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Dec

2025

How to Convert a Traditional 401(k) to a Roth IRA

By Pam O’Brien | Growing Wealth, invest, Investing | Comments Off

When moving on to a new job, it may be difficult to keep track of the 401(k) left behind at your last job.

What’s more, administrative fees on the account that may have been previously covered by your employer might now shift to you—making it more expensive to maintain the 401(k) account once you’ve left the company. This may leave you wondering, can you roll over a 401(k) to a Roth IRA?

You can! In fact, one of the rollover options for a 401(k) is to convert it to a Roth IRA. For some people, especially those at a certain salary level, this may be an attractive option.

Read on to learn more about rolling over a 401(k) to a Roth IRA, and explore the benefits, restrictions, and ways to execute a rollover, so that you can decide if that’s the right financial move for you.

Key Points

• Rolling over a 401(k) to a Roth IRA involves converting pre-tax retirement savings to an account funded with after-tax dollars.

• Taxes must be paid at the time of conversion based on current income rates.

• There are no limits on the amount that can be transferred, unlike annual contribution limits.

• The rollover can be direct, transferring funds between providers, or indirect, requiring a 60-day deposit window to avoid penalties.

• Converting to a Roth IRA can be advantageous for those expecting to be in a higher tax bracket during retirement.

What Happens When You Convert a 401(k) to a Roth IRA?

Converting, or rolling over, your 401(k) to a Roth IRA means taking your money out of one retirement fund and placing it into a new one.

When you convert your 401(k) to a Roth IRA this is known as a Roth IRA conversion. However, because of some important differences between a traditional 401(k) and a Roth IRA, you will owe taxes when you make this kind of rollover.

The reason: A traditional 401(k) is funded with pre-tax dollars. You don’t pay taxes on the money when you contribute it. Instead, you pay taxes on the funds when you withdraw them in retirement. A Roth IRA, on the other hand, is funded with after-tax dollars. You pay taxes on the contributions in the year you make them, and your withdrawals in retirement are generally tax free.

Because with a 401(k) you haven’t yet paid taxes on the money in your account, when you roll it over to a Roth IRA, you’ll owe taxes on the money at that time. The money will be taxed at your ordinary income rate, depending on what tax bracket you’re in. For the 2025 and 2026 tax years, the income tax brackets range from 10% to 37%.

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

Steps to Converting a 401(k) to a Roth IRA

These are the actions you’ll need to take to convert your 401(k) retirement plan to a Roth IRA.

1. Open a new Roth IRA account.

There are multiple ways to open an IRA, including through online banks and brokers. Choose the method you prefer.

2. Decide whether you want the rollover to be a direct transfer or indirect transfer.

With a direct transfer, you will fill out paperwork to transfer funds from your old 401(k) account into a Roth IRA. The money will get transferred from one account to another, with no further involvement from you.

With an indirect transfer, you cash out the 401(k) account with the intention of immediately reinvesting it yourself into another retirement fund. To make sure you actually do transfer the money into another retirement account, the government requires your account custodian to withhold a mandatory 20% tax — which you’ll get back in the form of a tax exemption when you file taxes.

The caveat: You will have to make up the 20% out of pocket and deposit the full amount into your new retirement account within 60 days. If you retain any funds from the rollover, they may be subject to an additional 10% penalty for early withdrawal.

3. Contact the company that currently holds your current 401(k) and request a transfer.

Tell them the type of transfer you want to make, direct or indirect. They will then send you the necessary forms to fill out.

4. Keep an eye out to make sure the transfer happens.

You’ll likely get an alert when the money is transferred, but check your new Roth IRA account to see that your funds land there safely. At that point, you can decide how you want to invest the money in your new IRA to start saving for retirement.

¹Terms and conditions apply. Roll over a minimum of $20K to receive the 1% match offer. Matches on contributions are made up to the annual limits.

Considerations Before Rolling a 401(k) to a Roth IRA

There are a few rules to consider when rolling over 401(k) assets to a Roth IRA.

Roth IRA Contribution Limits

Contribution limits for Roth IRAs and traditional IRAs are much lower than they are for 401(k)s. For tax year 2025, individuals can contribute up to $7,000 in a Roth IRA, and those 50 and over can contribute up to $8,000, which includes $1,000 of catch-up contributions.

For tax year 2026, you can contribute up to $7,500 in a Roth. Those aged 50 and up can contribute up to $8,600, which includes $1,100 of catch-up contributions.

By comparison, 2025 contribution limits for a 401(k) are:

• $23,500 for those under age 50.

• $31,000 for those aged 50 and over, including an additional $7,500 in catch-up contributions

• $34,750 for those aged 60 to 63, including an additional $11,250 instead of $7,500, thanks to SECURE 2.0.

In 2026, 401(k) contribution limits are:

• $24,500 for those under age 50.

• $32,500 for those aged 50 and older, including an additional $8,000 in catch-up contributions

• $35,750 for those aged 60 to 63, including an additional $11,250 instead of $8,600.

Income Limits for Roth IRA Eligibility

Unlike traditional IRAs, which anyone can contribute to, Roth IRAs have an income cap on eligibility. These income limits are adjusted each year to account for inflation. However, when you are rolling a 401(k) to a Roth IRA, the income limits do not apply. So if you are a high earner, a conversion from a 401(k) to a Roth IRA could be a good option for you.

For tax year 2025, single filers with a MAGI:

• less than $150,000 can contribute the full amount

• $150,000 to $165,000 can make a partial contribution

• $168,000 or more can’t contribute.

For individuals married filing jointly for tax year 2025, those with a MAGI:

• less than $236,000 can contribute the full amount

• $236,000 to $246,000 can contribute a partial amount

• $246,000 or more can’t contribute.

For tax year 2026, single filers with a MAGI:

• less than $153,000 can contribute the full amount

• $153,000 to $168,000 can make a partial contribution

• $168,000 or more can’t contribute.

For individuals married filing jointly for tax year 2026, those with a MAGI:

• less than $242,000 can contribute the full amount

• $242,000 to $252,000 can contribute a partial amount

• $252,000 or more can’t contribute.

Rollover Amount Will be Taxed

You will have to pay taxes on your IRA rollover. Since your 401(k) account was funded with pre-tax dollars and a Roth IRA is funded with post-tax dollars, you’ll need to pay income tax on the 401(k) amount being rolled over in the same tax year in which your rollover takes place.

A Roth IRA is Subject to the Five-Year Rule

Once you transfer money into your new Roth IRA, it pays to keep it there for a while. If you withdraw any earnings that have been in the account for less than five years, you will likely be required to pay income tax and an additional 10% penalty. This is known as the five-year rule. After five years, any earnings withdrawn through a non-qualified distribution is subject to income tax only, with no penalties.

Penalties for Early Withdrawals

In addition to the five-year rule, non-qualified distributions or withdrawals from a Roth IRA — meaning those made before you reach age 59 ½ — can result in penalties and taxes. While there are certain exceptions that may apply, including having a permanent disability or using the funds to buy or build a first home, it’s wise to think twice and research any potential consequences before withdrawing money early from a Roth IRA.

Should You Convert Your 401(k) to a Roth IRA ?

Converting a 401(k) to a Roth IRA may be beneficial if you anticipate being in a higher tax bracket when you retire since withdrawals from the account in retirement are tax-free. And if you are a high earner, a 401(k) rollover to a Roth IRA may give you the opportunity to participate in a Roth IRA that you otherwise wouldn’t have.

Another advantage of a Roth IRA is that you can withdraw the money you contributed (but not the earnings) at any time without paying taxes or penalties. And unlike 401(k)s, there are no required minimum distributions (RMDs) with a Roth IRA. Finally, IRAs generally offer more investment options than many 401(k) plans do.

Can You Reduce the Tax Impact?

There are some potential ways to reduce the tax impact of converting a 401(k) to a Roth IRA. For instance, rather than making one big conversion, you could consider making smaller conversion amounts each year, which may help reduce your tax bill.

Another way to possibly lower the tax impact is if you have post-tax money in your 401(k). This might be the case if you contributed more than the maximum deductible amount allowed to your 401(k), for instance. You may be able to avoid paying taxes currently by rolling over the after-tax funds in your 401(k) to a Roth IRA, and the rest of the pre-tax money in the 401(k) to a traditional IRA.

In general it’s wise to consult a tax professional to see what the best strategy is for you and your specific situation.

The Takeaway

One way to handle a 401(k) account from a previous employer is by rolling it over into a Roth IRA. For some individuals, it might be the only way to take advantage of a Roth IRA, which typically has an income limit. With a Roth IRA, account holders can contribute post-tax dollars now, and enjoy tax-free withdrawals in retirement.

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

Easily manage your retirement savings with a SoFi IRA.

FAQ

Can I roll over my 401(k) to an existing Roth IRA?

Yes, you can roll over a 401(k) to an existing Roth IRA — or to a new Roth IRA.

Can I roll my 401(k) into a Roth IRA without penalty?

You can roll over 401(k) to a Roth IRA without penalty as long as you follow the 60-day rule if you’re doing an indirect rollover. You must deposit the funds into a Roth IRA within 60 days to avoid a penalty.

How much does it cost to roll over 401k to Roth IRA?

Typically there is no charge to roll over a 401(k) to a Roth IRA, unless you are charged processing fees by the custodian of your old 401(k) plan or the new Roth IRA. However, you will owe taxes on the money you roll over from a 401(k) to a Roth IRA. The money will be taxed at your ordinary income tax rate.

Is there a time limit when rolling over a 401(k) to a Roth IRA?

If you do an indirect rollover, in which you cash out the money from your 401(k), you have 60 days to deposit the funds into a Roth IRA in order to avoid being charged a penalty.

Is there a limit on rollover amounts to a Roth IRA?

No, there is no limit to the amount you can roll over to a Roth IRA. The standard annual contribution limits to a Roth IRA do not apply to a rollover.

How do you report a 401(k) rollover to a Roth IRA?

You will need to report a 401(k) rollover on your taxes. Your 401(k) plan administrator will send you a form 1099-R with the distribution amount. You typically report the distribution amount on IRS form 1040 when filing your taxes. You can consult a tax professional with any questions you might have.

Can you roll over partial 401(k) funds to Roth IRA?

You can typically roll over partial 401(k) funds as long as your plan allows it. Check with your plan’s administrator.

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

SOIN0124006
CN-Q425-3236452-03

Dec

2025

Numberless white vertical lines on a blue background forming a graph, illustrating fluctuations in the stock market.

10 Top Monthly Dividend Stocks for December 2025

By Michael Flannelly | Growing Wealth, invest, Investing | Comments Off

Table of Contents

Top 10 Monthly Dividend Stocks by Yield
What Are Monthly Dividend Stocks?
How Does Dividend Investing Work?
Types of Monthly Dividend Stocks
Ways to Evaluate Monthly Dividend Stocks
Pros and Cons of Investing in Monthly Dividend Stocks
Things to Avoid When Investing in Monthly Dividend Stocks
FAQ

While most dividend-paying stocks do so every quarter, some companies make monthly dividend payments. Getting dividend payouts on a monthly schedule may appeal to investors, especially those relying on dividends for a steady income stream.

A dividend is a portion of a company’s earnings that it pays to shareholders on a regular basis. Many investors seek out dividend-paying stocks as a way to generate income.

Note that there are no guarantees that a company that pays dividends will continue to do so.

Key Points

Monthly dividend stocks can provide steady income, but are less common than quarterly dividends.
Utility and energy companies may offer consistent dividends due to steady consumer demand and limited competition.
Dividend ETFs are passive and often track indexes of companies with a history of strong dividend growth.
REITs pay dividends from income-generating properties and must distribute 90% of income to shareholders.
Consider not only a dividend stock’s yield, but the long-term stability of the company and its dividend payout ratio.

Top 10 Monthly Dividend Stocks by Yield

Following are some of the top-paying dividend stocks by yield, as of December 1, 2025. The dividends for these stocks are expressed here as a 12-month forward dividend yield, meaning the percentage of a company’s current stock price that the company is projected to pay out through dividends over the next 12 months.

Company	Ticker	12-month forward yield
Orchid Island Capital, Inc.	ORC	19.92%
Prospect Capital Corp.	PSEC	16.68%
ARMOUR Residential REIT, Inc.	ARR	16.44%
Dynex Capital, Inc.	DX	14.53%
AGNC Investment Corp.	AGNC	13.73%
PennantPark Floating Rate Capital Ltd.	PFLT	13.29%
Ellington Financial, Inc.	EFC	11.59%
Capital Southwest Corp.	CSWC	11.49%
Gladstone Commercial Corp.	GOOD	10.85%
Apple Hospitality REIT, Inc.	APLE	8.15%

Source: Data from Bloomberg, as of December 1, 2025. Universe of stocks includes all U.S.-based companies with market capitalization of at least $500M and positive forward EPS.

What Are Monthly Dividend Stocks?

As mentioned above, dividend stocks usually pay out quarterly. However, some companies pay dividends monthly.

Stocks that pay dividends monthly may appeal to investors who want steady monthly income. Additionally, monthly dividend stocks may help investors who reinvest the payments to realize the benefit of compounding returns.

For example, through dividend reinvestment plans (DRIPs), investors can use dividend payouts to buy more shares of stock. Potentially, the more shares they own, the larger their future dividends could be.

How Does Dividend Investing Work?

Most dividends are cash payments made on a per-share basis, as approved by the company’s board of directors. For example, if Company A pays a monthly dividend of 30 cents per share, an investor with 100 shares of stock would receive $30 per month.

Some investors may utilize dividend-paying stocks as part of an income investing strategy. Retirees, for example, may seek investments that deliver a reliable income stream for their retirement. It’s also possible to reinvest the cash from dividend payouts.

A stock dividend is different from a cash dividend. Stock dividends are an increase in the number of shares investors own, reflected as a percentage. If an investor holds 100 shares of Company X, which offers a 3% stock dividend, the investor would have 103 shares after the dividend payout.

Understanding Dividend Yield

Understanding dividends is one part of an investor’s decision when choosing dividend-paying stocks. Another factor is dividend yield, which is the annual dividend amount the company pays shareholders divided by its stock price, and shown as a percentage.

If Company A pays 30 cents per share in dividends per month, that’s $3.60 per year, per share. If the share price is $50, to get the dividend yield you divide the annual dividend amount by the current share price:

$3.60 / $50 = 7.2%

The dividend yield can be useful as it can help an investor to assess the potential total return of a given stock, including possible gains or losses over a year.

But a higher or lower dividend yield isn’t necessarily better or worse, as the yield fluctuates along with the stock price. A stock’s dividend yield could be high because the share price is falling, which can be a sign that a company is struggling. Or, a high dividend yield may indicate that a company is paying out an unsustainably high dividend.

Investors will often compare a stock’s dividend yield to other companies in the same industry to determine whether a yield is attractive. Whether investing online or through a brokerage, it’s important to consider company fundamentals, risk factors, and other metrics when selecting any investment.

Types of Monthly Dividend Stocks

To invest in monthly dividend stocks, investors may want to consider companies in industries that tend to offer monthly dividend payouts. These companies usually have regular cash flow that can sustain consistent dividend payments.

Energy and Utility Companies

In the world of dividend payouts, utility and energy companies (e.g. water, gas, electricity) offer investors a certain consistency and reliability, thanks to the fact that consumer demand for utilities tends to be steady, and thus so is revenue.

Utility companies are considered a type of infrastructure investment, meaning that they provide systems that help society function. As such, these companies tend to be highly durable, offering tangible benefits to consumers and investors.

Also, many energy and utility companies may have little competition in a given region, which can add to the stability of revenue and thereby dividends.

ETFs

Just as an ordinary exchange-traded fund, or ETF, consists of a basket of securities, a dividend-paying ETF includes dividend-paying stocks or other assets. And similar to dividend-paying stocks, investors in dividend ETFs may benefit from regular monthly payouts, depending on the ETF.

Like most types of ETFs, dividend-paying funds are passive, meaning they track an index. In many cases, these ETFs seek to mirror indexes that include companies with a solid track record of dividend growth.

REITs

Real estate investment trusts (REITs) offer investors a way to buy shares in certain types of income-generating properties without the headache of having to manage these properties themselves.

REITs pay out dividends because they receive steady cash flow through rent payments and sometimes profits from the sale of a property. Also, these companies are legally required to pay at least 90% of their income to shareholders through dividends. Some REITs will pay dividends monthly.

Note: REIT payouts are ordinary dividends, i.e. they’re taxed as income, not at the more favorable capital gains rate.

Ways to Evaluate Monthly Dividend Stocks

Investors may want to analyze several criteria to determine the dividend stocks ideal for a wealth-building strategy. Here are a few things investors can consider when looking for the highest dividend stocks:

Dividend Payout Ratio

Investors will also factor in a stock’s dividend payout ratio when making investment decisions. This ratio expresses the percentage of income that a company pays to shareholders.

The dividend payout ratio is calculated by dividing a company’s total dividends paid by its net income.

Dividend payout ratio (%) = dividends paid / net income

Investors can also calculate the dividend payout ratio on a per share basis, dividing dividends per share by earnings per share.

Dividend payout ratio (%) = dividends per share / earnings per share

The dividend payout ratio can help determine if the dividend payments a company distributes make sense in the context of its earnings. Like dividend yield, a high dividend payout ratio may be good, especially if investors want a company to pay more of its profits to investors. However, an extremely high ratio can be difficult to sustain.

If a stock is of interest, it may help to check out the company’s dividend payout ratios over an extended period and compare it to comparable companies in the same industry.

Company Stability

Investors may also wish to focus on stable, well-run companies with a reputation for paying consistent or rising dividends for years. Dividend aristocrats – companies that have paid and increased their dividends for at least 25 years – and blue chip stocks are examples of relatively stable companies that are attractive to dividend-focused investors.

These companies, however, do not always have the highest dividend yields. Nor do these companies pay monthly dividends; most companies will pay dividends quarterly.

Furthermore, keep in mind a company’s future prospects, not just its past success, when shopping for high-dividend stocks.

Tax Implications

Dividends also have specific tax implications that investors should know.

A qualified dividend qualifies for the capital gains tax rate, which is typically more favorable than an investor’s marginal tax rate.
An ordinary dividend is taxed at an individual’s income tax rate, which is typically higher than the capital gains rate.

Investors will receive a Form DIV-1099 when $10 or more in dividend income is paid out during the year. If the dividends are in a tax-advantaged account, an IRA, 401(k), etc., the money will grow tax-free until it’s withdrawn.

Recommended: Ordinary vs Qualified Dividends

Pros and Cons of Investing in Monthly Dividend Stocks

While dividend stocks offer some advantages, they also come with some risks and disadvantages investors must bear in mind.

Pros and Cons of Monthly Dividend Stocks
Pros	Cons
Provide passive income	Dividend payments are not guaranteed
Dividend reinvestment can lead to compound returns	Selecting monthly dividend stocks can be tricky
Investors may earn a return even when the stock price goes down	Dividends may be cut or reduced during a downturn
Qualified dividends have preferential tax treatment over ordinary dividends; they qualify for the capital gains tax rate	Some companies view dividends as tax inefficient
	Share price appreciation may be limited compared to growth stocks

Pros

Passive income. As noted above, investing in dividend stocks can provide a source of passive income (although dividends can be cut at any time).
The ability to reinvest. Dividend stocks allow for reinvestment (using dividend payments to buy more stocks, thus compounding returns). Steady dividends may also allow investors who reinvest the gains to buy stocks at a lower price while the market is down — similar to using a dollar-cost averaging strategy. Additionally, the stocks of mature companies that pay dividends also may be less vulnerable to market fluctuations than a start-up or growth stock.
Potential income during a downturn. Another plus for those who choose dividend stocks is that they may receive dividend payments even if the market falls. That can help insulate investors during tough economic times.

Cons

Dividends are not guaranteed. A company can decide to suspend or cut its dividends at any time. It could be that the company is truly in trouble or that it simply needs the money for a new project or acquisition. This may be especially true for monthly dividend stocks; many REITs that pay monthly dividends suspended or cut dividends during the Covid-19 pandemic. Either way, if the public sees the dividend cut as a negative sign, the share price could fall. And if that happens, an investor could suffer a double loss.
Tax inefficiency. First, a corporation must pay tax on its earnings, and then when it distributes dividends to shareholders (which are considered profit-after-tax), the shareholder also must pay tax as an individual. Owing to this tax inefficiency, sometimes referred to as a type of double taxation, some companies decide not to offer dividends and find other ways to pass along profits. Note that this tax issue doesn’t impact REITs the same way. Entities such as REITs and Master Limited Partnerships (MLPs) pass along most of their profits to investors. In these cases, the company doesn’t owe tax on the profits it passes onto the investor.
Limited options. Also, choosing the right dividend stock can be tricky. First, monthly dividend stocks aren’t as common as quarterly dividend payouts. And the metrics for analyzing attractive dividend stocks are quite different from those for selecting ordinary stocks.
Dividends can drop or be cut. It’s important to remember that dividends may fluctuate depending on how a company is performing, or how it chooses to distribute its profits. During a downturn, it’s possible to see lower dividends, or for a company to cut its dividend payout.
Share price appreciation may be limited. Gains in the share price of some dividend stocks can be limited, as many dividend-paying companies are typically not in a rapid growth phase.

Things to Avoid When Investing in Monthly Dividend Stocks

When investing in monthly dividend stocks, there are a few things to avoid:

Avoid investing in a company that pays a monthly dividend solely to pay a monthly dividend. Many companies pay monthly dividends, but not all are suitable investments. Do your research and only invest in companies that you believe will be successful in the future.
Avoid investing in a company or industry that you don’t understand. If you don’t understand how a company makes money, you should hesitate to invest in it.
Avoid investing all of your money in monthly dividend stocks. Diversify your portfolio by investing in other types of stocks, bonds, funds, and other securities, which may help decrease risk and exposure to volatility.

The Takeaway

Dividend-paying stocks can be desirable. They can add to your income, or offer the potential for reinvestment via dividend reinvestment plans or other strategies you pursue to support your financial goals. Monthly dividend stocks offer the potential for steady income, but they are less common than stocks that pay on a quarterly basis.

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

Invest with as little as $5 with a SoFi Active Investing account.

FAQ

How do monthly dividend stocks work?

A monthly dividend stock is a stock that pays out dividends every month instead of the more common quarterly basis. This can provide investors with a supplemental stream of income, which can be particularly helpful if you rely on dividends for living expenses.

How can you get stocks that pay monthly dividends?

To invest in stocks that pay monthly dividends, you need to research financial websites and publications to find companies that pay dividends monthly. There are not many monthly dividend stocks, especially compared with stocks that pay quarterly dividends.

How can you determine the stocks that pay the highest monthly dividends?

Investors use metrics like the dividend yield and dividend payout ratio to determine the stocks that might be most desirable. However, stocks that pay the highest monthly dividends can change over time, and it’s important to consider other methods of assessing a stock, since a higher dividend isn’t always a sign of company health.

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

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

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Mutual Funds (MFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risk, include the risk of loss. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

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.

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

Dollar Cost Averaging (DCA): Dollar cost averaging is an investment strategy that involves regularly investing a fixed amount of money, regardless of market conditions. This approach can help reduce the impact of market volatility and lower the average cost per share over time. However, it does not guarantee a profit or protect against losses in declining markets. Investors should consider their financial goals, risk tolerance, and market conditions when deciding whether to use dollar cost averaging. Past performance is not indicative of future results. You should consult with a financial advisor to determine if this strategy is appropriate for your individual circumstances.

This article is not intended to be legal advice. Please consult an attorney for advice.

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SOIN-Q425-054

Dec

2025

Understanding a Taxable Brokerage Account vs an IRA

By Michael Flannelly | Growing Wealth, invest, Investing | No Comments

Table of Contents

What Are Taxable Brokerage Accounts?
What Is an IRA?
Taxable Brokerage Accounts vs IRA Accounts
Tax Advantages of an IRA vs Taxable Brokerage Account
Which Type of Account Is Best for Me?
Pros and Cons of Taxable Brokerage Accounts
Is it Smart to Have Both an IRA and a Taxable Brokerage Account?
FAQ

Tax-sheltered accounts like the IRA and 401(k) have long been the go-to investment accounts for retirement planning. These types of accounts offer ways to build up tax-advantaged savings for the future. However, investing in taxable brokerage accounts is another common way to build wealth for the short or long term.

The most notable difference between an IRA and a taxable brokerage account can be seen around tax season. With taxable brokerage accounts, you typically pay taxes on your capital gains and dividends each year. In contrast, tax-advantaged accounts generally only involve paying taxes when you make your contribution or withdraw your money, depending on the type of account.

Investors should know the similarities and differences between IRAs and taxable brokerage accounts. Learning the ins and outs of these accounts can help you decide which is right for you to build wealth and meet your financial goals.

Key Points

• Taxable brokerage accounts and IRAs serve different purposes, with brokerage accounts focusing on general investment and IRAs designed specifically for retirement savings.

• Taxable brokerage accounts require annual taxes on capital gains and dividends, while IRAs allow for tax-deferred growth until funds are withdrawn.

• Different types of IRAs, such as Traditional and Roth, offer unique tax advantages and rules regarding contributions and withdrawals tailored to individual financial situations.

• A combination of both account types can provide flexibility and diversification, allowing investors to meet both short-term and long-term financial goals.

• Each account type has its pros and cons, making it essential to evaluate personal financial objectives before deciding on the appropriate investment strategy.

What Are Taxable Brokerage Accounts?

Think of taxable brokerage accounts as “traditional” investment accounts — brokerage-offered investment accounts with stocks, bonds, exchange-traded funds (ETFs), and mutual funds. Investors who utilize these accounts, including online brokerage accounts, invest and trade to build short- or long-term wealth, but not necessarily for retirement.

The investments within a taxable brokerage account are subject to tax on any capital gains, dividends, or interest earned. Brokerage account holders pay taxes each year based on investment income.

It’s also important to note that tax liability can vary based on variables like the types of investments held within the brokerage account, the length of time they are held, and an individual’s tax bracket. For example, short-term capital gains, which are gains on investments held for less than a year, are taxed at the same rate as ordinary income. In contrast, long-term capital gains, which are gains on investments held for more than a year, are typically taxed at a lower rate.

Recommended: Capital Gains Tax Guide

¹Terms and conditions apply. Roll over a minimum of $20K to receive the 1% match offer. Matches on contributions are made up to the annual limits.

What Is an IRA?

An IRA, or individual retirement account, is an investment account designed specifically to save for retirement. Contributions to an IRA may be tax-deductible or tax-deferred, and the accounts’ investments can grow tax-free until they are withdrawn at retirement age.

There are several different types of IRAs, including Traditional IRAs, Roth IRAs, and SEP IRAs, which have different rules for contributions, taxes, and withdrawals. An IRA can be a helpful tool for saving for retirement and taking advantage of potential tax benefits.

Taxable Brokerage Accounts vs IRA Accounts

Tax-sheltered, or tax-deferred, investment accounts like IRAs differ from taxable brokerage accounts because they generally offer tax advantages and have restrictions on contributions and withdrawals. The tax advantages make them designed for long-term retirement saving and investing. Besides having money invested for retirement, the most notable benefits of IRAs are no yearly tax burden and, in some cases, tax-deductible contributions.

Here’s a breakdown of what each tax-deferred account may offer compared to a brokerage account.

Traditional IRAs vs Taxable Brokerage Accounts

The traditional IRA has no income limits; as long as someone has a taxable income, they can contribute to a traditional IRA. The gains, dividends, and interest earned in IRAs grow tax-deferred during contributing years. Contributions to a traditional IRA may be tax-deductible, though the benefits phase out if you have a high enough income.

With a few exceptions, IRA withdrawal rules say account holders will have to pay a 10% early withdrawal penalty if they take a distribution before reaching age 59 ½. Additionally, account holders are required to start making withdrawals the year they turn age 73 (if they reach age 72 after December 31, 2022) that are taxed as income.

These limitations make a traditional IRA different from a taxable brokerage account, as taxable brokerage accounts do not have withdrawal restrictions and penalties.

With a traditional IRA, as with taxable brokerage accounts, account holders will need to manage it independently or with a financial planner’s help.

A traditional IRA might be a good option for investors who think they will be in a lower tax bracket when they retire. In theory, these investors would save money on taxes by paying them in retirement compared to paying taxes now.

For 2025, account holders can contribute up to $7,000 per year (or up to $8,000 if they are age 50 or older). For 2026, the total contributions investors can make to a traditional IRA is up to $7,500 (or up to $8,600 if they are 50 and up).

Roth IRAs vs Taxable Brokerage Accounts

Like taxable brokerage accounts, Roth IRA contributions aren’t tax-deductible. Investors contribute with post-tax dollars, but that also means they won’t be subject to taxes when they withdraw funds in retirement.

However, income limits exist for those who can contribute to a Roth IRA account. If you make more than the income limits, then the amount of money you can contribute to a Roth IRA may be reduced, and high earners may not be able to contribute to a Roth IRA at all. For 2025, income limits start at $150,000 per year for single tax filers and $236,000 for married couples filing jointly. For 2026, income limits start at $153,000 per year for single tax filers and $242,000 for married couples filing jointly. You can use a Roth IRA calculator to help determine your contribution limit.

As with brokerage accounts, Roth IRA account holders can contribute to their accounts at any age. Investors who want to make retirement contributions can do so even after they’ve retired.

Rules around Roth IRA withdrawals are less stringent than those for a traditional IRA. Roth account holders can also begin to take the account’s growth starting at age 59 ½ with no penalty as long as the account has been open for five years.

For those eligible to contribute to a Roth IRA, these accounts make the most sense if the account holder thinks they will be in a higher tax bracket in retirement. Since account holders pay taxes on the contributions in the year they were made, it makes the most sense to pay income taxes when in a lower tax bracket.

401(k)s vs Taxable Brokerage Accounts

Similar to an IRA, 401(k) accounts are one of the most common tax-sheltered accounts. The big difference between an IRA and a 401(k) account is that the 401(k) is employer-sponsored, and employees and employers can contribute to the account.

Employees can contribute up to $23,500 to their 401(k) in 2025 and up to $24,500 in 2026. Employees over 50 can make additional catch-up contributions of $7,500 annually in 2025, and up to $8,000 in 2026. In both 2025 and 2026, those 60 to 63 can make a higher catch-up contribution of up to $11,250 under the SECURE 2.0 Act. Many employers offer employees 401(k) plans, some even matching contributions up to a certain percentage.

The 401(k) is one of the most common ways to build a retirement nest egg because the contributions are automatic and come out of the employee’s paycheck, so employees may not even notice the money is gone.

Tax Advantages of an IRA vs Taxable Brokerage Account

As noted above, IRAs offer several tax advantages compared to taxable brokerage accounts. Investors generally use IRAs for tax efficient investing.

Here are some of the main differences:

• Contributions to traditional IRAs may be tax-deductible: Contributions to a traditional IRA may be tax-deductible, depending on your income and whether a retirement plan at work covers you or your spouse. This means that the money you contribute to a traditional IRA can be deducted from your taxable income, potentially reducing the amount of tax you owe.

• Earnings in an IRA grow tax-free or tax-deferred: The money you earn in an IRA, including interest, dividends, and capital gains, grows tax-deferred or tax-free until you withdraw it in retirement. In a taxable brokerage account, you would have to pay taxes on any capital gains and dividends you earn each year.

• Withdrawals from traditional IRAs may be taxed at a lower rate: When you withdraw money from a traditional IRA in retirement, it is taxed as ordinary income at your marginal tax rate. However, if you are in a lower tax bracket in retirement than when you made the contributions, your withdrawals may be taxed at a lower rate.

• Contributions to a Roth IRA are not tax-deductible: Contributions to a Roth IRA are not tax-deductible, but the money you withdraw in retirement is tax-free, provided you meet specific requirements. This can be a good option if you expect to be in a higher tax bracket in retirement than you are now.

Which Type of Account Is Best for Me?

Brian Walsh, Certified Financial Planner™ at SoFi, says ultimately, you’ll have a mixture of accounts. However, what’s right for you depends on your situation. “It depends if you have access to a 401(k) and an employer match … it depends on what you’re eligible for.” Here are a few considerations that can help you assess your situation.

Think About Investing in a Traditional IRA If…

• You want to take advantage of tax-deferred contributions.

• You expect to be in a lower tax bracket in retirement.

• You’ve maxed out your 401(k) contributions and make too much to contribute to a Roth account.

Think About Investing in a Roth IRA If…

• You expect to be in a higher tax bracket in retirement.

• You want the option to pass on the account easily to your heirs.

• You’ve maxed out your traditional 401(k) and want to offset some of your future tax burden with a Roth IRA.

Think About Investing in a 401(k) If…

• Your employer offers a plan with a match program.

• You’re uncertain about your future tax liability, and your employer allows you to split contributions between a traditional 401(k) and a Roth 401(k).

• You prefer a hands-off approach to investing.

Think About Investing in a Taxable Brokerage Account If…

• You’ve maxed out all contribution limits to your 401(k) and IRAs.

• You want to invest in investments not offered in your 401(k) or IRA, like options or cryptocurrency.

• You want more control over your investments with the opportunity to withdraw funds at your leisure.

Pros and Cons of Taxable Brokerage Accounts

Here are some of advantages and disadvantages of taxable brokerage accounts:

Pros of Taxable Accounts

• Flexibility: Taxable brokerage accounts allow you to invest in a wide range of assets, such as stocks and bonds, as well as derivatives. This allows you to create a diversified portfolio that may help you meet your investment goals.

• Growth potential: Taxable brokerage accounts offer the potential for significant growth, as you can earn capital gains on your investments if they increase in value.

• No contribution limits: Unlike tax-advantaged accounts, taxable brokerage accounts have no contribution limits. This means you can contribute as much as you want to your account, subject to income limits or restrictions.

Cons of Taxable Accounts

• Taxes: One of the main disadvantages of taxable brokerage accounts is that you will be required to pay taxes on your investment income and capital gains. This can significantly reduce your overall returns.

• Lack of tax benefits: Taxable brokerage accounts do not offer the same tax benefits as tax-advantaged accounts. For example, 401(k)s and IRA contributions may be tax-deductible, while investments in taxable brokerage accounts are not.

• Potential for loss: As with any investment, there is a risk of loss in a taxable brokerage account. If your investments decline in value, you could lose some or all of your initial investment.

Is it Smart to Have Both an IRA and a Taxable Brokerage Account?

It may be a consideration to have both an IRA and a taxable brokerage account, as each type has its specific benefits and drawbacks.

An IRA can be a good option if you are looking to open a retirement account and save for retirement and want the potential tax benefits of an IRA. On the other hand, a taxable brokerage account can be a good choice if you are looking to invest for goals other than retirement or if you are not eligible for a tax deduction on your contributions to an IRA.

Having both an IRA and a taxable brokerage account can give you more flexibility and diversification in your investments, which can help you manage risk and improve your overall financial situation.

The Takeaway

Every account — from taxable brokerage accounts to IRAs — has advantages and disadvantages, which is why some investors choose to invest in a few. The old cliche, “don’t put all your eggs in one basket,” is a solid philosophy for financial planning. Investing in several different “baskets” is one way to ensure that your money is working hard for you.

Take a step toward reaching your financial goals with SoFi Invest.

FAQ

What is the difference between an IRA and a taxable brokerage account?

An IRA is designed specifically to save for retirement. Unlike a taxable brokerage account, which is used for general investing, contributions to a traditional IRA may be tax-deductible, and the investments within the account grow tax-deferred until they are withdrawn at retirement age. There are several other types of IRAs, including Roth IRAs, which have different rules for contributions, taxes, and withdrawals.

Is it better to contribute to an IRA or a taxable brokerage account?

Whether to contribute to an IRA or a taxable brokerage account depends on your circumstances and financial goals. In general, an IRA can be a good option if you are looking to save for retirement and want the potential tax benefits of an IRA. However, if you are not eligible for a tax deduction on your contributions or looking to invest for goals other than retirement, a taxable brokerage account may be a better choice.

How is a taxable brokerage account taxed?

The investments held within a taxable brokerage account may be subject to tax on any capital gains, dividends, or interest earned. Short-term capital gains, which are gains on investments held for less than a year, are taxed at the same rate as ordinary income. Long-term capital gains, which are gains on investments held for more than a year, are typically taxed at a lower rate. Dividends and interest income earned are also subject to tax.

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

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CN-Q425-3236452-08

Dec

2025

Brokerage Accounts 101: Types & Benefits Explained

By Samuel Becker | Growing Wealth, invest, Investing | No Comments

Table of Contents

What Is a Brokerage Account?
What Is a Brokerage Account Used For?
How Are Brokerage Accounts Different From Bank Accounts?
Benefits of Having a Brokerage Account
Top 3 Types of Brokerage Accounts Explained
Other Types of Brokerage Accounts
How to Choose the Right Brokerage Account for You
FAQ

Brokerage accounts offer a way into the financial markets: think stocks, bonds, and other securities. Your account enables you to buy, sell, and trade these products. Not all brokerages operate the same way; nor do they all offer the same types of investments. We’ll break down what brokerage accounts are, the different account types available, and how they differ from other financial accounts.

Key Points

Brokerage accounts allow individuals to buy and sell securities.
Cash brokerage accounts allow trading securities using only deposited cash.
Margin accounts offer the ability to borrow for trading, increasing both leverage and risk.
Joint accounts are typically used by partners or family members for shared investments.
Discretionary accounts enable brokers to make investment decisions on behalf of the holder.

What Is a Brokerage Account?

A brokerage account is a type of investing tool offered by investment firms. These accounts allow people to invest their money by buying and selling stocks, bonds, exchange-traded funds (ETFs), and other types of securities.

These accounts are typically flexible and come in various forms, catering to different needs and experience levels. For prospective investors, knowing what a brokerage account is and how they work is important. For seasoned investors, learning even more about them can help deepen their knowledge, too.

What Is a Brokerage Account Used For?

Brokerage accounts open up the world of online investing or investing through a broker in stocks and allows investors to conduct other transactions, such as options trading. They are offered by different types of financial firms as well. Here’s a breakdown of different brokerage accounts, and what each might be used for:

Full-service brokerage firms usually provide a variety of financial services, including allowing you to trade securities. Full-service firms will sometimes provide financial insights and automated investing to customers.
Discount brokerage firms don’t usually provide additional financial consulting or planning services. Thanks to their pared-down services, a discount brokerage firm often offers lower fees than a full-service firm.
Online brokerage firms provide brokerage accounts via the internet, although some also have brick and mortar locations. Online brokers often offer some of the lowest fees and give investors freedom to trade online with ease. They also tend to make information and research available to consumers.

You can start the application either online or in-person. You can then fund your account by transferring money from a checking or savings account.

Some brokerage firms require investors to use cash to open their accounts, and to ensure they have sufficient funding to cover the cost of their investments (as well as any commission fees). Some do not require an initial deposit, however.

Brokerage accounts generally do not have restrictions on deposit or withdrawals. This makes them different from retirement accounts, which typically have more transaction limits or restrictions. Investors do need to claim any profits that they withdraw from their account as taxable income.^[1]

Here’s a closer look at how brokerage firm accounts differ from other types of money accounts.

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

How Are Brokerage Accounts Different From Bank Accounts?

Brokerage accounts are different from checking and savings accounts because of how your money is protected. Most checking accounts offered by a bank will come with Federal Deposit Insurance Corporation (FDIC) protection. FDIC insurance protects the first $250,000 per depositor, per bank, per account type.^[2]

For example, if you have a checking and a savings account at the same insured bank, the combined balances are covered up to $250,000. If you hold accounts that fall under different ownership categories (e.g., a joint checking account), those accounts may be covered separately, and be insured up to its own $250,000 total.
Brokerage accounts, on the other hand, are often protected by Securities Investors Protection Corporation (SIPC) insurance. The SIPC safeguards customers against losses caused by brokers becoming insolvent. They ensure the return of cash and securities, up to $500,000 (including $250,000 for cash).^[3] They do not cover losses due to market fluctuations or investment decisions, however.

Brokerage accounts and checking accounts have one key similarity: both can hold cash. Brokerage accounts will often “sweep” your cash holdings into a money market fund that’s managed by that same brokerage, so that it may potentially earn interest.

Benefits of Having a Brokerage Account

The biggest benefit of a brokerage account is the opportunity to invest. Although a money market account could accrue interest, its funds are designed to be invested rather than held. These accounts come with other advantages as well.

Flexibility and control: Brokerage accounts allow owners to trade financial securities and invest their money as they see fit.
Potential for returns: You may be able to realize gains that are greater than current interest rates. However, they also run the risk of unlimited loss depending on how their investments perform.
No contribution limits: You are only limited by the amount of money you want (or have) to invest. Beginners should seriously consider how much they are willing to lose before funding their account and trading securities.
Liquidity: Brokerage accounts offer full liquidity, enabling you to withdraw and deposit as you please.

Top 3 Types of Brokerage Accounts Explained

There are several types of brokerage accounts: cash brokerage accounts, margin accounts, and discretionary accounts.

1. Cash Brokerage Accounts

Cash brokerage accounts are a straightforward option for investors who want to trade securities without using borrowed funds, or leverage, as you would with a margin account. These accounts only let you invest with the cash you deposit, which can be a simpler approach to investing.

Features:

Simple account structure: Cash brokerage accounts are fairly simple in that investors can trade with whatever they deposit.
Trading ability: Investors have the ability to trade a wide variety of assets, including stocks, bonds, ETFs, and mutual funds.

Pros and Cons:

Brokerage accounts are simple, offer flexibility, and often do not have maintenance fees. They do not offer leverage, which can affect your trading strategies. They may be best for investors seeking simplicity.

2. Margin Brokerage Accounts

Margin brokerage accounts let you use margin when trading. You can effectively borrow money to trade with directly from the brokerage. Thus, you may require approval from a brokerage to open an account. There’s a higher degree of risk with these accounts than cash brokerage accounts, given that you are borrowing money to invest with. There is a significant risk of loss as well as gain.^[4]

Features:

Leverage: The ability to borrow funds to increase buying power, allowing you to trade more than your initial balance. Margin comes with interest, however, which can erode potential profits.
Risk management tools: Some margin accounts offer features like stop-loss orders or margin alerts to help manage risks.
Flexibility: Allows for short selling, providing opportunities to profit from declining markets.

Pros and Cons:

Margin accounts increase purchasing power, allowing investors to make larger trades, potentially leading to higher returns and the opportunity to profit from short selling. However, these benefits come with increased risk, as losses can be amplified, interest costs add up, and margin alerts may require investors to deposit additional funds or sell assets, making careful management essential.

3. Prime Brokerage Accounts

Prime brokerage accounts are designed mostly for institutional investors and high-net-worth individuals. These accounts offer advanced services (e.g., margin trading, securities lending) and proprietary research. These are sophisticated tools designed for experienced traders.

Features:

Access to leverage: Prime brokers allow clients to borrow funds for margin trading, enabling higher potential returns (but also increased risk).
Customized services: Tailored to meet the needs of sophisticated clients, including advanced trading strategies and risk management.
Securities lending: Clients can borrow securities to execute short sales, enhancing their trading flexibility.
Clearing and settlement services: Prime brokers handle the logistics of trades, including clearing and settlement, often allowing clients to access a broader range of financial instruments.
Research and reporting: Advanced market research, real-time data feeds, and detailed reporting on positions and trades.

Pros and Cons:

Prime brokers offer access to leverage, allowing clients to borrow funds for margin trading and enhance potential returns, while also providing tailored services for institutional investors or high-net-worth individuals. However, these advantages come with increased risk, as borrowing funds for margin trading amplifies potential losses.

Other Types of Brokerage Accounts

In addition to cash, margin, and joint brokerage accounts, there are other account types that serve specific needs and investment strategies. These accounts cater to different financial goals, investor preferences, and tax implications. Some common alternatives include:

Custodial Accounts: These accounts are set up by an adult for the benefit of a minor, with the custodian managing the assets until the minor reaches the age of majority.
Managed Accounts: In these accounts, a professional portfolio manager makes investment decisions on behalf of the account holder, often for a higher fee.

Each of these account types has unique benefits, tax treatments, and management structures designed to meet specific financial objectives. Depending on your investment goals, it may be advantageous to explore these alternatives to maximize returns and minimize tax liabilities.

How to Choose the Right Brokerage Account for You

Choosing the right brokerage account depends on your investment goals and risk tolerance. For those looking to amplify their investments, a margin account offers leverage, though with added risk. Joint accounts are ideal for shared investments, while more experienced investors may opt for managed or discretionary accounts for professional guidance. Your decision should align with your financial objectives, time horizon, and comfort with risk.

The Takeaway

Brokerage accounts allow owners to buy and sell investments and financial securities. They are offered by a number of financial institutions, and come in a few different types. By and large, though, they’re a very popular choice for investors looking to get their money in the markets.

They do have their pros and cons and associated risks, however. It may be beneficial to speak with a financial professional to learn more about how you can use a brokerage account to your advantage in pursuit of your financial goals.

¹Opening and funding an Active Invest account gives you the opportunity to get up to $3,000 in the stock of your choice.

FAQ

What is the minimum needed to open a brokerage account?

Different brokerage firms will have different rules regarding minimum deposits, but there are many that don’t require a minimum deposit. Again, it’ll depend on the specific firm.

Can I withdraw money from a brokerage account?

You can withdraw money from a brokerage account by transferring funds to a linked bank account, or by requesting a check or wire transfer. Keep in mind that any profits may be subject to capital gains tax, which may vary depending on how long you’ve held the assets among other factors.

Do you pay taxes on brokerage accounts?

The capital gains, dividends, and interest income earned in the account are all taxable, with long-term capital gains benefiting from lower tax rates compared to short-term gains. The specific tax rate depends on factors, such as how long you hold an asset and your overall income, so it’s best to consult with a tax professional for guidance.

About the author

Samuel Becker

Sam Becker is a freelance writer and journalist based near New York City. He is a native of the Pacific Northwest, and a graduate of Washington State University, and his work has appeared in and on Fortune, CNBC, Time, and more. Read full bio.

Article Sources

IRS. Topic no. 409, Capital gains and losses.
FDIC. Deposit Insurance.
SIPC. What SIPC Protects.
SEC. Understanding Margin Accounts.

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

SOIN-Q424-084

Dec

2025

The Black-Scholes Model, Explained

By Brian Nibley | Financial Independence, Growing Wealth, invest, Investing | Comments Off

Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.

Table of Contents

What Is the Black-Scholes Model?
The History of the Black-Scholes Model
What Does the Black-Scholes Model Tell?
The Black-Scholes Formula
Why Is the Black-Scholes Model Important?
How Accurate Is the Black-Scholes Model?
FAQ

The Black-Scholes option pricing model is a mathematical formula used to calculate the theoretical price of an option. It’s a commonly-used formula for determining the price of contracts, and as such, can be useful for investors in the options market to know.

But there are some important things to know about it, such as the fact that the model only applies to European-style options.

Key Points

• The Black-Scholes model is a mathematical formula used to calculate the theoretical price of an option.

• It is commonly used for pricing options contracts and helps investors determine the value of options they’re considering trading.

• The model takes into account factors like the option’s strike price, time until expiration, underlying stock price, interest rates, and volatility.

• The Black-Scholes model was created by Myron Scholes and Fischer Black in 1973 and is also known as the Black-Scholes-Merton model.

• While the model has some assumptions and limitations, it is considered an important tool for European options traders.

What Is the Black-Scholes Model?

As mentioned, the Black-Scholes model is one of the most commonly used formulas for pricing options contracts. The model, also known as the Black-Scholes formula, allows investors to estimate the value of options they’re considering trading.

The formula takes into account several important factors affecting options in an attempt to arrive at a theoretical price for the derivative. The Black-Scholes options pricing model only applies to European options.

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The History of the Black-Scholes Model

The Black-Scholes model gets its name from Myron Scholes and Fischer Black, who created the model in 1973. The model is sometimes called the Black-Scholes-Merton model, as Robert Merton also contributed to the model’s development. These three researchers were affiliated with the Massachusetts Institute of Technology (MIT) and University of Chicago.

The model functions as a differential equation that requires five inputs:

• The option’s strike price

• The amount of time until the option expires

• The price of its underlying stock

• Interest rates

• Volatility

Modern computing power has made it easier to use this formula and made it more popular among those interested in stock options trading.

The model is designed for European options, since American options allow contract holders to exercise at any time between the time of purchase and the expiration date. By contrast, European options may be priced differently and only allow the owner to exercise the option on the expiration date. So, while European options only offer a single opportunity to exercise, American option traders may choose any of the days up until and on expiration to exercise the option.

What Does the Black-Scholes Model Tell?

The main goal of the Black-Scholes model is to estimate the theoretical price of a European-style contract, giving options traders a benchmark to compare against market prices. To this end, the model goes deeper than simply looking at the fact that the price of a call option may increase when its underlying stock price rises and incorporates the impact of stock volatility.

The model looks at several variables, each of which may impact the value of that option. Greater volatility, for example, could increase the option’s theoretical value since it may have a higher chance of seeing larger price moves. Similarly, more time to expiration may increase the model’s estimate of the option ending in the money, and may lower the present value of the exercise price. Interest rates also influence the price of the option, as higher rates can make the option more expensive by decreasing the present value of the exercise price.

The Black-Scholes Formula

The Black-Scholes formula estimates the theoretical value of a call option or put option using inputs such as current stock price, time to expiration, volatility, and interest rates. It expresses the value of a call option by taking the current stock prices multiplied by a probability factor (d1) and subtracting the discounted exercise payment times a second probability factor (d2).

Explaining in exact detail what d1 and d2 represent can be complex. They are part of the mathematical process used to estimate option prices in the market, and are often debated.

💡 Quick Tip: If you’re an experienced investor and bullish about a stock, buying call options (rather than the stock itself) can allow you to take the same position, with less cash outlay. It is possible to lose money trading options, if the price moves against you.

Why Is the Black-Scholes Model Important?

The Black-Scholes option pricing model is so impactful that it once won the Nobel Prize in economics. Some consider it a foundational idea in financial history.

Some traders use the Black-Scholes model to estimate theoretical values of European options. Since its creation, many scholars have elaborated on and improved this formula. The model is widely recognized as a landmark in mathematical finance.

Some analysts argue that the model has contributed to greater pricing efficiency of options and stock markets. While designed for European options, the Black-Scholes model can still offer insights into how theoretical option values respond to changes in core pricing factors, which may help inform investors’ overall options trading strategies.

Some traders use the model hedge against portfolio risk, which they believe may improve overall market efficiency. However, others assert that the model has increased volatility in the markets, as more investors constantly try to fine tune their trades according to the formula.

How Accurate Is the Black-Scholes Model?

Some studies have shown the Black-Scholes model to be effective at estimating theoretical options prices. This doesn’t mean the formula has no flaws, however.

The model tends to underestimate the value of deep in-the-money calls and overestimate calls that are deeply out of the money.

That means the model might assign an artificially low value to options that are significantly in the money, while it may overvalue options that are significantly out of the money. Options tied to stocks yielding a high dividend may also get mispriced by the model.

Recommended: How Do Dividends Work?

Assumptions of the Black-Scholes Model

There are also a few assumptions made by the model that can limit its real-world accuracy. Some of these include:

• The assumption that volatility and the risk-free rate remain constant over the option’s life

• The assumption that stock prices move continuously and without sudden jumps

• The assumption that a stock doesn’t pay dividends during the option’s life

Such assumptions are necessary to simplify the model, even though they may negatively impact results. Relying on assumptions makes the model mathematically tractable, as only so many variables can reasonably be calculated.

Over the years, quantitative researchers have expanded on the original models to address limitations introduced by its assumptions.

This leads to another flaw of the Black-Scholes model: unlike other inputs in the model, volatility must be an estimate rather than an objective fact. Interest rates and the amount of time left until the option expires are concrete numbers, while volatility has no fixed numerical value.

The best a financial analyst can do is estimate volatility using something like the formula for variance. Variance is a measurement of the variability of an asset, or how much its price changes from time to time. One common measurement of volatility is the standard deviation, which is calculated as the square root of variance.

Test your understanding of what you just read.

The Takeaway

The Black-Scholes option-pricing model is among the most influential mathematical formulas in modern financial history, and it may be one of the most accurate ways to determine the theoretical value of a European call option. It’s a complicated formula that has some drawbacks that traders should be aware of, but it’s a useful tool for European options traders.

Given the Black-Scholes model’s complexity, it’s likely that many investors may never apply it directly in their trading decisions. That doesn’t mean it isn’t important to know or understand, of course, but many investors may not get much practical use out of it unless they delve deeper into options trading.

SoFi’s options trading platform offers qualified investors the flexibility to pursue income generation, manage risk, and use advanced trading strategies. Investors may buy put and call options or sell covered calls and cash-secured puts to speculate on the price movements of stocks, all through a simple, intuitive interface.

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FAQ

What is an example of the Black-Scholes method?

An example would be using the Black-Scholes formula to estimate the theoretical value of a European call option on a stock trading at $100, with a $105 strike price, 30 days to expiration, 20% volatility, and a 5% risk-free rate. The model would help determine the option’s theoretical worth under these conditions.

What is the 5 step method of Black-Scholes?

The five steps typically include: identifying the input values (stock price, strike price, time to expiration, volatility, and risk-free rate), calculating d1 and d2 (which are probability factors), finding the cumulative normal distribution values of d1 and d2, plugging the values into the Black-Scholes formula, and interpreting the result as the option’s theoretical price.

Is Black-Scholes still used?

Yes, the Black-Scholes model remains widely used as a foundational pricing tool for European options. Many traders and financial institutions still use it, though modifications or alternative models may be applied in complex or non-standard scenarios.

Why are Black-Scholes so important?

The Black-Scholes model helped transform how options are priced by offering a standardized, mathematically grounded method. Some argue that it has helped to improve market efficiency and risk management and pave the way for the modern derivatives market.

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

SOIN-Q325-076

How to Convert a Traditional 401(k) to a Roth IRA

What Happens When You Convert a 401(k) to a Roth IRA?

Steps to Converting a 401(k) to a Roth IRA

1. Open a new Roth IRA account.

2. Decide whether you want the rollover to be a direct transfer or indirect transfer.

3. Contact the company that currently holds your current 401(k) and request a transfer.

4. Keep an eye out to make sure the transfer happens.

Get a 1% IRA match on rollovers and contributions.

Double down on your retirement goals with a 1% match on every dollar you roll over and contribute to a SoFi IRA.1

Considerations Before Rolling a 401(k) to a Roth IRA

Roth IRA Contribution Limits

Income Limits for Roth IRA Eligibility

Rollover Amount Will be Taxed

A Roth IRA is Subject to the Five-Year Rule

Penalties for Early Withdrawals

Should You Convert Your 401(k) to a Roth IRA ?

Can You Reduce the Tax Impact?

The Takeaway

FAQ

Can I roll over my 401(k) to an existing Roth IRA?

Can I roll my 401(k) into a Roth IRA without penalty?

How much does it cost to roll over 401k to Roth IRA?

Is there a time limit when rolling over a 401(k) to a Roth IRA?

Is there a limit on rollover amounts to a Roth IRA?

How do you report a 401(k) rollover to a Roth IRA?

Can you roll over partial 401(k) funds to Roth IRA?

10 Top Monthly Dividend Stocks for December 2025

Top 10 Monthly Dividend Stocks by Yield

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.

What Are Monthly Dividend Stocks?

How Does Dividend Investing Work?

Understanding Dividend Yield

Types of Monthly Dividend Stocks

Energy and Utility Companies

ETFs

REITs

Ways to Evaluate Monthly Dividend Stocks

Dividend Payout Ratio

Company Stability

Tax Implications

Pros and Cons of Investing in Monthly Dividend Stocks

Pros

Cons

Things to Avoid When Investing in Monthly Dividend Stocks

The Takeaway

FAQ

How do monthly dividend stocks work?

How can you get stocks that pay monthly dividends?

How can you determine the stocks that pay the highest monthly dividends?

Understanding a Taxable Brokerage Account vs an IRA

What Are Taxable Brokerage Accounts?

Get a 1% IRA match on rollovers and contributions.

Double down on your retirement goals with a 1% match on every dollar you roll over and contribute to a SoFi IRA.1

What Is an IRA?

Taxable Brokerage Accounts vs IRA Accounts

Traditional IRAs vs Taxable Brokerage Accounts

Roth IRAs vs Taxable Brokerage Accounts

401(k)s vs Taxable Brokerage Accounts

Tax Advantages of an IRA vs Taxable Brokerage Account

Which Type of Account Is Best for Me?

Think About Investing in a Traditional IRA If…

Think About Investing in a Roth IRA If…

Think About Investing in a 401(k) If…

Think About Investing in a Taxable Brokerage Account If…

Pros and Cons of Taxable Brokerage Accounts

Pros of Taxable Accounts

Cons of Taxable Accounts

Is it Smart to Have Both an IRA and a Taxable Brokerage Account?

The Takeaway

FAQ

What is the difference between an IRA and a taxable brokerage account?

Is it better to contribute to an IRA or a taxable brokerage account?

How is a taxable brokerage account taxed?

Brokerage Accounts 101: Types & Benefits Explained

What Is a Brokerage Account?

What Is a Brokerage Account Used For?

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.

How Are Brokerage Accounts Different From Bank Accounts?

Double down on your retirement goals with a 1% match on every dollar you roll over and contribute to a SoFi IRA.¹

Double down on your retirement goals with a 1% match on every dollar you roll over and contribute to a SoFi IRA.¹

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