Set Up a Retirement Fund for Children

Setting Up a Retirement Account for Your Child

Opening a tax-advantaged individual retirement account (IRA) for minors becomes possible once they start earning income. Even babysitting or lawn-mowing money counts.

A custodial IRA offers certain advantages: It can jump start a child’s interest in investing, and possibly help build their future nest egg. But there are annual contribution limits and other potential drawbacks to consider, such as the child’s eligibility for college financial aid.

How to Open a Retirement Account for Your Child

Opening a retirement fund for a child means opening a custodial IRA. Generally speaking, a custodial account is one that’s owned by an adult — a parent, grandparent, or legal guardian — on behalf of a minor.

The adult does the investment planning for their child, and manages the money in the account until the child reaches the age of majority (it varies by state). At that point, all the money in the account belongs to the child.

Steps to Opening a Retirement Account for a Child

Here’s how opening a retirement account for minors typically works.

Step 1: Choose a Brokerage

Custodial IRAs are offered by many brokerages, so you’ll need to choose where to open yours. This could be the brokerage where you currently have your investment accounts or a different one.

When deciding on a custodial IRA, consider the range of investments offered, the fees you’re likely to pay, and how easy it is overall to open and manage new accounts. For example, some brokerages let you set up an IRA for a child online, while others require you to fill out and mail in the necessary paperwork.

Step 2: Complete the Application

On the application for a custodial IRA, the brokerage will typically ask for specific information, including:

•   Contact information (e.g., your phone number, email address, and mailing address)

•   Personal information about yourself, including your name, date of birth, and Social Security number

•   Personal information about your minor child, including their name, date of birth, and Social Security number

•   Employment information, if applicable

You’ll also need to share routing information and the account number for the bank account you plan to use to make contributions. If you’re moving money from another brokerage firm, you’ll be asked to provide the account number and type.

Step 3: Choose an IRA Type

Should you choose a traditional or a Roth IRA for your child? Both offer tax benefits and both have the same annual contribution limits for kids. For minors, a Roth IRA typically works better. One reason is that the child’s tax rate is typically quite low, and likely much lower than their tax rate will be upon retirement.

Step 4: Fund the Account and Choose Investments

Once you’ve opened a retirement account for a child, you can fund the account using your linked bank account and then make your investment selections. As the custodian, you choose how the money in the IRA is invested, though you might want to talk to your kids first to get their feedback. Generally, custodial IRAs can offer the same investment selections as IRAs for adults, which can mean stocks, mutual funds, exchange-traded funds (ETFs), bonds and other securities.

Recommended: How Much Should I Have in My 401(k) By Age 30?

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.

Different Types of IRAs for Children

As mentioned earlier, there are two main types of IRAs you can open for a minor child: traditional and Roth. The main difference lies in their tax treatment. The IRS regulates contributions to and withdrawals from each type of IRA.

Traditional IRA

A traditional IRA is funded with pre-tax dollars. The IRS allows eligible taxpayers to claim a deduction for contributions. When you take money out in retirement, you pay taxes on the earnings.

Traditional IRAs can make sense for people who can benefit from tax-deductible contributions. That might be less valuable to your child than the tax benefits that a Roth IRA could yield.

Roth IRA

You start a Roth IRA using after-tax dollars, so you get no tax deductions on your contributions. But they can offer something else: tax-free qualified distributions. This means no matter what tax bracket your child is in when they retire, they can withdraw their money from a Roth IRA tax-free.

Roth IRA withdrawal rules also allow contributions to be withdrawn at any time, tax- and penalty-free.

Funding a Child’s Retirement Account

Both traditional and Roth IRAs have annual contribution limits, and you have to contribute earned income. For 2023, the IRA contribution limit is $6,500. If you’re 50 or older, you can add another $1,000 to help you catch up for retirement.

The same rules apply to custodial IRAs. In 2023, kids can contribute an amount equal to their earnings for the year or the $6,500 limit, whichever is lower. So if your child makes $5,000 by babysitting and mowing lawns, the most they’d be able to add to their IRA is $5,000.

Again, it’s important to remember that kids need to have income (specifically, taxable compensation) to open and contribute to a traditional or Roth IRA. According to the IRS, that includes:

•   Wages

•   Salaries

•   Commissions

•   Tips

•   Bonuses

•   Net income from self-employment

Investment income, including interest and dividend income, doesn’t count as income that can be contributed to the child’s IRA, under IRS guidelines.

Can a Parent Contribute to a Child’s IRA?

A parent can contribute to a child’s IRA only if that child has earned income of their own for the year.

Again, contributions to a child’s IRA must not exceed their allowed limit for the year. Going back to the previous example, in which your child earned $5,000, they could technically put all of that money into their IRA. Or you could offer to split the difference and let them put in $2,500 while contributing the remaining $2,500 yourself.

Keeping careful records of your child’s earnings for the year can help you avoid contributing too much to their IRA. Also, offering to put in an equivalent amount (without breaching the limit) can be a good motivator for kids to invest in their IRA.

Recommended: IRA vs. 401(k): What’s the Difference?

Benefits of a Child Opening a Retirement Account

Opening up a Roth IRA for a child can benefit them in several ways.

•   Kids can get an early taste of what it means to invest money rather than saving it. The IRA can be a teaching tool to help a child learn how the market works and the importance of setting long-term financial goals.

•   Kids who start saving for retirement at an early age have the ability to take full advantage of the power of compounding interest. A child who contributes $5,000 each year starting at age 14 and earns a 7% annual return, for example, could have $2.3 million saved for retirement by age 65. Running the numbers using a Roth IRA calculator can give you an idea of how much of a head start on growing wealth you might be able to give your child by opening a minor IRA.

•   The money in a Roth IRA for a child is tax-free when they take qualified distributions. This can result in substantial tax savings if they’re in a higher tax bracket when they retire.

Cons of a Child Opening a Retirement Account

Before you open a traditional or Roth IRA for a child, there are some drawbacks to consider.

•   While contributing to a Roth IRA may offer some long-term benefits, there are no guarantees, and the money is then locked up until your child turns 59 ½ (although early withdrawals are possible, and might incur a penalty).

•   A Roth IRA might affect your college-bound child’s financial aid eligibility. Just having money in a Roth IRA won’t cause any snags if your child is applying for federal student aid. But if they withdraw contributions from their Roth IRA for any reason — including paying for college expenses — that money is counted as income, which may affect eligibility for need-based aid.

•   Investments within a custodial IRA entail some level of risk, as with all investments.

Pros

Cons

An IRA can be a good way to teach kids about investing and the stock market. Funds in an IRA are typically restricted (although Roth contributions can be withdrawn at any time, penalty-free).
Starting an IRA for a child at a young age means they have more time to benefit from compounding interest. Withdrawal of contributions from a Roth IRA could affect a child’s financial aid eligibility.
Qualified distributions are tax-free in retirement. Investments within a custodial IRA entail some level of risk.

Open a Retirement Account Today With SoFi

IRAs can be a valuable addition to a retirement savings strategy if you’re interested in investment planning for children or for yourself. If you haven’t started saving for the future yet or your child is starting to earn income of their own, there’s no time like the present to consider opening an IRA.

When investing for retirement with SoFi, you can set up a traditional IRA, Roth IRA, or SEP IRA. The SEP IRA is designed for people who are self-employed. All three can offer tax benefits while helping you get closer to your retirement goals.

Easily manage your retirement savings with a SoFi IRA.

FAQ

How do I set up a retirement account for a minor?

To get started, find out which brokerages allow you to open custodial IRAs for minor children. Then you need to choose a brokerage and IRA type, fill out the appropriate paperwork, and make a deposit or transfer to fund the IRA.

How do I give my kids an IRA?

You can open an IRA for your child once they have earned income of their own. This would be a custodial account: You own it until the child reaches adulthood, at which point it belongs to them. The other way to give an IRA to your kids is to name them as your IRA beneficiary when you pass away. If the child is a minor when they inherit the IRA, they would need a custodian to manage it for them.

When can I start a 401(k) for my child?

You can’t start a 401(k) for a child, unless you run a business that offers a 401(k) to its employees and your child works for you. You can, however, open an IRA for a minor child who has earned income, and make contributions to it on their behalf, as long as the total contributions don’t surpass the amount earned by the child that year.


Photo credit: iStock/VioletaStoimenova

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
SoFi Invest®

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

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

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.

SOIN0322012

Read more
Understanding Highly Compensated Employees (HCEs)

Understanding Highly Compensated Employees (HCEs)

Internal Revenue Service (IRS) rules require companies with 401(k) retirement plans to identify highly compensated employees (HCEs). An HCE, according to the IRS, passes either an ownership test or a compensation test. Someone owning more than 5% of the company would qualify as an HCE, as would someone who was compensated more than $135,000 for the 2022 tax year.

The IRS uses this information to help all employees receive fair treatment when participating in their 401(k). As a result, your HCE status can affect the amount you can contribute to your 401(k).

What Does It Mean to Be an HCE?

A highly compensated employee’s 401(k) contributions will be subject to additional scrutiny by the IRS. Again, you’re identified as an HCE if you either:

•   Owned more than 5% of the business this year or last year, regardless of how much compensation you earned or received, or

•   Received at least $135,000 in compensation for the 2022 tax year ($150,000 for 2023) and, if your employer so chooses, you were in the top 20% of employees ranked by compensation.

If you meet either of these criteria, you’re considered an HCE, though that doesn’t necessarily mean that you earn a higher salary.

For example, someone could own 6% of a business while also drawing a salary of less than $100,000 a year. Because they meet the ownership test, they would still be classified as an HCE.

It’s also possible for you to be on the higher end of your company’s salary range and yet not qualify as an HCE. This can happen if your company chooses to rank employees by pay. If your income is above the IRS’s HCE threshold but you still earn less than the highest-paid 20% of employees (while not owning 5% of the company), you don’t meet the definition of an HCE.

Highly Compensated Employee vs Key Employee

Highly compensated employees may or may not also be key employees. Under IRS rules, a key employee meets one of the following criteria:

•   An officer making over $200,000 for 2022 ($215,000 for 2023)

•   Someone who owns more than 5% of the business

•   A person who owns more than 1% of the business and also makes more than $150,000 a year

•   Someone who meets none of these conditions is a non-key employee.

In order for a highly compensated employee to be a key employee, they must pass the ownership or officer tests. For IRS purposes, ownership is determined on an aggregate basis. For example, if you and your spouse work for the same company and each own a 2.51% share, then you’d collectively pass the ownership test.

Benefits of Being a Highly Compensated Employee

Being a highly compensated employee can offer certain advantages. Here are some of the chief benefits of being an HCE:

•   Having an ownership stake in the company you work for may entail additional employee benefits or privileges, such as bonuses or the potential to purchase company stock at a discount.

•   Even with a high salary, you can still contribute to your 401(k) retirement plan, possibly with matching contributions from your employer.

•   You may be able to supplement 401(k) contributions with contributions to an individual retirement account (IRA) or health savings account (HSA).

There are, however, some downsides to consider if you’re under the HCE umbrella.

Disadvantages of Being a Highly Compensated Employee

Highly compensated employees are subject to additional oversight when making 401(k) contributions. If you’re an HCE, here are a few disadvantages to be aware of:

•   You may not be able to max out your 401(k) contributions each year.

•   Lower contribution rates could potentially result in a shortfall in your retirement savings goal.

•   Earning a higher income could make you ineligible to contribute to a Roth IRA for retirement.

•   Any excess contributions that get refunded to you will count as taxable income when you file your return.

Benefits

Disadvantages

HCEs may get certain perks or bonuses. 401(k) contributions may be limited.
Can still contribute to a company retirement plan. Limits may make it more difficult to reach retirement goals.
Can still contribute to an IRA. High earnings may make you ineligible to contribute to a Roth IRA.
Refunds of excess contributions could raise employee’s taxable income.

Recommended: Rollover IRA vs. Regular IRA: What’s the Difference?

Nondiscrimination Regulatory Testing

The IRS requires employers to conduct 401(k) plan nondiscrimination compliance testing each year. The purpose of this testing is to ensure that highly compensated employees and non-highly compensated employees have a more level playing field when it comes to 401(k) contributions.

Employers calculate the average contributions of non-highly compensated employees when testing for nondiscrimination. Depending on the findings, highly compensated employees may have their contributions restricted in certain ways. If you aren’t sure, it’s best to ask someone in your HR department, or the plan sponsor.

If an employer reviews the plan and finds that it’s overweighted in favor of HCEs, the employer must take steps to correct the error. The IRS allows companies to do that by either making additional contributions to the plans of non-HCEs or refunding excess contributions back to HCEs.

401(k) Contribution Limits for HCEs

In theory, highly compensated employees’ 401(k) limits are the same as retirement contribution limits for other employees. For 2022, the limit is $20,500; it’s $22,500 for 2023. Employees age 50 and older can make an additional $6,500 in catch-up contributions for 2022, and $7,500 for 2023.

But, as noted above, these plans may be restricted for HCEs, so it’s wise to know the terms before you begin contributing.

Other Retirement Plan Considerations

For example, one thing to watch out for if you’re a highly compensated employee is the possibility of overfunding your 401(k). If your employer determines that you, as an HCE, have contributed more than the rules allow, the employer may need to refund some of that money back to you.

As mentioned earlier, refunded money would be treated as taxable income. Depending on the refunded amount, you could find yourself in a higher tax bracket and facing a larger tax bill. So it’s important to keep track of your contributions throughout the year so the money doesn’t have to be refunded to you.

Recommended: Should You Retire at 62?

401(k) vs IRAs for HCEs

A highly compensated employee might consider opening an IRA account, traditional or Roth IRA, to supplement their 401(k) savings. Either kind of IRA lets you contribute money up to the annual limit and make qualified withdrawals after age 59 ½ without penalty.

However, income-related rules could constrain highly compensated employees in terms of funding both a 401(k) and a traditional or Roth IRA.

•   An HCE’s contributions to a traditional IRA may not be fully tax-deductible if they or their spouse are covered by a workplace retirement plan. Phaseouts depend on income and filing status.

•   Highly compensated employees may be barred from contributing to a Roth IRA. Eligibility phases out as income rises. For the 2023 tax year, people become ineligible when their MAGI exceeds $153,000 (if single) or $228,000 (if married, filing jointly).

The Takeaway

A highly compensated employee is generally someone who owns more than 5% of the company that employs them, or who received compensation of more than $135,000 in 2022 ($150,000 in 2023).

Being an HCE can restrict how much you’re able to save in your company’s 401(k); under certain circumstances the IRS may require the employer to refund some of your contributions, with potential tax consequences for you. Even so, HCEs may still be able to save and invest through other retirement accounts.

SoFi offers traditional and Roth IRAs to help you grow your retirement savings. You can open an account online in minutes and build a diversified portfolio that suits your goals. It’s a hassle-free way to work toward a secure financial future.

Help grow your nest egg with a SoFi IRA.

FAQ

Does HCE income include bonuses?

The IRS treats bonuses as compensation for determining which employees are highly compensated. Overtime, commissions, and salary deferrals to a 401(k) account are also counted as compensation.

What is the difference between a key employee and a highly compensated employee?

A highly compensated employee is someone who passes the IRS’s ownership test or compensation test. A key employee is someone who is an officer or meets ownership criteria. Highly compensated employees can also be key employees.

Can you be a key employee and not an HCE?

It is possible to be a key employee and not a highly compensated employee in certain situations. For example, you might own 1.5% of the business and make between $150,000 and $200,000 per year, while not ranking in the top 20% of employees by compensation.


Photo credit: iStock/nensuria

SoFi Invest®

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

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

SOIN1122014

Read more
The 401(k) Force-out Explained

The 401(k) Force-out Explained

If you change jobs and leave a balance of $5,000 or less in your old 401(k), IRS regulations permit your former employer to distribute all of those funds to you in what’s known as a 401(k) force-out.

This move could potentially lower your former employer’s plan costs and lessen their administrative duties — but it also can affect your retirement planning. Here’s what you should know about the 401(k) force-out process.

What Is a 401(k) Force-out?

As noted above, a 401(k) plan is a type of qualified retirement plan offered by employers to help employees save money and build wealth. Once an employee moves to a new job, their former employer can impose a 401(k) force-out — a distribution from the retirement plan that the IRS allows when an ex-employee’s plan balance is $5,000 or less.

The distribution does not require the ex-employee’s consent.

That doesn’t mean your former employer can do whatever they like with your 401(k) money. The IRS requires employers to observe certain 401(k) force-out rules. The rules specify:

•   When an employer must notify you about your 401(k) forced distribution

•   What happens to the money in your account if you’re forced out

Not every former employee is subject to a 401(k) force-out. If your 401(k) balance is greater than $5,000, your former employer can’t force you out unless you give consent. Your spouse may also need to consent.

The 401(k) Force-out Process

How 401(k) force-outs are handled can depend on the employer and the terms of your plan. It’s important to note that your plan documents must include a provision for force-outs; your former employer can’t just impose the policy on a whim.

When force-outs take place, they generally begin with an employer’s review of their 401(k) retirement plan’s account balances, including those of ex-employees. Again, if you are an ex-employee with a balance over $5,000, the IRS requires your consent before your ex-employer can do anything with the money in your account.

If the vested balance is between $1,000 and $5,000, the former employer can:

•   Cut you a check for the amount

•   Give you the option to roll the money over to an eligible retirement plan

•   Transfer the money to an individual retirement account (IRA) on your behalf

When the balance is below $1,000 the employer can send you a check or transfer the money to an IRA.

Before the employer can do any of those things, however, they’re required to give you at least 30 days’ notice so you can decide for yourself what happens to the money. Whatever resolution you choose, you’ll no longer be investing in the 401(k) at your old employer.

Recommended: How to Open Your First IRA

Why Do Force-outs Happen?

Why do employers force 401(k) distributions on former employees? Cost is one reason. A plan with fewer enrolled employees can be less expensive to administer. Removing inactive participants can also streamline recordkeeping and potentially reduce the plan’s regulatory compliance obligations.

What Happens to a 401(k) After You Leave Your Job?

When you leave a job your 401(k) doesn’t follow you. The money stays where it is. You can’t make new contributions, but your balance may continue to grow if your investments appreciate in value.

Generally, when you leave a job, there are four things you can do with your account:

•   Roll the money from your former employer’s 401(k) into your new employer’s retirement plan

•   Rollover your 401(k) money into an IRA

•   Leave it where it is

•   Withdraw it

Keep in mind that a 401(k) cash distribution is subject to ordinary income tax — including in the case of a force-out, where it’s required by your ex-employer. You may also face a 10% early withdrawal penalty if you’re younger than age 59 ½.

Ways to Cope With a 401(k) Force-Out

What can you do to prevent the additional tax and potential penalty? Rolling over a 401(k) to your new employer’s retirement plan or to an IRA within 60 days can prevent you from owing taxes on the amount (or the 10% penalty).

A rollover may also allow you to preserve some tax benefits. For example, if you’re rolling money from one 401(k) to another or to a traditional IRA, it can continue to grow on a tax-deferred basis until you’re ready to retire. And you can keep saving for retirement in your new employer’s plan if one is offered.

Leaving the money in your former employer’s plan could make sense if you’re comfortable with the investment options offered and the fees you’re paying. Of course, that may not be possible if that employer has 401(k) force-out rules that require you to either cash out or move the money elsewhere.

Withdrawing money from a 401(k) when you leave a job is usually the least preferable option for people below the age of 59 ½. Barring exceptions, any 401(k) cash distribution before you reach that age is treated as taxable income. The IRS can also assess an early withdrawal penalty.

Keep in mind that if you’ve taken out a loan against that 401(k) account, you’ll need to pay the loan’s full outstanding balance at the time of separation. Otherwise, the IRS views the entire loan as a taxable distribution.

Can a Company Refuse to Give You Your 401(k) Money?

A company can’t refuse to give you your 401(k) funds, but there may be restrictions on when you can access those funds. If you’ve borrowed from your 401(k), for instance, an employer may require you to repay the rest of the loan before permitting you to roll over or withdraw your balance.

Starting a New 401(k)

Having left an old employer behind, you may find that starting a new 401(k) account can be as simple as opting into automatic enrollment in your new company’s plan. You may need to work a certain number of months before you’re eligible for automatic enrollment; that will depend on the plan rules.

Regardless, contributing to a 401(k) is one way to ensure that you’re on track for retirement.

For the new 401(k) plan, it’s important to consider the amount you’re deferring into the account and the fees you’ll be paying. It’s a good idea to at least contribute enough to get the full employer match (if one is offered).

You can also ask your plan administrator about scheduling annual contribution increases to coincide with yearly raises you might receive (some companies offer this as an automatic feature). Making regular adjustments to contributions and asset allocation can help you make the most of every dollar when saving for retirement.

The Takeaway

If you participated in the 401(k) plan at a past job and left less than $5,000 in the account, your former employer has the option of cashing you out of their plan. The account balance determines whether they can do this by distributing the money as cash or rolling it over into a retirement account.

In any event, you will be notified at least 30 days in advance of the company’s action. You can generally inform them of your preference at that time.

With the funds from that old account, you could open a traditional or Roth IRA to add to your savings. Or do a direct 401(k) rollover. SoFi makes the direct rollover process streamlined and simple.

Help grow your nest egg with a SoFi IRA.

FAQ

Can your employer force you to cash out your 401(k)?

Yes. If you leave your job and your 401(k) balance is less than $1,000, your ex-employer can cut you a check for that amount. Keep in mind that a 401(k) cash distribution is subject to ordinary income tax; you may also pay a 10% early withdrawal penalty if you’re younger than age 59 ½. For larger balances, you’ll likely have a rollover option, even if your consent isn’t required. If your balance is more than $5,000, the IRS requires your ex-employer to get your consent before doing anything with the funds in your account.

What happens when your company no longer offers a 401(k)?

When an employer opts to terminate a 401(k) plan, they’re required to make sure employees are able to access the full amount of their 401(k) savings. Assets are usually distributed within a year or so. You may be given the option to withdraw the balance in cash or put it into a rollover IRA in order to avoid negative tax consequences.

Can your company kick you out of the 401(k) plan?

A company can cull its 401(k) plan enrollment by forcing out ex-employees who are no longer active plan participants. If you’re forced out of a former employer’s 401(k), you may opt to receive a cash distribution, or you may wish to roll the money over to your current employer’s retirement plan. Your former employer may also have the ability to transfer your 401(k) funds to an IRA for you.


Photo credit: iStock/AJ_Watt

SoFi Invest®

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

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

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.

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
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.

SOIN0422055

Read more
Roth IRA vs Savings Account: Key Similarities and Differences

Roth IRA vs Savings Account: Key Similarities and Differences

Saving is an important part of your financial health and building wealth, but it can be confusing to understand all the different vehicles out there. For instance, if you want to stash cash away for a good long while, should you open a Roth IRA or a savings account?

A Roth Individual Retirement Account (IRA) offers a tax-advantaged way to invest money for retirement. Brokerages and banks can offer Roth IRAs for investors who want to set aside money that they don’t anticipate spending for the near future.

Savings accounts can also be used to hold money you plan to spend at a later date. The main difference between a Roth IRA and savings account, however, lies in what they’re intended to be used for.

If you’re debating whether to keep your money in a Roth IRA or savings account, it’s helpful to understand how they work and what sets them apart from one another. Read on to learn:

•   What is a savings account?

•   What are the pros and cons of a savings account for retirement?

•   What is a Roth IRA?

•   What are the pros and cons of a Roth IRA for retirement?

•   What are the similarities and differences between these two account types?

•   How can you tell if a savings account or Roth IRA is right for you?

What Is a Savings Account?

A savings account is a type of deposit account that can be opened at a bank, credit union, or another financial institution. Savings accounts are designed to help you separate money you plan to spend later from money you plan to spend now.

Here’s how a savings account works:

•   You open the account and make an initial deposit.

•   Money in your account can earn interest over time, at a rate set by the bank.

•   When you need to spend the money in your savings account, you can withdraw it.

Previously, savers were limited to making six withdrawals from a savings account per month under Federal Reserve rules. In 2020, the Federal Reserve lifted that restriction, though banks can still impose monthly withdrawal limits on savings accounts. Exceeding the allowed number of withdrawals per month could trigger a fee or could lead to the account being converted to a checking account.

Types of Savings Accounts

Banks can offer more than one kind of savings account. The range of savings accounts available can depend on whether you’re dealing with a traditional bank, an online bank, or a credit union.

Typically, these accounts will be insured up to $250,000 per ownership category by either the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA).

Generally, the types of savings accounts you can open include:

•   Traditional savings. Traditional savings accounts, also called regular, basic, or standard savings accounts, allow you to deposit money and earn interest. Rates for traditional savings may be on the low side, and you might pay a monthly fee for these accounts at brick-and-mortar banks.

•   High-interest savings. The main benefits of high-interest savings accounts include above-average interest rates and low or no monthly fees. For example, online banks can offer high-yield savings accounts with rates that are five to 10 times higher than the national savings rate, with no monthly fee.

•   Money market savings. Money market savings accounts or money market accounts can combine features of savings and checking. For example, you can earn interest on deposits but have access to your money via paper checks or a debit card.

•   Specialty savings. Some types of savings accounts are created with a specific purpose in mind. For example, Christmas Club accounts are designed to help you save money for the holidays. A Health Savings Account (HSA) is a tax-advantaged specialty savings account that’s meant to be used just for health care expenses, though some people use an HSA for retirement.

You could also add certificate of deposit accounts (CDs) to this list, though a CD works differently than a savings account. CDs are time deposits, meaning that when you put money in the account, you agree to leave it there for a set term. If you take the funds out before then, you will likely be charged a fee.

Once the CD matures, you can withdraw your initial deposit and the interest earned. For that reason, CDs offer less flexibility than other types of savings accounts.

Quick Money Tip: If you’re saving for a short-term goal — whether it’s a vacation, a wedding, or the down payment on a house — consider opening a high-yield savings account. The higher APY that you’ll earn will help your money grow faster, but the funds stay liquid, so they are easy to access when you reach your goal.

Pros and Cons of Using a Savings Account for Retirement Savings

Savings accounts can be used to save for a variety of financial goals, including retirement. You might be wondering whether it makes a difference if you use, say, a high yield savings account vs. Roth IRA or other retirement account to save, as long as you’re setting money aside consistently.

While savings accounts can offer convenience and earn interest, they’re not necessarily ideal when saving for retirement if your primary goal. Here are some of the advantages and disadvantages of using a savings account to plan for retirement.

Pros

Cons

Savings accounts are easy to open and typically don’t require a large initial deposit.A savings account does not offer any tax benefits or incentives for use as a retirement account.
Banks and credit unions can pay interest on savings account deposits, allowing you to grow your money over time.Interest rates for savings accounts can be low, especially if you’re saving at a traditional bank vs. an online bank.
You can withdraw money as needed and don’t have to reach a specific age in order to use your savings.Banks can impose fees or even convert your savings account to checking if you’re making frequent withdrawals.
Savings accounts are safe and secure; deposits are protected up to $250,000 per depositor, per account ownership type, per financial institution when held at an FDIC member bank.If you’re putting all of your retirement funds into the same savings account, it’s possible that your balance might exceed the FDIC covered limit.

Recommended: Different Ways to Earn More Interest on Your Money

Get up to $300 when you bank with SoFi.

Open a SoFi Checking and Savings Account with direct deposit and get up to a $300 cash bonus. Plus, get up to 4.60% APY on your cash!


What Is a Roth IRA?

Before diving into what is a Roth IRA, know this: There are different retirement plans to choose from, including workplace plans and IRAs. A Roth IRA is an individual retirement account that is not a traditional IRA. Traditional IRAs are funded with pre-tax dollars and allow for tax-deductible contributions when doing taxes. Once you turn 72, you’re required to begin taking money from this kind of account.

If you don’t know how the Roth IRA works, these accounts allow you to set aside money using after-tax dollars, up to the annual contribution limit. That means you can’t deduct contributions to a Roth IRA, but you can get something better: tax-free qualified distributions.

You can leave money in your Roth IRA until you need, which allows it even more time to grow. Unlike traditional IRAs, there are no required minimum distributions for Roth IRAs. If you don’t use all of the money in your Roth IRA in retirement, you can pass it on to anyone you’d like to name as your beneficiary.

The IRS allows you to make a full contribution to a Roth IRA if you’re within certain income thresholds, based on your tax filing status. The full contribution limit for 2022 is $6,000, with an additional $1,000 catch-up contribution allowed if you’re age 50 or older. You can make a full contribution for 2022 if your tax status is:

•   Married filing jointly or a qualified widow(er) with a modified adjusted gross income of less than $204,000

•   Single, head of household, or married filing separately and did not live with your spouse during the year with a modified adjusted gross income of less than $129,000

Contributions are reduced once you exceed these income thresholds. They eventually phase out completely for higher earners.

To open a retirement account like a Roth IRA can be a simple, straightforward process. It can even be done online.

Pros and Cons of Using a Roth IRA for Retirement Savings

Roth IRAs are specifically designed to be used for retirement saving. Again, that’s the chief difference between a Roth IRA and savings account. That doesn’t mean, however, that a Roth IRA is necessarily right for everyone. For example, you may need to weigh whether a Roth IRA or traditional IRA is better, based on your income and tax situation.

Here are some of the advantages and disadvantages associated with choosing a Roth IRA for retirement savings.

Pros

Cons

Money in a Roth IRA can be invested in stocks, mutual funds, and other securities, potentially allowing your money to grow faster.Investing money in the market is riskier than stashing it in a savings account; there’s no guarantee that you won’t lose money in a Roth IRA.
You may be able to open a Roth IRA with as little as $500 or $1,000, depending on the brokerage or bank you choose.Brokerages can charge various fees for Roth IRAs. Individual investments may also carry fees of their own.
Qualified distributions from a Roth IRA are always 100% tax-free, and you can withdraw original contributions at any time, without a penalty.Tax penalties may apply if you withdraw earnings from your Roth IRA less than five years after you opened it.
You can save money in a Roth IRA in addition to contributing money to a 401(k) plan at work.Not everyone is eligible to open a Roth IRA, and there are annual contribution limits.

Similarities Between a Roth IRA and a Savings Account

Roth IRAs and savings accounts do have some things in common. For example:

•   Both can be used to save money for the long-term and both can earn interest. So you could use either one as part of a retirement savings strategy.

•   You can open a Roth IRA or savings account at a bank and initial deposits for either one may be relatively low. Some banks also offer Roth IRA CDs, which are CD accounts that follow Roth IRA tax rules.

•   Savings accounts and Roth IRAs held at banks are also FDIC-insured. The FDIC insures certain types of retirement accounts, including Roth IRAs, when those accounts are self-directed and the investment decisions are made by the account owner, not a plan administrator.

•   It’s possible to open a savings account for yourself or for a child. Somewhat similarly, you can also open a Roth IRA for a child if they have income of their own but haven’t turned 18 yet.

When comparing the benefits of Roth IRA vs. savings account, however, Roth accounts have an edge for retirement planning. Whether it makes sense to choose something like a high yield savings accounts vs. Roth IRA can depend on what you want to set money aside for.

Roth IRA vs Savings Account: Key Differences

Comparing a savings account vs. Roth IRA isn’t that difficult once you understand how each one works and what they’re intended to be used for. Here are some important differences between a Roth IRA and a savings account:

Roth IRA

Savings Account

PurposeA Roth IRA is designed to save for retirement.Savings accounts can fund virtually any short- or long-term goal.
Who Can OpenTaxpayers who are within certain income thresholds can open a Roth IRA.Adults with valid proof of ID can open a savings account, regardless of income or tax status.
InterestMoney in a Roth IRA earns compounding interest based on the value of underlying investments.Savings accounts earn interest at a rate set by the bank.
Tax BenefitsRoth IRAs allow for 100% tax-free qualified distributions, with no required minimum distributions.Savings accounts don’t offer any tax benefits; interest earned is considered taxable income.
Contribution LimitsRoth IRAs have an annual contribution limit. For 2022, the limit is $6,000 or $7,000 if you’re 50 or older.)There are no contribution limits, though FDIC protection only applies to the first $250,000 per depositor, per account ownership type, per financial institution.
WithdrawalsGenerally, withdrawals of earnings are not allowed before age 59 ½ unless an exception applies. Original contributions can be withdrawn at any time without a tax penalty.Banks can limit the number of withdrawals you’re allowed to make from a savings account each month and impose a fee for exceeding that limit.
RiskInvesting money in a Roth IRA can be risky; you may lose money.Savings are safe, secure places to keep up to the FDIC-insured $250,000 limit detailed above.

How to Decide If a Roth IRA or Savings Account Is Right for You

If you’re unsure whether to open a Roth IRA vs. high-yield savings account, it’s helpful to consider your goals and what you want to do with your money.

You might decide to open a Roth IRA if you:

•   Specifically want to save for retirement and earn a higher rate of return

•   Would like to be able to withdraw money tax-free to buy a home or pay higher education expenses (the IRS allows you to avoid a tax penalty for these distributions)

•   Want to supplement the money you’re contributing to a 401(k) at work

•   Expect to be in a higher tax bracket at retirement and want to be able to withdraw savings tax-free

•   Don’t want to be required to make minimum distributions at age 72

On the other hand, you might open a savings account if you:

•   Have a short- or long-term goal you’re saving for

•   Want a safe, secure place to keep your money

•   Are satisfied with earning a lower rate of return on savings

•   Need to be able to keep some of your money liquid and accessible

•   Aren’t concerned with getting any type of tax break for your savings

The good news is that you don’t have to choose between a high-interest savings account vs. Roth IRA. You can open one of each type of account to save for both retirement and other financial goals.

The Takeaway

Opening a retirement account can be a smart move if you’d like to save money for your later years while enjoying some tax breaks. A Roth IRA could be a good fit if you’re eligible to open one and you’d like to be able to make tax-free withdrawals once you retire.

Having a savings account is also a good idea if you’re building an emergency fund, saving for a vacation, or planning for another big money goal. When you open a SoFi online bank account with direct deposit, you can get checking and savings in one convenient place. You’ll earn a competitive APY and pay no account fees, which can help your money grow faster. You’ll also have access to a suite of simple tools that can make budgeting and socking away savings even easier.

Want your money to work harder for you? Bank smarter with SoFi.

FAQ

Is it better to put money in savings or a Roth IRA?

A savings account can be better for setting aside cash you know you’ll eventually need to spend. A Roth IRA, on the other hand, can be better for saving for retirement if you’d like to invest your money to earn higher returns and gain some tax benefits.

Should I use a Roth IRA as a savings account?

While you could use a Roth IRA as a savings account, that could be problematic if you need to make a withdrawal. Generally, the IRS expects you to wait until age 59 ½ to withdraw money from a Roth IRA. Withdrawing money before then could trigger tax penalties.

What is the downside of a Roth IRA?

The main downside of a Roth IRA is that not everyone can open and contribute to one. If your income is above the thresholds allowed by the IRS, you’d only be able to open a traditional IRA instead. It’s possible, however, to convert traditional IRA funds to a Roth IRA, though that can result in a tax bill at the time of the conversion.

Can I move money from savings to a Roth IRA?

You can link a savings account to a Roth IRA to transfer funds. If you’d like to move money from savings to your Roth account, you’d just log into your brokerage account and schedule the transfer. Keep in mind that Roth IRAs do have annual limits on how much you can contribute.

Are Roth IRAs Insured?

The FDIC insures Roth IRAs held at banks when those accounts are self-directed vs. a plan administrator being responsible for making investment decisions. The same FDIC insurance limits that apply to savings accounts apply to Roth IRAs.


Photo credit: iStock/dima_sidelnikov

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.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.


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

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

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

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

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

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


SOBK0322048

Read more
TLS 1.2 Encrypted
Equal Housing Lender