Jan
10
2025
IRA vs 401(k): What Is the Difference?

IRA vs 401(k): What Is the Difference?

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

The biggest difference between an IRA vs. a 401(k) is the amount you can save. You can save over three times as much in a 401(k) vs. an IRA — $23,000 versus $7,000 for tax year 2024, and $22,500 versus $6,500 for tax year 2023. But not everyone has access to a 401(k), because these are sponsored by an employer, typically for full-time employees.

“A 401(k) is probably one of the most common retirement vehicles,” says Brian Walsh, a CFP® at SoFi. “A 401(k) will be available through work. Your employer is going to choose whether or not to make a 401(k) available to all the employees. Generally speaking, 401(k)s are the most popular retirement plan employers provide.”

Other than that, a traditional IRA and a 401(k) are similar in terms of their basic provisions and tax implications. Both accounts are considered tax deferred, which means you can deduct the amount you contribute each year — unless you have a Roth account, which has a different tax benefit.

Before you decide whether one or all three types of retirement accounts might make sense for you, it helps to know all the similarities and differences between a 401(k) and a traditional IRA and Roth IRA.

Key Points

•   An IRA (Individual Retirement Account) and a 401(k) are both retirement savings accounts, but they have different features and eligibility requirements.

•   IRAs are typically opened by individuals, while 401(k)s are offered by employers to their employees.

•   IRAs offer more investment options and flexibility, while 401(k)s may have employer matching contributions and higher contribution limits.

•   Both accounts offer tax advantages, but the timing of tax benefits differs: IRAs provide tax benefits during retirement, while 401(k)s offer tax benefits upfront.

•   Choosing between an IRA and a 401(k) depends on factors like employment status, employer contributions, investment options, and personal financial goals.

How Are IRAs and 401(k)s Different?

The government wants you to prioritize saving for retirement. As a result, they provide tax incentives for IRAs vs. 401(k)s.

In that respect, a traditional IRA and a 401(k) are somewhat similar; both offer tax-deferred contributions, which may lower your taxable income, and tax-deferred investment growth. Also, you owe taxes on the money you withdraw from these accounts in retirement (or beforehand, if you take an early withdrawal).

There is a bigger difference between a Roth IRA and a 401(k). Roth accounts are funded with after-tax contributions — so they aren’t tax deductible. But they provide tax-free withdrawals in retirement.

And while you can’t withdraw the contributions you make to a traditional IRA until age 59 ½ (or incur a penalty), you can withdraw Roth contributions at any time (just not the earning or growth on your principal).

These days, you may be able to fund a Roth 401(k), if your company offers it.

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

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.

Other Key Differences Between IRAs and 401(k)s

As with anything that involves finance and the tax code, these accounts can be complicated. Because there can be stiff penalties when you don’t follow the rules, it’s wise to know what you’re doing.

Who Can Set Up a 401(k)?

As noted above, a key difference between an IRA and a 401(k) is that 401(k)s are qualified employer-sponsored retirement plans. You typically only have access to these plans through an employer who offers them as part of a full-time compensation package.

In addition, your employer may choose to provide matching 401(k) funds as part of your compensation, which is typically a percentage of the amount you contribute (e.g. an employer might match 3%, dollar for dollar).

Not everyone is a full-time employee. You may be self-employed or work part-time, leaving you without access to a traditional 401(k). Fortunately, there are other options available to you, including solo 401(k) plans and opening an IRA online (individual retirement accounts).

Who Can Set Up an IRA?

Anyone can set up an individual retirement account (IRA) as long as they’re earning income. (And if you’re a non-working spouse of someone with earned income, they can set up a spousal IRA on your behalf.)

If you already have a 401(k), you can still open an IRA and contribute to both accounts. But if you or your spouse (if you’re married) are covered by a retirement plan at work, you may not be able to deduct the full amount of your IRA contributions.

Understanding RMDs

Starting at age 73 (for those who turn 72 after December 31, 2022), you must take required minimum distributions (RMDs) from your tax-deferred accounts, including: traditional IRAs, SEP and SIMPLE IRAs, and 401(k)s. Be sure to determine your minimum distribution amount, and the proper timing, so that you’re not hit with a penalty for skipping it.

It’s worth noting, though, that RMD rules don’t apply to Roth IRAs. If you have a Roth IRA, or inherit one from your spouse, the money is yours to withdraw whenever you choose. The rules change if you inherit a Roth from someone who isn’t your spouse, so consult with a professional as needed.

However, RMD rules do apply when it comes to a Roth 401(k), similar to a traditional 401(k). The main difference here, of course, is that the Roth structure still applies and withdrawals are tax free.

A Closer Look at IRAs

An IRA is an individual retirement account that has a much lower contribution limit than a 401(k) (see chart below). Anyone with earned income can open an IRA, and there are two main types of IRAs to choose from: traditional and Roth accounts.

Self-employed people can also consider opening a SEP-IRA or a SIMPLE IRA, which are tax-deferred accounts that have higher contribution limits.

Traditional IRA

Like a 401(k), contributions to a traditional IRA are tax deductible and may help lower your tax bill. In 2024, IRA contribution limits are $7,000, or $8,000 for those aged 50 or older. In 2023, IRA contribution limits are $6,500, or $7,500 for those aged 50 or older.

With a traditional IRA, investments inside the account grow tax-deferred. And unlike 401(k)s where an employer might offer limited options, IRAs are more flexible because they are classified as self-directed and you typically set up an IRA through a brokerage firm of your choice.

Thus it’s possible to invest in a wider range of investments in your IRA, including stocks, bonds, mutual funds, exchange-traded funds, and even real estate.

When making withdrawals at age 59 ½, you will owe income tax. As with 401(k)s, any withdrawals before then may be subject to both income tax and the 10% early withdrawal penalty.

What Are Roth Accounts?

So far, we’ve discussed traditional 401(k) and IRA accounts. But each type of retirement account also comes in a different flavor — known as a Roth.

The main difference between traditional and Roth IRAs lies in when your contributions are taxed.

•   Traditional accounts are funded with pre-tax dollars. The contributions are tax deductible and may provide an immediate tax benefit by lowering your taxable income and, as a result, your tax bill.

•   Money inside these accounts grows tax-deferred, and you owe income tax when you make withdrawals, typically when you’ve reached the age of 59 ½.

Roth accounts, on the other hand, are funded with after-tax dollars, so your deposits aren’t tax deductible. However, investments inside Roth accounts also grow tax-free, and they are not subject to income tax when withdrawals are made at or after age 59 ½.

As noted above, Roths have an additional advantage in that you can withdraw your principal at any time (but you cannot withdraw principal + earnings until you’ve had the account for at least five years, and/or you’re 59 ½ or older — often called the five-year rule).

Roth accounts may be beneficial if you anticipate being in a higher tax bracket when you retire versus the one you’re in currently. Then tax-free withdrawals may be even more valuable.

It’s possible to hold both traditional and Roth IRAs at the same time, though combined contribution limits are the same as those for traditional accounts. And those limits can’t be exceeded.

Additionally, the ability to fund a Roth IRA is subject to certain income limits: above a certain limit you can’t contribute to a Roth. There are no income limits for a designated Roth 401(k), however.

A Closer Look at a 401(k)

Contributions to your 401(k) are made with pre-tax dollars. This makes them tax-deductible, meaning the amount you save each year can lower your taxable income in the year you contribute, possibly resulting in a smaller tax bill.

In 2024, you can contribute up to $23,000 to your 401(k). If you’re 50 or older, you can also make catch-up contributions of an extra $7,500, for a total of $30,500. In 2023, you can contribute up to $22,500 each year to your 401(k). If you’re 50 or older, you can also make catch-up contributions of an extra $7,500, for a total of $30,000.

401(k) catch-up contributions allow people nearing retirement to boost their savings. In addition to the contributions made, an employer can also match their employee’s contribution, up to a combined employer and employee limit of $69,000 in 2024 and $66,000 in 2023.

An employer may offer a handful of investment options to choose from, such as exchange-traded funds (ETFs), mutual funds, and target date mutual funds. Money invested in these options grows tax-deferred, which can help retirement investments grow faster.

When someone begins taking withdrawals from their 401(k) account at age 59 ½ (the earliest age at which you can start taking penalty-free withdrawals), those funds are subject to income tax. Any withdrawals made before 59 ½ may be subject to a 10% early withdrawal penalty, on top of the tax you owe.

When Should You Use a 401(k)?

If your employer offers a 401(k), it may be worth taking advantage of the opportunity to start contributing to your retirement savings. After all, 401(k)s have some of the highest contribution limits of any retirement plans, which means you might end up saving a lot. Here are some other instances when it may be a good idea:

1. If your employer matches your contributions

If your company matches any part of your contribution, you may want to consider at least contributing enough to get the maximum employer match. After all, this match is tantamount to free money, and it can add up over time.

2. You can afford to contribute more than you can to an IRA

For tax year 2024, you can only put $7,000 in an IRA, but up to $23,000 in a 401(k) — if you’re over 50, those amounts increase to $8,000 for an IRA and $30,500 for a 401(k).

For tax year 2023, you can only put $6,500 in an IRA, but up to $22,500 in a 401(k) — if you’re over 50, those amounts increase to $7,500 for an IRA and $30,000 for a 401(k). If you’re in a position to save more than the IRA limit, that’s a good reason to take advantage of the higher limits offered by a 401(k).

3. When your income is too high

Above certain income levels, you can’t contribute to a Roth IRA. How much income is that? That’s a complicated question that is best answered by our Roth IRA calculator.

And if you or your spouse are covered by a workplace retirement plan, you may not be able to deduct IRA contributions.

If you can no longer fund a Roth, and can’t get tax deductions from a traditional IRA, it might be worth throwing your full savings power behind your 401(k).

When Should You Use an IRA?

If you can swing it, it may not hurt to fund an IRA. This is especially true if you don’t have access to a 401(k). But even if you do, IRAs can be important tools. For example:

1. When you leave your company

When you leave a job, you can rollover an old 401(k) into an IRA — and it’s generally wise to do so. It’s easy to lose track of old plans, and companies can merge or even go out of business. Then it can become a real hassle to find your money and get it out.

You can also roll the funds into your new company’s retirement plan (or stick with an IRA rollover, which may give you more control over your investment choices).

Recommended: How to Roll Over Your 401(k)

2. If your 401(k) investment choices are limited

If you have a good mix of mutual funds in your 401(k), or even some target date funds and low-fee index funds, your plan is probably fine. But, some plans have very limited investment options, or are so confusing that people can’t make a decision and end up in the default investment — a low interest money market fund.

If this is the case, you might want to limit your contributions to the amount needed to get your full employer match and put the rest in an IRA.

3. When you’re between jobs

Not every company has a 401(k), and people are not always employed. There may be times in your life when your IRA is the only option. If you have self-employment income, you can make higher contributions to a SEP IRA or a Solo 401(k) you set up for yourself.

4. If you can “double dip.”

If you have a 401(k), are eligible for a Roth IRA, or can deduct contributions to a traditional IRA, and you can afford it — it may be worth investing in both. After all, saving more now means more money — and financial security — down the line. Once again, you can check our IRA calculator to see if you can double dip. Just remember that the IRA contribution limit is for the total contributed to both a Roth and traditional IRA.

The real question is not: IRA vs. 401(k), but rather — which of these is the best place to put each year’s contributions? Both are powerful tools to help you save, and many people will use different types of accounts over their working lives.

When Should You Use Both an IRA and 401(k)?

Using an IRA and a 401(k) at the same time may be a good way to save for your retirement goals. Funding a traditional or Roth IRA and 401(k) at once can allow you to save more than you would otherwise be able to in just one account.

Bear in mind that if you or your spouse participate in a workplace retirement plan, you may not be able to deduct all of your traditional IRA contributions, depending on how high your income is.

Having both types of accounts can also provide you some flexibility in terms of drawing income when you retire. For example, you might find a 401(k) as a source of pre-tax retirement income. At the same time you might fund a Roth IRA to provide a source of after-tax income when you retire.

That way, depending on your financial and tax situation each year, you may be able to strategically make withdrawals from each account to help minimize your tax liability.

The Takeaway

What is the difference between an IRA and a 401(k)? As you can see now, the answer is pretty complicated, depending on which type of IRA you’re talking about. Traditional IRAs are tax deferred, just like traditional 401(k)s — which means your contributions are tax deductible in the year you make them, but taxes are owed when you take money out.

Roth accounts — whether a Roth IRA or a Roth 401(k) — have a different tax treatment. You deposit after-tax funds in these types of accounts. And then you don’t pay any tax on your withdrawals in retirement.

The biggest difference is the amount you can save in each. For tax year 2023, it’s $23,000 in a 401(k) ($30,500 if you’re 50 and over) versus only $7,000 in an IRA ($8,000 if you’re 50+). For tax year 2023, it’s $22,500 in a 401(k) ($30,000 if you’re 50 and over) versus only $6,500 in an IRA ($7,500 if you’re 50+).

Another difference is that a 401(k) is generally sponsored by your employer, so you’re beholden to the investment choices of the firm managing the company’s plan, and the fees they charge. By contrast, you set up an IRA yourself, so the investment options are greater — and the fees can be lower.

Generally, you can have an IRA as well as a 401(k). The rules around contribution limits, and how much you can deduct may come into play, however.

If you’re ready to open an IRA, it’s easy when you set up an Active Invest account with SoFi Invest.

Not sure what the right strategy is for you? SoFi Invest® offers educational content as well as access to financial planners. The Active Investing platform lets investors choose from an array of stocks, ETFs or fractional shares. For a limited time, funding an account gives you the opportunity to win up to $1,000 in the stock of your choice. All you have to do is open and fund a SoFi Invest account.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

Is a 401(k) considered an IRA for tax purposes?

No. A 401(k) is a completely separate account than an IRA because it’s sponsored by your employer.

Is it better to have a 401(k) or an IRA?

You can save more in a 401(k), and your employer may also offer matching contributions. But an IRA often has a much wider range of investment options. It’s wise to weigh the differences, and decide which suits your situation best.

Can you roll a 401(k) Into an IRA penalty-free?

Yes. If you leave your job and want to roll over your 401(k) account into an IRA, you can do so penalty free within 60 days. If you transfer the funds and hold onto them for longer than 60 days, you will owe taxes and a penalty if you’re under 59 ½.

Can you lose money in an IRA?

Yes. You invest all the money you deposit in an IRA in different securities (i.e. stocks, bonds, mutual funds, ETFs). Ideally you’ll see some growth, but you could also see losses. There are no guarantees.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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Jan
07
2025
How to Open Your First IRA

How to Open an IRA in 5 Steps

By | Budgeting & Goals, Building Your Career, Growing Wealth, invest, Investing | No Comments

Saving for retirement may be the biggest financial goal many of us will ever set. So it makes sense to explore all retirement savings options, including an IRA, or individual retirement account. Individual retirement accounts are tax-advantaged tools that can be opened by virtually anyone with earned income, unlike employer-sponsored 401(k) plans. The sooner you open your first IRA, the more opportunity your savings have to grow over time, potentially leading to a nice nest egg upon retirement.

There are other benefits to opening an IRA. For one, it can deliver attractive tax perks — either up front or in retirement — and it can be especially attractive to individuals who don’t have an employer-sponsored 401(k) plan, or have maxed it out already.

This article will walk you through the steps of opening an IRA — whether a traditional, Roth, or SEP IRA.

Key Points

•   Opening an IRA provides a tax-advantaged way to save for retirement, allowing individuals with earned income to benefit regardless of employer-sponsored plans.

•   Selecting the right investing style, either through a robo-advisor for automation or an online broker for hands-on management, is crucial when setting up an IRA.

•   Different types of IRAs, including Traditional, Roth, and SEP IRAs, offer various tax benefits and contribution limits based on income and employment status.

•   The process of opening an IRA involves providing personal information, identification, and selecting beneficiaries, followed by funding the account through transfers or rollovers.

•   Choosing the right investments within an IRA, such as stocks, bonds, or target date funds, should align with individual risk tolerance and retirement goals for optimal growth.

How to Open an IRA

1. Choose Your Investing Style

When setting up an IRA, you have the option to select the investing style that aligns with your preferences and goals. You can choose between two primary methods: using an online broker for self-directed investing or opting for a robo-advisor for automated investing.

•   Consider a robo-advisor for a hands-off approach: If you find the array of investment choices daunting or you’re unsure where to begin, a robo-advisor might be the ideal solution. This option allows you to take a more hands-off approach and automate your investments. Simply share your retirement and investment objectives, and the robo-advisor will create and maintain a tailored portfolio specifically designed to meet your needs.

•   Choose an online broker to take control of your investments: For those who prefer to be more involved and make their own investment decisions, using an online broker for self-directed investing is the way to go. This method allows you to directly manage your investments and typically comes with the benefit of commission-free trades. This is a great choice for individuals who want to actively participate in the management of their IRA investments.

2. Decide Where to Open Your IRA

You can open an IRA online, a bank, mutual fund company, or other financial services provider. Typically, the more personal care and advice you get, the higher the account fees will be. A robo-advisor, for instance, might charge lower fees than a brokerage.

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

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.

3. Determine the Type of IRA You Want to Open

Traditional IRA

If you have earned income, you can open a traditional IRA regardless of how much you make per year. An IRA can be a good next step if you’ve maxed out your 401(k), for instance.

One notable difference between traditional and Roth IRA accounts is that traditional IRAs allow you to deduct your contributions on your tax returns now, meaning you pay taxes on distributions when you retire. You’ll pay a 10% penalty tax (in addition to regular income tax) on any money you withdraw from a traditional IRA before age 59 ½, with a few exceptions.

It may be better to go with a traditional IRA if you think you’ll be in a lower tax bracket after retirement. This is because you’ll be saving on a higher tax rate now (vs. the lower rate you’d be paying later, since you’d be in a lower tax bracket in retirement).

Roth IRA

Unlike traditional IRAs, Roth IRAs have income limits for contributions. For 2024 and 2025, single filers can contribute the maximum amount to a Roth IRA if their income meets a certain threshold. If their income exceeds this threshold but falls below another, they can contribute a reduced amount. Similarly, married couples filing jointly can contribute the maximum if their income meets a specific level, with a reduced contribution amount available for those who don’t meet the full threshold.

Roth IRA contributions are made with after-tax income. While that doesn’t offer any tax advantages now, it does mean that when you withdraw money upon retirement, you won’t have to pay taxes on it. As such, a Roth IRA may make sense for eligible individuals who typically get a tax refund and expect to be in a similar or higher tax bracket when they retire (for example, if they plan to have substantial income from a business, investments, or work).

SEP IRA

A SEP IRA, or simplified employee pension, can be set up by either an employer at a small business or by someone who is self-employed. For 2024, you can contribute up to 25% of your total compensation or a maximum of $69,000, whichever is less, to a SEP IRA. For 2025, you can contribute the lesser of up to 25% of your total compensation or a maximum of $70,000.

Employers get a tax deduction when they contribute to their employees’ IRAs, and they’re also allowed to contribute on a “discretionary basis” (meaning the employer doesn’t have to contribute in years where it’s not as financially feasible for the company.) For employees, this option may allow you to contribute a greater amount than other IRAs, depending on your income.

4. Open the IRA Account

Once you decide where to open an IRA, you’ll need to follow through with doing so. The process to open an IRA can vary a bit from provider to provider, but it’s generally pretty straightforward.

What You’ll Need to Open an IRA

•   A copy of your government-issued ID

•   Personal information, including contact information and Social Security number

•   Details on intended beneficiaries

5. Fund Your Account

Once your account is opened, you’ll receive guidance on funding an IRA. If you want to fund your account through an electronic transfer, you’ll be asked to provide banking information. It’s also possible to roll over existing retirement accounts — and yes, it is possible to open an IRA if you have a 401(k) already.

In 2024 and 2025, you can contribute up to $7,000 a year to a traditional or Roth IRA, or up to $8,000 if you’re 50 or older. If you take home more than the maximum earnings allowed for a Roth IRA but still prefer a Roth IRA over a traditional account, you might be able to contribute a reduced amount of Roth IRA contribution limits. An IRA contribution calculator can help you get an idea of how much you can contribute this year.

In many cases, it’s a good idea to invest as much as you can up to that amount each year to take full advantage of the power of compound growth.

A retirement calculator can help you figure out whether you’re on track for retirement. A quick rule of thumb: By the time you’re 30, it’s typically good to have the equivalent of one year’s salary saved.

Rolling Over a 401(k) into an IRA

If you’re leaving a job with an employee-sponsored retirement plan, you can roll over your 401(k) into a traditional IRA. When you roll money over from a 401(k), there’s no limit to how much you can add to an IRA at that time. Going forward, additional contributions will be capped at the typical IRA contribution limit.

6. Select Your Investments

Investors can choose to invest in stocks, bonds, mutual funds, low-cost index funds, or exchange-traded funds (ETFs) — or a combination thereof – through a financial institution.

One popular type of investment fund geared toward retirement savings is a “target date fund.” A target date fund is calibrated to the year you plan to retire, and it’s meant to automatically update your mix of assets, like stocks and bonds, so they’re more aggressive earlier in life and more conservative as you approach retirement.

Ultimately, the mix of investments in your IRA should depend on your personal risk tolerance, lifestyle, and retirement goals.

Investing in Your Retirement

Once you’re familiar with how to open an individual retirement account, the process itself is pretty straightforward — possibly the biggest lift involved is deciding which IRA suits your personal situation and retirement goals best: a traditional, Roth, or SEP IRA. From there, you’ll need to decide where to start a Roth IRA or other type or IRA, then go through the formal process of starting an IRA, which includes providing certain information, funding the account, selecting a contribution amount, and deciding where to invest your funds.

That can all sound like a lot, but getting started on saving for your retirement doesn’t have to be difficult. SoFi Invest makes opening an IRA simple — it’s possible to sign up in less than five minutes. You can be as involved in the investment process as you want to be — either with hands-on investing or our automated investing technology, in which our algorithm will recommend an appropriate mix of investments based on your age and retirement goals.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

How much money is required to open an IRA?

There’s no universal minimum amount required to open an IRA. That being said, some providers will have minimum requirements.

Can you open an IRA all on your own?

Yes, it’s definitely possible to open an IRA on your own. The process is simple, similar to opening a bank account, and you can do so at most banks, brokerages, or other financial institutions. Often, it’s possible to start an IRA online.

Can you open an IRA at a bank?

Yes, many banks offer IRAs. You can also open an IRA at credit unions, brokerages, and investment companies.

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.

For a limited time, funding an account gives you the opportunity to win up to $1,000 in the stock of your choice. All you have to do is open and fund a SoFi Invest account.
CalculatorThis retirement calculator is provided for educational purposes only and is based on mathematical principles that do not reflect actual performance of any particular investment, portfolio, or index. It does not guarantee results and should not be considered investment, tax, or legal advice. Investing involves risks, including the loss of principal, and results vary based on a number of factors including market conditions and individual circumstances. Past performance is not indicative of future results.

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.

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.

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Nov
18
2024
When to Start Saving for Retirement

When Should You Start Saving for Retirement?

By | Budgeting & Goals, Growing Wealth, invest, Preparing for Retirement | No Comments

If you ask any financial advisor when you should start saving for retirement, their answer would likely be simple: Now, or in your 20s if possible.

It’s not always easy to prioritize investing for retirement. If you’re in your 20s or 30s, you might have student loans or other goals that seem more “immediate,” such as a down payment on a house or your child’s tuition. But starting early is important because it can allow you to save much more. In fact, setting aside a little every year starting in your 20s could mean an additional hundreds of thousands of dollars of accumulated investment earnings by retirement age.

No matter what age you are, putting away money for the future is a good idea. Read on to learn more about when to start saving for retirement and how to do it.

Key Points

•   Starting to save for retirement in your 20s is ideal, as it gives your money more time to potentially grow and benefit from compounding. Compounding occurs when any earnings received are added to your principal balance, so future earnings are calculated on this updated, larger amount.

•   Assessing personal financial situations and retirement goals is crucial when determining how much to save for retirement, regardless of age.

•   Individuals in their 30s, 40s, 50s, or 60s can still successfully start saving for retirement, with different strategies tailored to each age group.

•   Regular contributions and taking advantage of employer-sponsored plans are key steps in building a solid retirement savings strategy at any age.

This article is part of SoFi’s Retirement Planning Guide, our coverage of all the steps you need to create a successful retirement plan.

money management guide for beginners

What Is the Ideal Age to Start Saving for Retirement?

Ideally, you should start saving for retirement in your 20s, if possible. By getting started early, you could reap the benefits of compound interest. That’s when money in savings accounts earns interest, that interest is added to the principal amount in the account, and then interest is earned on the new higher amount.

Starting to save for retirement in your 20s can allow you to save much more. In fact, setting aside a little every year starting in your 20s could mean an additional hundreds of thousands of dollars of accumulated investment earnings by retirement age.

That said, if you are older than your 20s, it’s not too late to start saving for retirement. The important thing is to get started, no matter what your age.

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

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.

The #1 Reason to Start Early: Compound Interest

If you start saving early, you could reap the benefits of compound interest.

CFP®, Brian Walsh says, “Time can either be your best friend or your worst enemy. If you start saving early, you make it a habit, and you start building now, time becomes your best friend because of compounded growth. If you delay — say 5, 10, 15 years to save — then time becomes your worst enemy because you don’t have enough time to make up for the money that you didn’t save.”

Here’s how compound interest works and why it can be so valuable: The money in a savings account, money market account, or CD (certificate of deposit) earns interest. That interest is added to the balance or principle in the account, and then interest is earned on the new higher amount.

Depending on the type of account you have, interest might accrue daily, weekly, monthly, quarterly, twice a year, or annually. The more frequently interest compounds on your savings, the greater the benefit for you.

Investments — including investments in retirement plans, such as an employee-sponsored 401(k) plan or a traditional or Roth IRA — likewise benefit from compounding returns. Over time, you can see returns on both the principal as well as the returns on your contributions. Essentially, your money can work for you and potentially grow through the years, just through the power of compound returns.

The sooner you start saving and investing, the more time compounding has to do its work.

💡 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.

Saving Early vs Saving Later

To understand the power of compound returns, consider this:

If you start investing $7,000 a year at age 25, by the time you reach age 67, you’d have a total of $2,129,704.66. However, if you waited until age 35 to start investing the same amount, and got the same annual return, you’d have $939,494.76.

Age

 Annual Return

 Savings
25 8% $2,129,704.66
35 8% $939,494.76

As you can see, starting in your 20s means you may save double the amount you would have if you waited until your 30s.

Starting Retirement Savings During Different Life Stages

Retirement is often considered the single biggest expense in many peoples’ lives. Think about it: You may be living for 20 or more years with no active income.

Plus, while your parents or grandparents likely had a pension plan that kicked off right at the age of 65, that may not be the case for many workers in younger generations. Instead, the 401(k) model of retirement that’s more common these days requires employees to do their own saving.

As you get started on your savings journey, do a quick assessment of your current financial situation and goals. Be sure to factor in such considerations as:

•   Age you are now

•   Age you’d like to retire

•   Your income

•   Your expenses

•   Where you’d like to live after retirement (location and type of home)

•   The kind of lifestyle you envision in retirement (hobbies, travel, etc.)

To see where you’re heading with your savings you could use a retirement savings calculator. But here are more basics on how to get started on your retirement savings strategy, at any age.

Starting in Your 20s

Starting to save for retirement in your 20s is something you’ll later be thanking yourself for.

As discussed, the earlier you start investing, the better off you’re likely to be. No matter how much or little you start with, having a longer time horizon till retirement means you’ll be able to handle the typical ups and downs of the markets.

Plus, the sooner you start saving, the more time you’ll be able to benefit from compound returns, as noted.

Start by setting a goal: At what age would you like to retire? Based on current life expectancy, how many years do you expect to be retired? What do you imagine your retirement lifestyle will look like, and what might that cost?

Then, create a budget, if you haven’t already. Document your income, expenses, and debt. Once you do that, determine how much you can save for retirement, and start saving that amount right now.

💡 Learn more: Savings for Retirement in Your 20s

Starting in Your 30s

If your 20s have come and gone and you haven’t started investing in your retirement, your 30s is the next-best time to start. While there may be other expenses competing for your budget right now — saving for a house, planning for kids or their college educations — the truth remains that the sooner you start retirement savings, the more time they’ll have to grow.

If you’re employed full-time, one easy way to start is to open an employer-sponsored retirement savings plan, like a 401(k). We’ll get into details on that below, but one benefit to note is that your savings will come out of your paycheck each month before you get taxed on that money. Not only does this automate retirement savings, but it means after a while you won’t even miss that part of your paycheck that you never really “had” to begin with. (And yes, Future You will thank you.)

💡 Learn more: Savings for Retirement in Your 30s

Starting in Your 40s

When it comes to how much you should have saved for retirement by 40, one general guideline is to have the equivalent of your two to three times your annual salary saved in retirement money.

Once you have high-interest debt (like debt from credit cards) paid off, and have a good chunk of emergency savings set aside, take a good look at your monthly budget and figure out how to reallocate some money to start building a retirement savings fund.

Not only will regular contributions get you on a good path to savings, but one-off sources of money (from a bonus, an inheritance, or the sale of a car or other big-ticket item) are another way to help catch up on retirement savings faster.

Starting in Your 50s

In your 50s, a good ballpark goal is to have six times your annual salary in your retirement savings by the end of the decade. But don’t panic if you’re not there yet — there are a few ways you can catch up.

Specifically, the government allows individuals over age 50 to make “catch-up contributions” to 401(k), traditional IRA, and Roth IRA plans. That’s an additional $7,500 in 401(k) savings, and an additional $1,000 in IRA savings for 2024 and 2023.

The opportunity is there, but only you can manage your budget to make it happen. Once you’ve earmarked regular contributions to a retirement savings account, make sure to review your asset allocation on your own or with a professional. A general rule of thumb is, the closer you get to retirement age, the larger the ratio of less risky investments (like bonds or bond funds) to more volatile ones (like stocks, mutual funds, and ETFs) you should have.

Starting in Your 60s

It’s never too late to start investing, especially if you’re still working and can contribute to an employer-sponsored retirement plan that may have matching contributions. If you’re contributing to a 401(k), or a Roth or traditional IRA, don’t forget about catch-up contributions (see the information above).

In general, when you’re this close to retirement it makes sense for your investments to be largely made up of bonds, cash, or cash equivalents. Having more fixed-income securities in your portfolio helps lower the odds of suffering losses as you get closer to your target retirement date.

💡 Learn more: Savings for Retirement in Your 60s

The Takeaway

Investing in retirement and wealth accounts is a great way to jump-start saving and investing for your golden years, whether you invest $10,000 or just $100 to get started.

The first step is to open an account or use the one that’s already open. You could also increase your contribution. If you’re opening an account, you may want to consider one without fees, to help maximize your bottom line.

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

Is 20 years enough to save for retirement?

It’s never too late to start investing for retirement. If you’re just starting in your 40s, consider contributing to an employer-sponsored plan if you can, so that you can take advantage of any employer matching contributions. In addition to regular bi-weekly or monthly contributions, make every effort to deposit any “windfall” lump sums (like a bonus, inheritance, or proceeds from the sale of a car or house) into a retirement savings vehicle in an effort to catch up faster.

Is 25 too late to start saving for retirement?

It’s not too late to start saving for retirement at 25. Take a look at your budget and determine the max you can contribute on a regular basis — whether through an employer-sponsored plan, an IRA, or a combination of them. Then start making contributions, and consider them as non-negotiable as rent, mortgage, or a utility bill.

Is 30 too old to start investing?

No age is too old to start investing for retirement, because the best time to start is today. The sooner you start investing, the more advantage you can take of compound returns, and potentially employer matching contributions if you open an employer-sponsored retirement plan.

Should I prioritize paying off debt over saving for retirement?

Whether you should prioritize paying off debt over saving for retirement depends on your personal situation and the type of debt you have. If your debt is the high-interest kind, such as credit card debt, for instance, it could make sense to pay off that debt first because the high interest is costing you extra money. The less you owe, the more you’ll be able to put into retirement savings.

And consider this: You may be able to pay off your debt and save simultaneously. For instance, if your employer offers a 401(k) with a match, enroll in the plan and contribute enough so that the employer match kicks in. Otherwise, you are essentially forfeiting free money. At the same time, put a dedicated amount each week or month to repaying your debt so that you continue to chip away at it. That way you will be reducing your debt and working toward saving for your retirement.

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.
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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.

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.

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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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Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
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Oct
02
2024
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How to Roll Over Your 401(k): Knowing Your Options

By | Budgeting & Goals, Building Your Career, Growing Wealth, invest, Investing, Life & Career | No Comments

It’s pretty easy to rollover your old 401(k) retirement savings to an individual retirement account (IRA), a new 401(k), or another option — yet millions of workers either forget to rollover their hard-won retirement savings, or they lose track of the accounts. Given that a 401(k) rollover typically takes minimal time and, these days, minimal paperwork, it makes sense to know the basics so you can rescue your 401(k), roll it over to a new account, and add to your future financial security.

Whether you’re starting a new job and need to roll over your 401(k), or are looking at what other options are available to you, here’s a rundown of what you need to know.

Key Points

•   Rolling over a 401(k) to an IRA or new 401(k) is typically straightforward and your retirement funds will continue to have the opportunity to grow.

•   Moving 401(k) funds to another 401(k) is often the simplest option and allows you to continue to have a higher contribution limit.

•   Moving 401(k) funds to an IRA may provide more investment choices and control over those investments.

•   Leaving a 401(k) with a former employer is an option but may involve additional fees and complications.

•   Direct transfers are simpler and generally preferred over indirect transfers, which run the risk of incurring tax liabilities and penalties.

401(k) Rollover Options

For workers who have a 401(k) and are considering next steps for those retirement funds — such as rolling them to an IRA or another 401(k), here are some potential avenues.

1. Roll Over Money to a New 401(k) Plan

If your new job offers a 401(k) or similar plan, rolling your old 401(k) funds into your new 401(k) account may be both the simplest and best option — and the one least likely to lead to a tax headache.

That said, how you go about the rollover has a pretty major impact on how much effort and paperwork is involved, which is why it’s important to understand the difference between direct and indirect transfers.

Here are the two main options you’ll have if you’re moving your 401(k) funds from one company-sponsored retirement account to another.

Direct Rollover

A direct transfer, or direct rollover, is exactly what it sounds like: The money moves directly from your old account to the new one. In other words, you never have access to the money, which means you don’t have to worry about any tax withholdings or other liabilities.

Depending on your account custodian(s), this transfer may all be done digitally via ACH transfer, or you may receive a paper check made payable to the new account. Either way, this is considered the simplest option, and one that keeps your retirement fund intact and growing with the least possible interruption.

Indirect Rollover

Another viable, but more complex, option, is to do an indirect transfer or rollover, in which you cash out the account with the expressed intent of immediately reinvesting it into another retirement fund, whether that’s your new company’s 401(k) or an IRA (see above).

But here’s the tricky part: Since you’ll actually have the cash in hand, the government requires your account custodian to withhold a mandatory 20% tax. And although you’ll get that 20% back in the form of a tax exemption later, you do have to make up the 20% out of pocket and deposit the full amount into your new retirement account within 60 days.

For example, say you have $50,000 in your old 401(k). If you elected to do an indirect transfer, your custodian would cut you a check for only $40,000, thanks to the mandatory 20% tax withholding.

But in order to avoid fees and penalties, you’d still need to deposit the full $50,000 into your new retirement account, including $10,000 out of your own pocket. In addition, if you retain any funds from the rollover, they may be subject to an additional 10% penalty for early withdrawal.

Pros and Cons of Rolling Over to a New 401(k)

With all of that in mind, rolling over your money into a new 401(k) has some pros and cons:

thumb_up

Pros:

•   Often the simplest, easiest rollover option when available.

•   Should not typically result in any tax liabilities or withholdings.

•   Allows your investments to continue to grow (hopefully!), uninterrupted.

thumb_down

Cons:

•   New employer may change certain aspects of your 401(k) plan.

•   There may be higher associated fees or costs with your new plan.

•   Indirect transfers may tie up some of your funds for tax purposes.

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

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.

2. Roll Over Your 401(k) to an IRA

If your new job doesn’t offer a 401(k) or other company-sponsored account like a 403(b), you still have options that’ll keep you from bearing a heavy tax burden. Namely, you can roll your 401(k) into an IRA.

The entire procedure essentially boils down to three steps:

1. Open a new IRA that will accept rollover funds.

2. Contact the company that currently holds your 401(k) funds and fill out their transfer forms using the account information of your newly opened IRA. You should receive essential information about your benefits when you leave your current position. If you’ve lost track of that information, you can contact the plan sponsor or the company HR department.

3. Once your money is transferred, you can reinvest the money as you see fit. Or you can hire an advisor to help you set up your new portfolio. It also may be possible to resume making deposits/contributions to your rollover IRA.

Pros and Cons of Rolling Over to an IRA

This option also has its pros and cons, however.

thumb_up

Pros:

•   IRAs may have more investment options available.

•   You’ll have more control over how you allocate your investments.

•   You could potentially reduce related expenses, depending on your specifications.

thumb_down

Cons:

•   May require you to liquidate your holdings and reinvest them.

•   Lower contribution limit compared to 401(k).

•   May involve different or higher fees and additional costs.

•   IRAs may provide less protection from creditor judgments.

•   You’ll be subject to new distribution rules – namely, you’ll need to be 59 1/2 before withdrawing funds to avoid incurring penalties.

3. Leave Your 401(k) With Your Former Employer

Leaving your 401(k) be – or, with your former employer – is also an option.

If you’re happy with your portfolio mix and you have a substantial amount of cash stashed in there already, it might behoove you to leave your 401(k) where it is.

You’ll also want to dig into the details and determine how much control you’ll have over the account, and how much your former employer might.

You might also consider any additional fees you might end up paying if you leave your 401(k) where it is. Plus, racking up multiple 401(k)s as you change jobs could lead to a more complicated withdrawal schedule at retirement.

Pros and Cons of Leaving Your 401(k) Alone

thumb_up

Pros:

•   It’s convenient – you don’t do anything at all, and your investments will remain where they are.

•   You’ll have the same protections and fees that you previously had, and won’t need to get up to speed on the ins and outs of a new 401(k) plan.

thumb_down

Cons:

•   If you have a new 401(k) at a new employer, you could end up with multiple accounts to juggle.

•   You’ll no longer be able to contribute to the 401(k), and may not get regular updates about it.

4. Cash Out Your Old 401(k)

Cashing out, or liquidating your old 401(k) is another option. But there are some stipulations investors should be aware of.

Because a 401(k) is an investment account designed specifically for retirement, and comes with certain tax benefits — e.g. you don’t pay any tax on the money you contribute to your 401(k), depending on the specific type — the account is also subject to strict rules regarding when you can actually access the money, and the tax you’d owe when you did.

Specifically, if you take out or borrow money from your 401(k) before age 59 ½, you’ll likely be subject to an additional 10% tax penalty on the full amount of your withdrawal — and that’s on top of the regular income taxes you’ll also be obligated to pay on the money.

Depending on your income tax bracket, that means an early withdrawal from your 401(k) could really cost you, not to mention possibly leaving you without a nest egg to help secure your future.

This is why most financial professionals generally recommend one of the next two options: rolling your account over into a new 401(k), or an IRA if your new job doesn’t offer a 401(k) plan.

Pros and Cons of Cashing Out Your 401(k)

thumb_up

Pros:

•   You’ll have immediate access to your funds to use as you like.

thumb_down

Cons:

•   Early withdrawal penalties may apply, and there will likely be income tax liabilities.

•   Liquidating your retirement account may hurt your chances of reaching your financial goals.

When Is a Good Time to Roll Over a 401(k)?

If there’s a good time to roll over your 401(k), it’s when you change jobs and have the chance to enroll in your new employer’s plan. But you can generally do a rollover any time.

That said, if you have a low balance in your 401(k) account — for example, less than $5,000 — your employer might require you to do a rollover. And if you have a balance lower than $1,000, your employer may have the right to cash it out without your approval. Be sure to check the exact terms with your employer.

When you receive funds from a 401(k) or IRA account, such as with an indirect transfer, you’ll only have 60 days from the date you receive them to then roll them over into a new qualified plan. If you wait longer than 60 days to deposit the money, it will trigger tax consequences, and possibly a penalty. In addition, only one rollover to or from the same IRA plan is allowed per year.

The Takeaway

Rolling over your 401(k) — to a new employer’s plan, or to an IRA — gives you more control over your retirement funds, and could also give you more investment choices. It’s not difficult to rollover your 401(k), and doing so can offer you a number of advantages. First of all, when you leave a job you may lose certain benefits and terms that applied to your 401(k) while you were an employee. Once you move on, you may pay more in account fees for that account, and you will likely lose the ability to keep contributing to your account.

There are some instances where you may not want to do a rollover, for instance when you own a lot of your old company’s stock, so be sure to think through your options.

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).

Help grow your nest egg with a SoFi IRA.

FAQ

How can you roll over a 401(k)?

It’s fairly easy to roll over a 401(k). First decide where you want to open your rollover account, then contact your old plan’s administrator, or your former HR department. They typically send funds to the new institution directly via an ACH transfer or a check.

What options are available for rolling over a 401(k)?

There are several options for rolling over a 401(k), including transferring your savings to a traditional IRA, or to the 401(k) at your new job. You can also leave the account where it is, although this may incur additional fees. It’s generally not advisable to cash out a 401(k), as replacing that retirement money could be challenging.

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.

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.

Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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May
23
2024

What Is a Roth IRA and How Does It Work?

By | Budgeting & Goals, invest, Terminology | No Comments

A Roth IRA is an individual retirement account that allows you to contribute after-tax dollars, and then withdraw the money tax free in retirement. A Roth IRA is different from a traditional IRA, which is a tax-deferred account: meaning, you contribute pre-tax dollars — but you owe tax on the money you withdraw later.

Many people wonder what a Roth IRA is because, although it’s similar to a traditional IRA, the two accounts have many features and restrictions that are distinct from each other. Roth accounts can be more complicated, but for many investors the promise of having tax-free income in retirement is a strong incentive for understanding how Roth IRAs work.

Key Points

•   A Roth IRA is a retirement savings account that offers tax-free growth and tax-free withdrawals in retirement.

•   Contributions to a Roth IRA are made with after-tax dollars, but qualified withdrawals are not subject to income tax.

•   Roth IRAs have income limits for eligibility, and contribution limits that vary based on age and income.

•   Unlike traditional IRAs, Roth IRAs do not require minimum distributions during the account holder’s lifetime.

•   Roth IRAs can be a valuable tool for long-term retirement savings, especially for individuals who expect to be in a higher tax bracket in the future.

What Is a Roth IRA?

A Roth IRA is a retirement account for people who want to make after-tax contributions. The trade-off for paying taxes upfront is that when you retire, all of your withdrawals will be tax free, including the earnings and other gains in your account.

That said, because you’re making after-tax contributions, you can’t deduct Roth deposits from your income tax the way you can with a traditional IRA.

Understanding Contributions vs Earnings

An interesting wrinkle with a Roth IRA is that you can withdraw your contributions tax and penalty-free at any time. That’s because you’ve already paid tax on that money before initially depositing or investing it.

Withdrawing investment earnings on your money, however, is a different story. Those gains need to stay in the Roth for a minimum of five years before you can withdraw them tax free — or you could owe tax on the earnings as well as a 10% penalty.

It’s important to know how the IRS treats Roth funds so you can strategize about the timing around contributions, Roth conversions, as well as withdrawals.

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

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.

Roth IRA Eligibility

Technically, anyone can open an IRA account, as long as they have earned income (i.e. taxable income). The IRS has specific criteria about what qualifies as earned income. Income from a rental property isn’t considered earned income, nor is child support, so be sure to check.

There are no age restrictions for contributing to a Roth IRA. There are age restrictions when contributing to a traditional IRA, however.

How to Open a Roth IRA

Roth IRA Annual Contribution Limits

For 2024, the annual limit is $7,000, and $8,000 for those 50 and up. The extra $1,000 is called a catch-up provision, for those closer to retirement.

For 2023, the annual contribution limits for both Roth and traditional IRAs was $6,500, or $7,500 for those 50 or older. So, there was a $500 increase in contribution limits between 2023 and 2024.

Remember that you can only contribute earned income. If you earn less than the contribution limit, you can only deposit up to the amount of money you made that year.

One exception is in the case of a spousal Roth IRA, where the working spouse can contribute to an IRA on behalf of a spouse who doesn’t have earned income.

Other Roth IRA Details

Since Roth IRAs are funded with after-tax income, contributions are not tax-deductible. One exception for low- and moderate-income individuals is something called the Saver’s Credit, which may give someone a partial tax credit for Roth contributions, assuming they meet certain income and other criteria.

Note that the deadline for IRA contributions is Tax Day of the following year. So for tax year 2023, the deadline for IRA contributions is April 15, 2024. But, if you file an extension, you cannot further postpone your IRA contribution until the extension date and have it apply to the prior year.

Calculate your IRA contributions.

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Roth IRA Income Restrictions

In addition, with a Roth there are important income restrictions to take into account. Higher-income individuals may not be able to contribute the full amount to a Roth IRA; some may not be eligible to contribute at all.

It’s important to know the rules and to make sure you don’t make an ineligible Roth contribution if your income is too high. Those funds would be subject to a 6% IRS penalty.

For 2023:

•   You could contribute the full amount to a Roth as long as your modified adjusted gross income (MAGI) was less than $138,000 (for single filers) or less than $218,000 for those married, filing jointly.

•   Single people who earned more than $138,000 but less than $153,000 could contribute a reduced amount.

•   Married couples who earned between $218,000 and $228,000 could also contribute a reduced amount.

For 2024 the numbers have changed and the Roth IRA income limits have increased:

•   For single and joint filers: in order to contribute the full amount to a Roth you must earn less than $146,000 or $230,000, respectively.

•   Single filers earning more than $146,000 but less than $161,000 can contribute a reduced amount. (If your MAGI is over $161,000 you can’t contribute to a Roth.)

•   Married couples who earn between $230,000 and $240,000 can contribute a reduced amount. (But if your MAGI is over $240,000 you’re not eligible.)

If your filing status is…

 If your 2023 MAGI is…

 If your 2024 MAGI is…

 You may contribute:
Married filing jointly or qualifying widow(er) Up to $218,000 Up to $230,000 For 2023 $6,500 or $7,500 for those 50 and up.
For 2024 $7,000 or $8,000 for those 50 and up.
$218,000 to $228,000 $230,000 to $240,000 A reduced amount*
Over $228,000 Over $240,000 Cannot contribute
Single, head of household, or married filing separately (and you didn’t live with your spouse in the past year) Up to $138,000 Up to $146,000 For 2023 $6,500 or $7,500 for those 50 and up.
For 2024 $7,000 or $8,000 for those 50 and up.
From $138,000 to $153,000 From $146,000 to $161,000 Reduced amount
Over $153,000 Over $161,000 Cannot contribute
Married filing separately** Less than $10,000 Less than $10,000 Reduced amount
Over $10,000 Over $10,000 Cannot contribute

*Consult IRS rules regarding reduced amounts.
**You did live with your spouse at some point during the year.

Advantages of a Roth IRA

Depending on an individual’s income and circumstances, a Roth IRA has a number of advantages.

Advantages of a Roth IRA

•   No age restriction on contributions. With a traditional IRA, individuals must stop making contributions at age 72. A Roth IRA works differently: Account holders can make contributions at any age as long as they have earned income for the year.

   * You can fund a Roth and a 401(k). Funding a 401(k) and a traditional IRA can be tricky, because they’re both tax-deferred accounts. But a Roth is after-tax, so you can contribute to a Roth and a 401(k) at the same time (and stick to the contribution limits for each account).

•   Early withdrawal option. With a Roth IRA, an individual can generally withdraw money they’ve contributed at any time, without penalty (but not earnings on those deposits). In contrast, withdrawals from a traditional IRA before age 59 ½ may be subject to a 10% penalty.

•   Qualified Roth withdrawals are tax-free. Investors who have had the Roth for at least five years, and are at least 59 ½, are eligible to take tax- and penalty-free withdrawals of contributions + earnings.

•   No required minimum distributions (RMDs). Unlike IRAs, which require account holders to start withdrawing money after age 73, Roth IRAs do not have RMDs. That means an individual can withdraw the money as needed, without fear of triggering a penalty.

Disadvantages of a Roth IRA

Despite the appeal of being able to take tax-free withdrawals in retirement, or when you qualify, Roth IRAs have some disadvantages.

•   No tax deduction for contributions. The primary disadvantage of a Roth IRA is that your contributions are not tax deductible, as they are with a traditional IRA and other tax-deferred accounts (e.g. a SEP IRA, 401(k), 403(b)).

•   Higher earners often can’t contribute to a Roth. Affluent investors are generally excluded from Roth IRA accounts, unless they do what’s known as a backdoor Roth or a Roth conversion. (There are no income limits for converting a traditional IRA to a Roth, but you’ll have to pay taxes on the money that goes into the Roth — though you won’t face a penalty.)

•   The 5-year rule applies. The 5-year rule can make withdrawals more complicated for investors who open a Roth later in life. If you open a Roth or do a Roth conversion at age 60, for example, you must wait five years to take qualified withdrawals of contributions and earnings, or face a penalty (some exceptions to this rule apply; see below).

Last, the downside with both a traditional or a Roth IRA is that the contribution limit is low. Other retirement accounts, including a SEP-IRA or 401(k), allow you to contribute far more in retirement savings. But, as noted above, you can combine saving in a 401(k) with saving in a Roth IRA as well.

Roth IRA Withdrawal Rules

Because Roth IRA withdrawal rules can be complicated, let’s review some of the ins and outs.

Qualified Distributions

Since you have already paid tax on the money you deposit, you’re able to withdraw contributions at any time, without paying taxes or a 10% early withdrawal penalty.

For example, if you’ve contributed $25,000 to a Roth over the last five years, and your investments have seen a 10% gain (or $2,500), you would have $27,500 in the account. But you could only withdraw up to $25,000 of your actual deposits.

Withdrawing any of the $2,500 in earnings would depend on your age and the 5-year rule.

The 5-Year Rule

What is the 5-year rule? You can withdraw Roth account earnings without owing tax or a penalty, as long as it has been at least five years since you first funded the account, and you are at least 59 ½. So if you start funding a Roth when you’re 60, you still have to wait five years to take qualified withdrawals.

The 5-year rule applies to everyone, no matter how old they are when they want to withdraw earnings from a Roth.

There are some exceptions that might enable you to avoid owing tax or a penalty.

Non-Qualified Withdrawals

Non-qualified withdrawals of earnings from a Roth IRA depends on your age and how long you’ve been funding the account.

•   If you meet the 5-year rule, but you’re under 59 ½, you’ll owe taxes and a 10% penalty on any earnings you withdraw, except in certain cases.

•   If you don’t meet the 5-year criteria, meaning you haven’t had the account for five years, and if you’re less than 59 ½ years old, in most cases you will also owe taxes and a 10% penalty.

There are some exceptions that might help you avoid paying a penalty, but you’d still owe tax on the early withdrawal of earnings.

Exceptions

Again, these restrictions apply to the earnings on your Roth contributions. (You can withdraw direct contributions themselves at any time, for any reason, tax and penalty free.)

You can take an early or non-qualified withdrawal prior to 59 ½ without paying a penalty or taxes, as long you’ve been actively making contributions for at least five years, in certain circumstances, including:

•   For a first home. You can take out up to $10,000 to pay for buying, building, or rebuilding your first home.

•   Disability. You can withdraw money if you qualify as disabled.

•   Death. Your heirs or estate can withdraw money if you die.

Additionally you can avoid the penalty, although you still have to pay income tax on the earnings, if you withdraw earnings for:

•   Medical expenses. Specifically, those that exceed 7.5% of your adjusted gross income.

•   Medical insurance premiums. During a time in which you’re unemployed.

•   Qualified higher education expenses.

Not only are the early withdrawal restrictions looser than with a traditional IRA, the post-retirement withdrawal restrictions are lesser, as well. Whereas account holders are required to start taking distribution of funds from their IRA after age 73, there is no pressure to take distribution from a Roth IRA at any age.

Roth IRA vs Traditional IRA

There are certain things a Roth IRA and a traditional IRA have in common, and several ways that they differ:

•   It’s an effective retirement savings plan: Though the plans differ in the tax benefits they offer, both are a smart way to save money for retirement.

•   Not an employer-sponsored plan: Individuals can open either type of IRA through a financial institution, and select their own investments or choose an automated portfolio.

•   Maximum yearly contribution: For 2023, the annual limit is $6,500, with an additional $1,000 allowed in catch-up contributions for individuals over age 50. For 2024 it’s $7,000, and $8,000 if you’re 50 and older.

There are also a number of differences between a Roth and a traditional IRA:

•   Roth IRA has income limits, but a traditional IRA does not.

•   Roth IRA contributions are not tax deductible, but contributions you make to a traditional, tax-deferred IRA are tax deductible.

•   Roth IRA has no RMDs. Individuals can withdraw money when they want, without the age limit imposed by a traditional IRA.

•   Roth IRA allows for penalty-free withdrawals before age 59 ½. While there are some restrictions, an account holder can typically withdraw contributions (if not earnings) before retirement.

Is a Roth IRA Right for You?

How do you know whether you should contribute to a Roth IRA or a traditional IRA? The quiz below or this checklist might help you decide.

•   You might want to open a Roth IRA if you don’t have access to an employer-sponsored 401(k) plan, or if you do have a 401(k) plan but you’ve already maxed out your contribution there. You can fund a Roth IRA and an employer-sponsored plan.

•   Because contributions are taxed immediately, rather than in retirement, using a Roth IRA can make sense if you are in a lower tax bracket or if you typically get a refund from the IRS. It may also make sense to open a Roth IRA if you expect your tax bracket to be higher in retirement than it is today.

•   Individuals who are in the beginning of their careers and earning less might consider contributing to a Roth IRA now, since they might not qualify under the income limits later in life.

•   A Roth IRA can be helpful if you think you’ll work past the traditional retirement age.

The Takeaway

A Roth IRA has many of the same benefits of a traditional IRA, with some unique aspects that can be attractive to some people saving for retirement. With a Roth IRA you don’t have to contend with required minimum distributions (RMDs); you can contribute to a Roth IRA at any age; and qualified withdrawals are tax free. With all that, a Roth IRA has a lot going for it.

That said, not everyone is eligible to fund a Roth IRA. You need to have earned income, and your annual household income cannot exceed certain limits. Also, even though you can withdraw your Roth IRA contributions at any time without owing a penalty, the same isn’t true of earnings.

You must have been funding your Roth for at least 5 years, and you must be at least 59 ½, in order to make qualified withdrawals of earnings. Otherwise, you would likely owe taxes on any earnings you withdraw — and possibly a penalty. Still, the primary advantage of a Roth IRA — being able to have an income stream in retirement that’s completely tax free — can outweigh some of the restrictions for certain investors.

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).


For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

Are Roth IRAs insured?

If your Roth IRA is held at an FDIC-insured bank and is invested in bank products like certificates of deposit (CDs) or money market account, those deposits are insured up to $250,000 per depositor, per institution. On the other hand, if your Roth IRA is with a brokerage that’s a member of the Securities Investor Protection Corporation (SIPC), and the brokerage fails, the SIPC provides protection up to $500,000, which includes a $250,000 limit for cash. It’s important to note that neither FDIC or SIPC insurance protects against market losses; they only cover losses due to institutional failures or insolvency.

How much can I put in my Roth IRA monthly?

For tax year 2023, the maximum you can deposit in a Roth or traditional IRA is $6,500, or $7,500 if you’re over 50. How you divide that per month is up to you. You just can’t contribute more than the annual limit.

Who can open a Roth IRA?

Anyone with earned income (i.e. taxable income) can open a Roth IRA, but your income must be within certain limits in order to fund a Roth.

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

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