokerage firm. Some brokerages may have an automated method that can allow the account owner to be relatively hands off with the account once they input goals and risk tolerance, others may require the account owner to direct the account, choosing investments. Choosing the right brokerage and account depends on the investor and their preferences.

Who Can Contribute to a Custodial Roth IRA for Your Child?

Unlike a 529, which anyone can contribute to, only the custodian of the Roth IRA account can contribute funds into the account. But it’s important to be mindful of how much your child has earned during the year and only contribute up to that limit.

For example, if a child has a lifeguarding job that earns her $2,000 a year, only $2000 may be contributed to the Custodial Roth IRA that year—regardless of whether the child contributes the money themselves, or whether the parents contribute their own money to the account and allow the teen to use the money she earned as she sees fit.

Some parents create an arrangement with their child where the minor contributes a certain percentage of their income (and keeps the rest), and the parents make up the difference in contributions.

How a Roth IRA Can Help Your Child Understand Investing

Not only can a Custodial Roth IRA unlock the power of compound interest and grow contributions substantially more than a typical savings account, but they can also be a powerful tool to help a child understand investing and how compound interest works.

While some custodians may contribute the equivalent of their child’s income and let their child use their earned income for their own discretionary spending, others might encourage their child to actively earmark a certain portion of their earnings for their Roth IRA account. Either way, custodians can share the account status with their child, explaining their portfolio, showing gains, and otherwise making the investment feel more active to their child.

There’s no “wrong” way to manage a Roth IRA with your child, but letting your child peek into their account can help them ask questions about personal finance and grasp investing well before they have to make their own retirement saving decisions. This can help your child have a grasp on financial fluency that can be helpful when they reach the age where they can manage their accounts themselves.

The Takeaway

For a child with an income, Opening a Roth IRA for a child with an income can be a good way to start them on the path to investing—whether it’s saving for retirement, education, a first home, or more.

When it comes to making an investment strategy for kids, it can also be a good time for parents to audit overall retirement strategies. In some cases, it may make sense for parents to make sure their own retirement strategies are on track before opening a Roth IRA for their children.

SoFi Invest® offers both active and automated IRA options as part of their investing plans for retirement. Find out how SoFi can help you reach your retirement goals.

SoFi Invest®
SoFi Invest refers to the two 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 and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA(www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of SoFi Digital Assets, LLC, please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Bank, N.A.

Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
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.

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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