Jan
19
2024

What is a Roth 401(k)?

By | Growing Wealth, invest, Investing, Life & Career, Preparing for Retirement | Comments Off on What is a Roth 401(k)?

A Roth 401(k) is a type of retirement plan that may be offered by your employer. You contribute money from your paychecks directly to a Roth 401(k) to help save for retirement.

A Roth 401(k) is somewhat similar to a traditional 401(k), but the potential tax benefits are different.

Here’s what you need to know about a Roth 401(k) to help answer the question of what is a Roth 401(k)?, and to decide if it may be the right type of retirement account for you.

Roth 401(k) Definition

What is a Roth 401(k)? The plan combines some of the features of a traditional 401(k) and a Roth IRA.

Like a traditional 401(k), a Roth 401(k) is an employer-sponsored retirement account. Your employer may offer to match some of your Roth 401(k) contributions.

Like a Roth IRA, contributions to a Roth 401(k) are made using after-tax dollars, which means income tax is paid upfront on the money you contribute.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

How a Roth 401(k) Works

Contributions to a Roth 401(k) are typically made directly and automatically from your paycheck. Your employer may match your Roth 401(k) contributions up to a certain amount or percentage, depending on the employer and the plan.

Your contributions to a Roth 401(k) are taxed at the time you contribute them, and you pay income taxes on them. In general, your money grows in the account tax-free and withdrawals in retirement are also tax-free, as long as the account has been open at least five years.

Differences Between a Roth 401(k) and a Traditional 401(k)

While a Roth 401(k) shares some similarities to a traditional 401(k), there are some differences between the two plans that you should be aware of. Here is how a Roth 401(k) differs from a traditional 401(k):

•   Contributions to a Roth 401(k) are made with after-tax dollars and you pay taxes on them upfront. With a traditional 401(k), your contributions are made with pre-tax dollars, and you pay taxes on them later.

•   With a Roth 401(k), your take-home pay is a little less because you’re paying taxes on your contributions now. That typically lowers your tax bill for the year. With a traditional 401(k), your contributions are taken before taxes.

•   Your money generally grows tax-free in a Roth 401(k). And in retirement, you withdraw it tax-free, as long as the account is at least five years old and you are at least 59 ½. With a traditional 401(k), you pay taxes on your withdrawals in retirement at your ordinary income tax rate.

•   You can start withdrawing your Roth 401(k) money at age 59 ½ without penalty or taxes. However, you must have had the account for at least five years. With a traditional 401(k), you can withdraw your money at age 59 ½. There is no 5-year rule for a traditional 401(k).

Roth 401(k) Contribution Limits

A Roth 401(k) and a traditional 401(k) share the same contribution limits. Both plans allow for the same catch-up contributions for those 50 and older.

Here are the contribution limits for each type of plan.

Roth 401(k) Traditional 401(k)
2023 Contribution Limit $22,500 $22,500
2023 Contribution Limit for individuals 50 and older $30,000 $30,000
2024 Contribution Limit $23,000 $23,000
2024 Contribution Limit for individuals 50 and older $30,500 $30,500
2023 Contribution Limit on employer and employee contributions combined $66,000
($73,500 for individuals 50 and older)		 $66,000
($73,500 for individuals 50 and older)
2024 Contribution Limit on employer and employee contributions combined $69,000
($76,500 for individuals 50 and older)		 $69,000
($76,500 for individuals 50 and older)

Roth 401(k) Withdrawal Rules

When it comes to withdrawal rules, a Roth 401(k) is subject to the 5-year rule. Under this rule, an individual can start taking tax-free and penalty-free withdrawals from a Roth 401(k) at age 59 ½ only once they’ve had the account for at least five years.

This means that if you open a Roth 401(k) at age 56, you can’t take tax- or penalty-free withdrawals of your earnings at age 59 ½ the way you can with a traditional 401(k). Instead, you’d have to wait until age 61, when your Roth 401(k) is five years old.

Early Withdrawal Rules

It’s possible to take early withdrawals — meaning withdrawals taken before age 59 ½ or from an account that’s less than five years old — from a Roth 401(k), but it’s complicated. Early withdrawals are subject to taxes and a 10% penalty.

However, you may not owe taxes and penalties on the entire amount. Here’s how it typically works: You can withdraw as much as you’ve contributed to a Roth 401(k) without paying taxes or penalties because your contributions were made with after-tax dollars. In other words, you’ve already paid taxes on them. Any earnings you withdraw, though, are subject to taxes and penalties, and you’ll owe tax proportional to your earnings.

For example, if you have $150,000 in a Roth 401(k) and $130,000 of that amount is contributions and $20,000 is earnings, those $20,0000 in earnings are taxable gains, and they represent 13.3% of the account. Therefore, if you took an early withdrawal of $30,000, you would owe taxes on 13.3% of the amount to account for the gains, which is $3,990.


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

Roth 401(k) RMDs

Previously, individuals with a Roth 401(k) had to take required minimum distributions (RMDs) starting at age 73. However, in 2024, as a stipulation of the SECURE 2.0 Act, RMDs will be eliminated for Roth accounts in employer retirement plans.

By comparison, traditional 401(k)s still require you to take RMDs starting at age 73.

Pros and Cons of a Roth 401(k)

A Roth 401(k) has advantages, but there are drawbacks to the plan as well. Here are some pros and cons to consider:

Pros

You can make tax-free withdrawals in retirement with a Roth 401(k).
This can be an advantage if you expect to be in a higher tax bracket when you retire, since you’ll pay taxes on your Roth 401(k) contributions upfront when you’re in a lower tax bracket. Your money grows tax-free in the account.

Your current taxable income is reduced when you have a Roth 401(k).
Because Roth 401(k) contributions are made after taxes, your paycheck will typically be reduced. That lowers your tax bill for the year.

There are no longer RMDs for a Roth 401(k).
Because of the SECURE 2.0 Act, required minimum distributions will no longer be required for Roth 401(k)s as of 2024. With a traditional 401(k), you must take RMDs starting at age 73.

Early withdrawals of contributions in a Roth 401(k) are not taxed.
Because you’ve already paid taxes on your contributions, you can withdraw those contributions early without paying a penalty or taxes. However, if you withdraw earnings before age 59 ½, you will be subject to taxes on them.

Cons

Your Roth 401(k) account must be open for at least five years for penalty-free withdrawals.
Otherwise you may be subject to taxes and a 10% penalty on any earnings you withdraw if the account is less than five years old. This is something to consider if you are an older investor.

A Roth 401(k) will reduce your paycheck now.
Your take home pay will be smaller because you pay taxes on your contributions to a Roth 401(k) upfront. This could be problematic if you have many financial obligations or you’re struggling to pay your bills.

Is a Roth 401(k) Right for You?

If you expect to be in a higher tax bracket when you retire, a Roth 401(k) may be right for you. It might make sense to pay taxes on the account now, while you are making less money and in a lower tax bracket.

However, if you expect to be in a lower tax bracket in retirement, a traditional 401(k) might be a better choice since you’ll pay the taxes on withdrawals in retirement.

Your age can play a role as well. A Roth 401(k) might make sense for a younger investor, since they are likely to be earning less now than they may be later in their careers. That’s something to keep in mind as you choose a retirement plan to help reach your future financial goals.

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).

FAQ

How is a Roth 401(k) taken out of a paycheck?

Contributions to a Roth 401(k) are automatically deducted from your paycheck. Because contributions are made with after-tax dollars, meaning you pay taxes on them upfront, your paycheck will be lower.

What is the 5-year rule for a Roth 401(k)?

According to the 5-year rule for a Roth 401(k), the account must have been open for at least five years in order for an investor to take withdrawals of their Roth 401(k) earnings at age 59 ½ without being subject to taxes and a 10% penalty.

What happens to a Roth 401(k) when you quit?

When you quit a job, you can either keep your Roth 401(k) with your former employer, transfer it to a new Roth 401(k) with your new employer, or roll it over into a Roth IRA.

There are some factors to consider when choosing which option to take. For instance, if you leave the plan with your former employer, you can no longer contribute to it. If you are able to transfer your Roth 401(k) to a plan offered by your new employer, your money will be folded into the new plan and you will choose from the investment options offered by that plan. If you roll over your Roth 401(k) into a Roth IRA, you will be in charge of choosing and making investments with your money.

Do I need to report a Roth 401(k) on my taxes?

Because your contributions to a Roth 401(k) are made with after tax dollars and aren’t considered tax deductible, you generally don’t need to report them on your taxes. And when you take qualified distributions from a Roth 401(k) they are not considered taxable income and do not need to be reported on your taxes. However, it’s best to consult with a tax professional about your particular situation.

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.

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

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

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.

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Jan
18
2024
man on laptop and phone mobile

How to Fund an IRA

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

Saving for retirement is important. But it can be challenging to put away money for the future when you have a lot of right-now financial commitments to take care of. Almost half of all American households report they have no retirement account savings, according to the Federal Reserve’s latest Survey of Consumer Finances.

However, it’s better to start with a small amount of savings than not to save at all. And the sooner you begin, the more time your savings will have to grow. One way to help kickstart retirement savings is with an IRA, a type of account designed specifically to help you save for retirement.

If you’re wondering how to fund an IRA, read on to find out about some potential methods that could help you contribute to an IRA.

Before You Start, Know Your Contribution Limits

First things first, it’s important to be aware that IRAs have contribution limits set by the IRS, and those limits often change annually. In 2024, you can contribute up to $7,000 in an IRA, or up to $8,000 if you’re 50 or older.

IRAs also come with potential tax benefits, which vary depending on the type of IRA you have. With a traditional IRA, contributions may be tax-deductible. For instance, if you and your spouse don’t have access to an employer-sponsored retirement plan, you can deduct the full amount contributed to a traditional IRA on your tax return in the year you make the contribution, regardless of your income.

And, even if you or your spouse is covered by an employer-sponsored retirement plan, the IRS still allows you to deduct a portion of your contribution.

With a Roth IRA, the contributions are made with after-tax money, which means they are not tax deductible. You can only fund a Roth IRA in years when your income falls below a certain limit.

In 2024, if you’re married and filing jointly, you can contribute the full amount to your Roth IRA if your modified adjusted gross income (MAGI) is less than $230,000. If your MAGI is between $230,000 and $240,000, you can contribute a reduced amount, and your income is over $240,000, you can’t contribute to a Roth. Those who are single can contribute the full amount if their MAGI is below $146,000, or a reduced amount if it’s between $146,000 and $161,000. They cannot contribute at all if their MAGI is more than $161,000.

💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

6 Ways You Can Fund an IRA

After you decide which type of IRA is right for you, your next step is to contribute to it. Here are some suggestions for how to fund an IRA.

1. Use Your Tax Refund

If you expect to get a tax refund, consider using that money to open an IRA, or to contribute to your IRA if you already have one. If you don’t want to contribute the entire refund, you could contribute a portion of it. Minimum amounts to open an IRA vary by institution, so do a bit of research to find the right account for the amount of money you currently have.

2. Take Advantage of Tax Deductions

You may be able to get a bigger tax refund next year by deducting your contributions to a traditional IRA this year, as long as you are eligible for the deduction. You can then use the bigger refund to fund your IRA next year.

3. Contribute “New” Money

If you get a raise or a bonus at work, or if a relative gives you money for your birthday, consider contributing all or part of it to your IRA. Just be sure to stay below the annual IRA contribution limit throughout the course of the year.

4. Make Small Monthly Contributions

You can contribute to your IRA throughout the year so if you open an account with, say, $100 (as mentioned earlier, how much you need to open an IRA depends on the institution), you can then make a monthly contribution to the account. Even if you put only $50 a month into the account, by the end of the year you would have $600. Increase that monthly contribution to $100, and you’re up to $1,200.

5. Set Up Automatic Contributions

Automating your contributions will allow you to save for retirement without thinking about it. You can even set up your automatic contribution so that it comes out of your bank account on payday. That can make it easier to put away funds for retirement. After all, you won’t be tempted to spend money that you don’t actually see in your bank account.

6. Roll Over Your 401(k) When You Leave a Job

When you change jobs, you generally have three options for your old 401(k). You could leave it with your old employer, roll it over to your new 401(k) if that’s available to you, or rollover your 401(k) into an IRA account.

You may want to review the fees associated with your 401(k) in order to understand what you are paying by leaving it with your old plan or rolling it over into your new 401(k).

Possible benefits of rolling your old 401(k) over to an IRA may be things like lower fees, expanding your choice of investment options, or a managed solution that invests your money for you based on your goals and risk tolerance.

The Takeaway

If you haven’t started saving for retirement, or if you haven’t been saving enough, it’s not too late to begin. No matter what stage of your life you’re in, you can create a plan to help you achieve your retirement goals, which could include contributing to an IRA.

You can fund an IRA by using your tax refund, making contributions automatic, or contributing a bonus, raise, or monetary gift you receive. No matter how you choose to contribute, or how much you contribute, the important thing is to get started with retirement saving to help make your future more secure.

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).

FAQ

How can I put money into my IRA?

There are many different ways to fund an IRA. For instance, if you get a tax refund, you could contribute that money to your IRA. You can also contribute funds from a bonus or raise you might get at work, or from birthday or holiday money from a relative. In addition, you can set up automatic contributions so that a certain amount of money goes directly from your bank account to your IRA on payday. That way, you won’t be tempted to spend it.

Can I contribute to an IRA on my own?

Yes. As long as you have earned income, you can open and fund a traditional or Roth IRA. This is true even if you have a 401(k) at work. There is a limit to the amount you can contribute to an IRA, however, which is $7,000 (or $8,000 if you are 50 or older) in 2024.

What is the best way to fund a traditional IRA?

One of the best ways to fund a traditional IRA is to use your tax refund. This is “found” money, rather than money you’re taking out of your bank account, so if you contribute it to your IRA you likely won’t even miss it. Also,consider this: By making a contribution to your traditional IRA, you may be able to deduct it from your taxes, which means you might get an even bigger refund next time around. And then you can use that bigger refund to fund your IRA next year.

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.

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.

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.

SOIN0124004

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Jan
09
2024
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What To do With an Inheritance: A Comprehensive Guide

By | Growing Wealth, Investing | No Comments

Getting an inheritance can usher in a wide range of emotions.

On one hand, you’ve just lost someone close to you, and that can be very difficult to process and deal with. On the other hand, inheritance money can change lives for the better. Who hasn’t dreamed of getting a chunk of change to put toward their financial dreams?

But receiving a sudden windfall can also be unexpectedly stressful. If you mismanage an inheritance, it could leave you back where you started financially, or even create new financial problems for you.

It’s crucial to think carefully about what to do with an inheritance, and to consider all your options before you act. From paying off debt to buying a home to investing the inheritance, there are many ways to use your inheritance that may help you get ahead financially.

Here are some ideas for what to do with an inheritance, including how to think about this new money and how to invest your inheritance in your financial goals.

First Steps After Receiving an Inheritance

If you receive an inheritance, first take a breath and just sit with the news for a bit. Don’t do anything rash or you might end up regretting it.

The Importance of Slowing Down

It’s wise to take it easy right now. You’ve just lost someone close to you and you are still dealing emotionally with that. Give yourself time to grieve before making any major decisions about what to do with an inheritance. In most cases, you don’t have to do anything about the inheritance immediately, so don’t feel pressured to act right away. Instead, take your time and be strategic.

For instance, you could put the money in a high-yield savings account for the time being. Then, when you’re ready, you can start mapping out a plan for the funds.

Paying Tribute: Honoring Their Legacy in Your Decisions

Your loved one worked hard to earn or accumulate the money you’ve inherited. Take some time to feel gratitude toward them and what they’ve done for you.

Think about how they might want you to spend the money. Would they want you to put it toward your retirement savings? Buy a house so you can finally stop renting? Keeping your loved one top of mind as you plan what to do with the money, might help give you purpose and hold you accountable so that you don’t spend the inheritance frivolously.

Building Your Support Team: Financial Advisors, Lawyers, and Accountants

Inheriting money can be confusing since you probably aren’t quite sure how the process works. And you may not know the best thing to do with the funds. That’s why having some support, such as estate lawyers, accountants, or financial advisors, might be wise, especially if you’re inheriting a large sum.

But be an active participant in the process. Ask these professionals for their input and suggestions and then carefully weigh the different options. You need to make the decisions that are best for you and your situation.


💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.

Managing a Cash Inheritance

Receiving a cash inheritance is a great reason to sit down and review your financial situation and assess your current needs and priorities. Looking at your financial statements — including your income, expenses, assets, and liabilities — might be the easiest way to start.

Taking some time to think about your short-term and long-term financial goals may help define your values and guide you as you determine the best course of action for saving and investing the money. How you ultimately invest an inheritance will depend on your financial goals.

Strategies for Small, Medium, and Large Sums

What you do with your inheritance may depend on how much you inherit. If it’s a small sum, you may want to put it toward a downpayment on a house, for example. Or you could use it to build up an emergency fund.

If you inherit a medium-size sum, you may want to earmark it for your children’s college education. Or you could put it toward your own retirement savings.

And finally, if you inherit a large sum, you may want to do several different things with the money. For instance, you may decide to invest a chunk of it for your future. And you might use another portion if it to pay off your mortgage or other debts you have. Perhaps you want to donate some to charity. You could even use some of the money to take the vacation you’ve always dreamed of.

Balancing Savings, Debt Repayment, and Investments

It could be wise to make several financial moves with your inheritance to help secure your future. That way you can balance your different priorities.

Some of the money could go into your emergency savings fund so that you have a robust financial cushion in case you need it.

Another portion might go toward paying off debt, such as credit card or student loan debt. This can help free up your cash flow and even help you save more money for your future.

And you could invest the rest for retirement. You can explore the different types of retirement accounts that you may be eligible for to find the right options for you.

Retirement, Education, and Emergency Fund Priorities

Saving and investing for retirement could be an excellent use of inheritance money. As mentioned above, the first step is determining which type of account to open.

Because inherited money is not earned income, you cannot put it directly into a retirement account like a traditional or Roth IRA. However, you could open a brokerage account and build an investment portfolio for retirement. You may want to consider stocks, mutual funds, exchange-traded funds (ETFs), or a mix of all three in your portfolio.

Another priority for your inheritance might be your children’s college education. You could consider using your inherited money to fund a college savings account or invest towards your child’s future educational costs.

This can be done through a 529 plan, a prepaid tuition plan, or a Coverdell education savings account. A 529 plan allows for tax-free investment growth when the money is used for higher education expenses.

Each state has its own 529 plan, but you’re not required to use the plan for the state for which you live. Some states may offer a state income tax deduction if you use their state’s plan, so check with the plan (or your tax advisor) to be sure.

Another way you may want to use inherited money is building up an emergency fund. Just like it sounds, an emergency fund is cash, typically held in a savings account, that’s available in the event of an emergency, such as a sudden, unexpected expense like a car accident or a root canal. Having the cash available to cover such an expense may help you avoid going into credit card or other debt in the future.

While it’s ultimately up to you to determine how much money to keep in an emergency fund, you may want to consider having the recommended three to six months’ worth of expenses in the bank. This amount may help cover you in the event you are laid off from your job and need time to find a new opportunity.

Investment Opportunities for Inherited Wealth

Once you’ve paid off any debts you owe and allocated money to an emergency fund and possibly to your children’s college funds, you may want to invest the rest for your future financial goals.

Diversifying Investments: Stocks, Bonds, and Funds

Building a diversified, balanced portfolio with investments that have different degrees of risk is one strategy to consider. Diversification may help mitigate risk, though it’s important to remember that there is still risk involved with investing. Some investments with different levels of risk to explore are stocks, bonds, and mutual funds. Stocks are considered more volatile — they may potentially offer higher growth but also have higher risk — while bonds typically have lower risk and smaller returns. Mutual funds typically include a mix of stocks and bonds.

Tax-Advantaged Accounts and Minimizing Tax Burden

Inheritances are not considered taxable income for federal taxes. However, any earnings on your inherited assets are generally taxable.

Some of the most popular types of accounts that may offer tax advantages include IRAs and 401(k)s. Inheritance money per se cannot be invested in these accounts (because it’s not earned income). However, the additional money you get from an inheritance might give you the flexibility to use your income to open an IRA or contribute more to your 401(k) at work.

Here’s how: If you use inheritance money to pay down debt or pay bills, such as your mortgage, you may be able to afford to invest more of your earned income in a retirement account. Because some of these accounts are tax deferred, including traditional IRAs and 401(k)s, they may also help reduce your tax burden.

Real Estate Investments: Pros, Cons, and Considerations

If you’re thinking about investing your inheritance in real estate, you might want to consider a real estate investment trust (REIT). A REIT is a company that owns or operates properties that generate income. With a REIT, you can invest in real estate properties without having to buy actual properties and manage them yourself.

But REITS do come with risks. For instance, REITs tend to be very sensitive to changes in interest rates. When rates rise, the value of a REIT can fall. Also, commercial properties can be affected by trends. For instance, if a REIT focuses on a type of store that suddenly becomes less popular with consumers, your investment could take a hit.


💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.

How to Handle Inherited Properties and Valuables

Part of your inheritance might include a house, a car, antiques, or jewelry. These can all be financially beneficial, depending on their value. But they can also pose challenges since you will need to decide what to do with them.

Decisions for an Inherited House: Sell, Rent, or Move In?

If you inherit a house, for instance, the big decision you’ll face is whether to move into it, rent it, or sell it.

Selling the house will provide you with a profit. You could then use that money to pay debt or invest for the future. There may also be a tax benefit. That’s because inherited homes have a step-up tax basis. That means you don’t pay taxes on the full amount of the home, but only on any amount it sold for that’s more than what the home was worth on the date your loved one died. So if the house was worth $300,000 at the time your relative died, and you sell it for $375,000, you only pay taxes on $75,000.

Just remember that you’ll have to empty out the house and get it ready to sell. You’ll also need to pay the utilities, mortgage, taxes, etc. until the house sells.

You can rent out the home instead, which could potentially give you steady rental income. However, you will need to manage the property and take care of maintenance and repairs. This could be tricky if you don’t live nearby. And even if you do, it can be time consuming. You’ll also need to figure out the tax implications of renting out the house, which may be complicated.

Finally, you may choose to move into the house. This might be a good option for you if you haven’t been able to afford buying a home of your own previously. Just remember that while you won’t have to pay a mortgage, you will have to pay such ongoing expenses as real estate taxes and homeowner’s insurance.

Inherited Vehicles and Heirlooms: Assessing Value and Sentiment

If you inherit a vehicle like a car, you’ll need to decide whether to keep it or sell it. Your decision will likely depend on the age of the vehicle and the shape it’s in. It will also hinge on whether you need or want a new car. You might be perfectly happy with your own current vehicle. In that case, you could sell the inherited car and make a profit from it.

Deciding what to do with inherited items that have sentimental value as well as monetary value — such as jewelry, antiques, or a relative’s prized collection — can be more difficult. You may feel an attachment to these items. Wait a bit before making a decision about them and give yourself time to think through the best course of action. For instance, you might want to hold onto a few items that have special meaning to you and sell the rest. Or perhaps you’ll decide you’re not ready to part with them and you’ll keep them all. Do what feels right to you.

Tax Implications of an Inheritance

There are two types of taxes related to an inheritance: estate taxes and inheritance taxes.

Estate and Inheritance Taxes: What You Need to Know

The federal government does not impose an inheritance tax. That means you won’t have to pay federal taxes on your inheritance. But keep in mind that any earnings you make from your inheritance are subject to taxes.

Some states have inheritance taxes that you may need to pay. To find out if your state is one of them, check with the state department of taxation. You might also want to consult a tax professional.

Estate taxes are a different matter. These taxes are not levied against you, the person inheriting money. Instead, they are levied against the estate of the deceased person. However, unless the estate is extremely large ($12.92 million or more in 2023, and $13.61 in 2024), the estate won’t have to pay federal estate taxes.

Capital Gains Tax: How It Affects Your Inherited Assets

Capital gains taxes are something you typically pay when you sell inheritance assets and make money on them. Thanks to what’s known as a step-up in basis, the value of the item you inherit is adjusted to its value on the date of your loved one’s death.

For example, if you inherit a house your mother bought for $100,000 and the house is worth $500,000 on her date of death, the value of the house is adjusted to $500,000. If you sell the house for that amount, there are no capital gains. If you sell the house for more than $500,000 you pay capital gains on anything over that amount.

In addition to real estate, this rule also generally applies to other things you inherit, such as stocks, mutual funds, bonds, and collectibles.

Capital gains taxes can be quite complicated, so you may want to consult a tax professional to make sure you report and pay these taxes properly.

Leveraging Professional Financial Advice

Dealing with an inheritance and all it involves can be overwhelming. A trusted advisor could help you decide what to do with the money in order to make the most of it.

Choosing the Right Advisor for Your Inheritance Needs

You may want to begin your search for an advisor with the person or people associated with the estate before it was passed along, such as the estate’s executor or a trustee.

That said, you’ll want to be certain that this person is a “fiduciary,” which means that they always act in your best financial interest.

Another option is to directly hire a financial advisor. When choosing a financial advisor, you can start by asking family, friends, and colleagues for recommendations. You can also consult industry associations such as the National Association of Personal Financial Advisors or the Financial Planning Association

The Role of Financial Planning in Estate Inheritance

A financial planner can help you create a financial plan for your inheritance based on your financial goals and your current situation.

A good financial plan can help you make the most of your money. It can allocate money to help you pay down debt and to create an emergency fund. It can also help you manage your inheritance assets. For instance, you might choose to put some of the money in investments to help reach future financial goals such as buying a house or saving for retirement.

Inheriting money requires careful decision making. That’s why having a solid financial plan in place can be so useful. It can help you stay on track to meet your goals.

Avoiding Common Mistakes with Inherited Wealth

When you receive an inheritance, it’s wise to take some time to decide the best course of action to take. This can help prevent you from doing something you may regret later. These are some common mistakes to avoid:

Failing to put together a solid financial plan. A good plan lays out your financial goals and priorities. It can help you pay off debt now and save money for your future. Without such a plan, you might end up frittering away a chunk of your inheritance before you realize it.

Making emotional decisions. Dealing with the loss of a loved one is difficult, and emotions could cloud your judgment about what to do with your inheritance. Don’t make rash decisions. Instead, put the money someplace safe for the time being, like a high-yield savings account, and give yourself time to grieve before making major decisions.

Spending too much. You may be tempted to use your windfall to purchase a boat or buy a luxury car. While these purchases are fun, they won’t help you in the long-term the way paying off debt or saving for your retirement will. Plus, cars and boats require ongoing maintenance — and even storage in the case of the boat — that you’ll need to keep paying for.

If you’re not careful, you could end up burning through your entire inheritance and not have a lot to show for it. Instead, create a financial plan as outlined above. In your plan you can set aside a small part of your inheritance for fun spending. For instance, maybe you dedicate 5% or 10% of the amount you inherited to taking that trip to Italy you’ve always dreamed of. That way you’ll be able to enjoy some of the money now and save and invest the rest for the future.

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.

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.

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

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

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.

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09
2024
Complete Guide to Investing in Foreign Currency

The Essential Guide to Investing in Foreign Currency

By | Growing Wealth, invest, Investing | Comments Off on The Essential Guide to Investing in Foreign Currency

Investing in foreign currency involves purchasing money, or currency, in another country. The market for foreign currency investing is the largest and most liquid in the world. There are some differences between investing in foreign currency and investing in stocks or bonds, though, that investors should be aware of.

Further, foreign currency investing can be somewhat confusing to new investors, and it also entails its own unique risks. For that reason, it can be beneficial to learn the basics before folding it into an investment strategy.

Understanding Foreign Currency Investment

As noted, investing in foreign currency means purchasing another country’s currency, or money, as a means of investment. You’re not planning on spending it, in other words, and are hoping that it accrues value to generate a return. It’s also different from exchanging foreign currency, though it may feel similar.

Foreign currency investment is often, or typically done via “forex” trading. Forex is short for “foreign exchange market,” and refers to trading fiat currencies, or those that are backed by the government that uses them. For example, an investor could trade their United States dollars (USD) for Euros. Or, they can trade their Japanese yen for New Zealand dollars.

Key Takeaways for New Investors

Forex trades can happen at any time throughout the day, since there’s always a foreign currency market open somewhere in the world. Foreign currency investors are typically institutional investors, although it is possible for individual investors to participate.

Investors should also know that currencies tend to trade in pairs — more on that below.

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Start trading funds that include commodities, private credit, real estate, venture capital, and more.

Exploring the Benefits of Investing in Foreign Currencies

Like other types of investments, forex trading, or investing in foreign currencies, can offer up some benefits.

Diversification of Portfolio

For one, investing in foreign currencies can add a degree of diversification to an investor’s portfolio. That means that while an investor may have built a portfolio with a number of other investments, such as stocks, bonds, and ETFs, foreign currency can be another element in the mix. Note, though, that it’s likely foreign currency should only comprise a small portion of a portfolio’s overall holdings.

Convenience and Accessible Markets

The forex markets operate 24 hours per day, 365 days per year, unlike the standard stock exchanges. So, for investors who want to trade around the clock, the markets are almost always accessible.

There are four major forex trading sessions in a 24-hour period, split up by international region:

•   Sydney (Australia)

•   Tokyo (Asia)

•   London (Europe)

•   New York (The Americas)

There are minor sessions, too, but these are the four major sessions, and markets can be busy (when the Americas’ session overlaps with Europe’s), or less busy, depending on the time of day, and how many people are actively trading.

Hedge Against Domestic Currency Inflation

It’s possible that while a domestic currency is losing value due to inflation, foreign currencies could retain their value at the same time. That would, theoretically, provide investors with a hedge against inflation — but there’s no guarantee prevailing market forces would work to an investor’s advantage in such a scenario.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

Ways to Invest in Foreign Currencies

Foreign currency investment doesn’t typically involve using physical money, so you’ll have to find something else to do with the foreign currency left over from your last international vacation. There are several ways to get started in currency exchange investment.

1. Standard Forex Trading Account

First, you can work with a foreign exchange brokerage to trade the currency you’re holding (such as U.S. dollars) for another currency (Euros, Yen, etc.). The goal is that the currency you’re trading for, or buying, will increase in value relative to the currency you’re trading away, or selling.

So, if you buy, or trade U.S. dollars for Euros, you’re hoping that in the future, you’d be able to trade the Euros back for more U.S. dollars than you originally used to make the purchase. You’re looking to make a profit, in other words.

While the goal is straightforward, the process can get more complicated. For instance, there are a few ways traders can execute trades, such as spot trading, forward trading, and future trading. Spot trading is an instant trade, whereas forward and future trading may involve settling on terms at a time in the future (similar to trading options).

Further, investors should understand the concept of the spread, which represents the difference between a trader’s cost and the dealer’s profits.

Beyond that, investors should also have a working knowledge of currency pairs, which is how much of the forex market trades. More on that below.

2. Currency CDs and Savings Accounts

Investors can also look into foreign currency CDs (certificates of deposit), which work more or less like traditional CDs but might offer higher yields. Foreign savings accounts are another potential option, and can serve as investment vehicles by accruing interest and currency appreciation, though nothing is guaranteed.

3. Foreign Bond Funds

Investors can look at the possibility of purchasing foreign bonds, which are issued in other countries by foreign governments or foreign companies. There are many types of foreign bond investment types, so investors would do well to do a bit of research to figure out if it’d be a good addition to their portfolio.

4. Currency ETFs

As mentioned, investors may want to look at currency ETFs. These ETFs are similar to foreign bond funds, there are also foreign currency ETFs on the market, which offer many of the same advantages of domestic or traditional ETFs, but can give investors exposure to the forex market. Likewise, exchange-traded notes, or ETNs, which are similar to bonds, are another potential investment investors can check out.

💡 Looking for other alternatives to invest in? Check out: 10 Types of Alternative Investments

The Risks Associated with Foreign Currency Investment

Foreign currency investment isn’t without risk, and in fact, can introduce some types of risk that investors may not otherwise encounter — such as political and interest rate risks.

Market Volatility and Political Risks

Since forex markets are so active, prices can change quickly, which means it’s a fairly volatile asset class. The news cycle (including economic, political, or social news) can cause sudden and drastic changes to prices. That means it may be a better fit for investors with a relatively high risk tolerance than those who are more risk averse.

Political risk is something to consider, too, as currencies are backed by governments. If a foreign government is unstable or otherwise involved in some sort of political drama, it can affect the price of a currency. That can pose a risk to investors.

Interest Rate Risk

Some investments incur interest rate risk, which is when an investment loses value due to a fluctuation in interest rates. Foreign currencies may be subject to such risk, though interest rate risk is more commonly associated with bonds.

Currency Conversion and Transfer Costs

There may also be additional costs associated with currency trading and investing, including currency conversion and transfer costs. These may not always be applicable, but are something that investors should at least be aware of in the event that they do encounter them.

💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

How to Approach Foreign Currency Safely

In order to invest in foreign currency investing as safely as possible — remember, no investment is completely safe or risk-free — investors should brush up on the mechanics of the forex market, and know what they’re getting into.

Education is Key: Understanding the Mechanics of Currency Investment

A couple of things investors should also know about are “pips,” and the use of leverage in forex trading.

A “pip” is a unit of measure that represents the smallest unit of value in a currency quote. Using the above quote as an example, the difference between the “bid” (1.2100) and the “ask” (1.2104) is four pips.

Why does this matter? Because currency values fluctuate very slightly during the trading day, perhaps only several pips. That means that to make a significant return, traders deal with large quantities of currencies.

And as for leverage? To get to those large quantities, traders often use leverage. For example, you may give your broker $100 to trade with $10,000 on the markets (using, or borrowing the broker’s $9,900 to make trades is called “margin”). Most forex trading is done this way, using leverage and margin in order to generate returns.

That, of course, has its risks, since traders may incur losses, and end up owing money to their brokers. For beginners, it may be best to use lower margins for that very reason.

The Importance of a Bid-Ask Spread

Also noted previously, the bid-ask spread is another important concept to know and incorporate if you’re trading or investing in foreign currency. Effectively, the spread refers to the difference between a trader’s cost and the dealer’s profits. There’s a slight difference in what you’re willing to pay, and what a seller is willing to sell for. In forex trading, the spread can be important to calculating overall potential returns.

Evaluating Risks Versus Rewards

Above all, it’s critical that investors keep their own personal risk tolerances in mind, and weigh that against the potential gains they could see from foreign currency investing. It may not be a good fit for everyone’s investment strategy.

Currency Investment Strategies for Beginners

Forex trading is different from other types of investing or trading. Generally, investing in or trading foreign currency involves pairs of currencies. That’s because two different currencies are quoted based on their relative value to each other. On an exchange, that may appear as “USD/EUR,” or something similar, while a pairing of Japanese yen and Euros, it may be represented as such: “JPY/EUR.”

Some currencies are more widely traded than others and are “paired” with one another or grouped as “major” currencies:

•   U.S. dollars

•   Euros

•   Japanese yen

•   British pounds

•   Swiss francs

•   Australian dollars

•   Canadian dollars

•   New Zealand dollars

There are also “minor” and “exotic” currency pairs. These are not traded as widely as the majors, but are still often swapped on exchanges. They may include pairings with the Hong Kong dollar, the Mexican peso, the Singapore dollar, or the Norwegian krone, among others.

Additionally, investors should know about foreign currency quotes. These quotes are similar to stock quotes, which list the current value, or price of a stock. Forex quotes display the bid and ask prices for a currency pair, since one currency’s value is relative to another currency. Here’s an example of a quote for a common pairing, Euros and U.S. dollars:

EUR/USD = 1.2100

In this example, Euros are the “base” currency, and U.S. dollars are the “quote” currency. What does the quote say, exactly? That a single Euro is equal to 1.21 U.S. dollars. Or, €1 = $1.21.

So, in terms of a basic trading strategy for a beginner? It may be best to choose a pair and stick to it — at least for a while, until you get the gist of it. After that, you can look at other, more in-depth trading strategies.

Broadening Your Investment Horizon With Currency ETFs

As mentioned, investors may want to look at currency ETFs. These ETFs are similar to foreign bond funds, there are also foreign currency ETFs on the market, which offer many of the same advantages of domestic or traditional ETFs, but can give investors exposure to the forex market. Likewise, exchange-traded notes, or ETNs, which are similar to bonds, are another potential investment investors can check out.

Advanced Currency Investment Options

While investors can trade currency itself, they can also look at more advanced ways of investing in the forex markets. That can include trading futures and options, or other types of relevant derivatives.

Foreign Currency Futures and Options — An Introduction

First and foremost, investors should be aware of the unique risks that financial derivatives can introduce into their portfolios. Trading options contracts is a whole different beast from choosing stocks, so before you dive headfirst into forex options, it may be worth it to speak to a financial professional.

But at their core, currency options are derivatives, with currency itself as their underlying asset. There are calls, puts, and futures — if you’re not familiar with traditional options, it may be a good idea to review the basics before looking at forex options.

In effect, though, these options allow investors to hedge against unfavorable fluctuations of foreign currencies, or to speculate on volatility in the forex market. Again, it’s fairly high-level stuff, so if you feel like it’s over your head, it may be best to bone up on your investment knowledge before including options trading in your overall strategy.

The Takeaway

Trading or investing in foreign currency is yet another avenue that investors can explore in an attempt to generate returns. As discussed, it involves actually purchasing money with money — foreign currencies — with the hopes that the price differences will work in the investors’ favor, and they’ll generate returns. Foreign currency markets are also extremely liquid, which is another potential upside for some traders.

As always, though, there are risks to consider, and learning the ropes of the foreign currency markets may be tricky. If investors feel like they want to get their feet wet in the market, though, without diving straight in, it may be worthwhile to discuss their plans with a financial professional.

Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.


Invest in alts to take your portfolio beyond stocks and bonds.

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Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.

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.

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.

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. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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