Feb
27
2024
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Safe Harbor 401(k) Plan: What Is It? Is It for You?

By | Growing Wealth, Investing, Preparing for Retirement | Comments Off on Safe Harbor 401(k) Plan: What Is It? Is It for You?

Safe harbor 401(k) plans enable companies to avoid the annual IRS testing that comes with traditional 401(k) plans. With a safe harbor 401(k), an employer makes mandatory contributions to all employees’ retirement accounts, and those funds vest immediately.

Often a perk used to attract top talent, safe harbor 401(k) plans are a way for highly compensated employees, like company executives and owners, to save more than a traditional 401(k) plan would normally allow.

Keep reading to learn more about safe harbor rules, why companies use these plans, along with the benefits, drawbacks, and relevant deadlines.

Key Points

•   Like a traditional 401(k), a safe harbor 401(k) lets employees deposit tax-deferred funds from their paychecks into a retirement savings account.

•   Employers are required to contribute to employees’ safe harbor 401(k) accounts.

•   Employer contributions in a safe harbor 401(k) vest immediately. There is no waiting period.

•   Highly-paid employees can contribute more to a safe harbor 401(k) than a traditional 40(k).

•   Safe harbor 401(k) plans allow companies to skip the annual nondiscrimination regulatory testing required by the IRS for traditional 401(k)s.

What Is a Safe Harbor 401(k) Plan?

A 401(k) safe harbor plan is similar to a traditional 401(k) plan — but with a twist. In both cases, eligible employees can use the plan to contribute pre-tax funds to a retirement account and employers may contribute matching funds.

But with a traditional 401(k) retirement plan, companies must submit to annual nondiscrimination regulatory testing by the IRS to ensure that the company plan doesn’t treat highly compensated employees (HCEs) — generally defined as earning at least $150,000 in the 2023 tax year and $155,000 in the 2024 tax year and being in the company’s top 20% in pay, or owning more than 5% of the business — more favorably than others. The testing process is complex and can be a burden for some companies.

An alternative is to set up a safe harbor 401(k) plan with a safe harbor match. This allows a company to skip the annual IRS testing — and avoid imposing restrictions on employee saving — by providing the same 401(k) contributions to all employees, regardless of title, salary, or even years spent at the company. And those funds must vest immediately.

This is an important benefit, because in many cases, employer contributions to traditional 401(k) plans vest over time, requiring employees to stay with the company for some years in order to get the full value of the employer match. Often, if you leave before the employer contributions or match have vested, you may forfeit them.

For smaller companies, it may be worth making the extra safe harbor match contributions in order to avoid the time and expense of the IRS’s annual nondiscrimination testing. For larger companies, giving all employees the same percentage contribution could be expensive. But the upside is that highly paid employees can then make much larger 401(k) contributions without running afoul of IRS rules, a real perk for company leaders. In addition, 401(k) safe harbor plans are typically less expensive to set up than traditional plans.

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Traditional 401(k) vs Safe Harbor 401(k) Plans

While safe harbor 401(k)s and traditional 401(k) plans are similar in many ways, there are some important differences that employers should be aware of.

For instance, with traditional 401(k) plans, contributions from highly compensated employees can’t comprise more than 2% of the average of all other employee contributions, in addition to other restrictions. However, with safe harbor 401(k) plans, those limits don’t apply.

Comparing Plan Features and Benefits

Here is a side-by-side comparison of a safe harbor 401(k) vs. a traditional 401(k)

Safe Harbor 401(k) Traditional 401(k)
Employer contributions are required. Employer contributions are optional.
Employer contributions are vested immediately. Employer contributions may vest over time.
Highly-paid employees can contribute up to the $22,500 maximum in tax year 2023 and up to $23,000 in 2024. Highly-paid employees can be limited in how much they can contribute.
Companies do not have to do annual nondiscrimination testing. Companies must do annual nondiscrimination testing.

Choosing the Right Plan for Your Business

A safe harbor plan may be beneficial for some smaller companies that can’t afford the expense of nondiscrimination testing. In addition, the plan is simpler with less administrative tasks.

A company might also choose a safe harbor 401(k) if it has some key high-earning employees that make up a large share of the workforce.

However, if your company is able to easily manage the nondiscrimination testing process, you may want to opt for a traditional 401(k). A traditional 401(k) could also be a good option for business owners who want to try to retain employees over the long-term. They could set up a vesting schedule for employer contributions that requires employees to be with the company for three years before becoming fully vested, for instance.

Setting Up a Safe Harbor 401(k) Plan

For employers interested in using a safe harbor 401(k), there are some general rules and guidelines they will need to follow.

Requirements, Contribution Formulas, and Deadlines

To fulfill the safe harbor 401(k) requirements, the employer must make qualifying 401(k) contributions (a.k.a. the safe harbor match) that vest immediately. The company contributes to employees’ retirement accounts in one of three ways:

•   Non-elective: The company contributes the equivalent of 3% of each employee’s annual salary to a company 401(k) plan, regardless of whether the employee contributes.

•   Basic: The company offers 100% matching for the first 3% of an employee’s 401(k) plan contributions, plus a 50% match for up to 5% of an employee’s contributions.

•   Enhanced: The company offers a 100% company match for all employee 401(k) contributions, up to 4% of a staffer’s annual salary.

Companies that opt for a safe harbor 401(k) plan have to adhere to strict compliance filing deadlines. These are the dates worth knowing.

October 1: That’s the deadline for filing for a safe harbor 401(k) for the current calendar year. This deadline meets the government criteria of a company needing to have a safe harbor 401(k) in operation for at least three months in a 12 month period, for the first year operating a safe harbor plan.

December 1: By this date, all companies — whether they’re rolling out a brand new safe harbor plan or are administering an existing one — must issue a formal notice to employees that a safe harbor 401(k) will be offered to company staffers.

January 1: The date that all safe harbor 401(k) plans are activated. For companies that currently have no 401(k) plan at all, they can roll out either a traditional 401(k) plan or a safe harbor 401(k) plan at any point in the year, for that calendar year.

Advantages of Implementing a Safe Harbor 401(k) Plan

Safe harbor 401(k)s offer some distinct upsides for business owners and employees alike.

Benefits for Employers and Employees

By creating a safe harbor 401(k) plan, a business owner can potentially attract and maintain highly skilled employees. Employees are attracted to higher retirement plan contributions and the ability to optimize retirement plan contribution amounts, ensuring more money for long-term retirement savings.

Plus, a safe harbor 401(k) plan can also help business owners save money on the compliance end of the spectrum. For example, companies save on regulatory costs by avoiding the costs of preparing for a nondiscrimination test (and the staff hours and training that goes with it).

There are some additional upsides to offering a safe harbor 401(k) retirement plan, for higher paid employees and regular staff too.

•   Playing catch up. If a company owner, or high-level managers, historically haven’t stowed enough money away in a company retirement plan, a safe harbor 401(k) plan can help them catch up. The same may be true, although to a lesser degree, for regular employees.

•   The spread of profit. Suppose a company has a steady and robust revenue stream and is managed efficiently. In that case, company owners may feel comfortable “spreading the wealth” with not only high-profile talent but rank-and-file employees, too.

•   Encourage retirement savings. If a company is seeing weak contribution activity from its rank-and-file employees, it may feel more comfortable going the safe harbor route and at least guaranteeing minimum 401(k) contributions to employees while rewarding higher-value employees with more lucrative 401(k) plan contributions.

Disadvantages of Safe Harbor Plans

Safe harbor 401(k) plans have their downsides, too. Here are some drawbacks to consider.

Financial Implications for Employers

The matching contribution requirements for safe harbor 401(k)s can add up to a hefty expense, depending on employee salaries. And because employees are vested immediately, there’s no incentive to stay with the company for a certain period.

In addition, if a company introduces a safe harbor 401(k) plan, it must commit to it for one calendar year, no matter how the plan is performing internally. Even after a year, 401(k) plan providers (which administer and manage the retirement plans) may charge a termination fee if a company decides to pull the plug on its safe harbor plan after one year.

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Safe Harbor 401(k) Contribution Limits and Match Types

There are some different rules for employer contribution limits and matching with a safe harbor 401(k) vs. a traditional 401(k).

Understanding Contribution Limits

Just like traditional 401(k) plans, the maximum employee contribution limit for a safe harbor plan is $22,500 in 2023 and $23,000 in 2024. If you are over 50, you would be eligible for an additional $7,500 catch-up contribution, if your plan allows it.

But in a safe harbor plan, a company owner can reserve the maximum $22,500 (in 2023) and $23,000 in 2024 for their plan contribution and also boost contribution payments to valued team members up to an individual profit-sharing maximum amount of 100% of their compensation, or $66,000 in 2023 ($73,500 for those over age 50) — whichever is less. In 2024, that number is $69,000 (76,500 for those over age 50).

Regular employees are allowed the standard maximum contribution limit of $22,500 in 2023 and $23,000 in 2024, plus anyone over age 50 can contribute an extra “catch-up” amount of $7,500. Those are the same maximum contribution ceilings as regular 401(k) plans.

Different Types of Employer Matching Contributions

As mentioned earlier, with a safe harbor 401(k), an employer must make qualifying 401(k) contributions that vest immediately in one of these ways:

•   Non-elective: The company contributes the equivalent of 3% of each employee’s annual salary to a company 401(k) plan.

•   Basic: The company matches 100% for the first 3% of an employee’s 401(k) plan contributions, plus a 50% match for the following 2% of their contributions.

•   Enhanced: The company provides a 100% company match for all employee 401(k) contributions, up to 4% of a staffer’s annual salary.

IRS Compliance Testing and Safe Harbor Provisions

To help understand the benefit of safe harbor plans, it helps to see what employers with traditional 401(k) plans face in terms of following IRS rules and submitting to the annual nondiscrimination tests.

Navigating Non-Discrimination Testing

Each year, a company must conduct Actual Deferral Percentage (ADP), Actual Contribution Percentage (ACP), and Top Heavy tests to confirm there is no compensation discrimination.

If the company fails one of the tests, it could mean considerable administrative hassle, plus the expense of making corrections, and potentially even refunding 401(k) contributions.

Before explaining the details of each test, here’s a refresher on how the IRS defines highly compensated employees (HCEs) and non-highly compensated employees (NHCEs).

To be a HCE:

•   The employee must own more than 5% of the company at any time during the current or preceding year (directly or through family attribution).

•   The employee is paid over $150,000 in compensation from the employer for 2023 and $155,000 in 2024. The plan can limit these employees to the top 20% of employees who make the most money.

Employees who don’t fit these criteria are considered non-highly compensated. The nondiscrimination tests are designed to assess whether top employees are saving substantially more than the rank-and-file staffers.

•   The Actual Deferral Percentage (ADP) test measures how much income highly paid employees contribute to their 401(k), versus staff employees.

•   The Actual Contribution Percentage (ACP) test compares employer retirement contributions to HCEs versus the contributions to everyone else.

According to the IRS, the terms of the ADP test — which compares the amounts different employees are saving in their 401(k)s — are met if the ADP for highly compensated employees (HCE) doesn’t exceed the greater of:

•   125% of the deferral percentage for ordinary, i.e., non-highly compensated employees (NHCEs)

Or the lesser of:

•   200% of the deferral percentage for the NHCEs

•   or the deferral percentage for the NHCEs plus 2%.

The ACP test is met if the deferral percentage for highly compensated employees doesn’t exceed the greater of:

•   125% of the deferral percentage for the NHCEs,

Or the lesser of:

•   200% of the deferral percentage for the group of NHCEs

•   or the deferral percentage for the NHCEs plus 2%.

Last, the top-heavy test measures the value of the assets in all company 401(k) accounts, total. If the 401(k) balances of “key employees” account for more than 60% of total plan assets, the 401(k) would fail the top heavy test. The IRS defines key employees somewhat differently than highly compensated employees, although both groups are similar in that they earn more than ordinary staff.

As you can see, maintaining a traditional 401(k) plan, and meeting these requirements each year, can be a burden for some companies. Fortunately, by setting up a safe harbor 401(k) plan, a company can avoid the annual nondiscrimination tests and still provide a 401(k) savings plan for employees.

The Takeaway

Companies that don’t want the regulatory obligations of a traditional 401(k) plan, and would like to prioritize talent acquisition and employee retention may want to consider safe harbor 401(k) plans.

However, a business owner needs to weigh the pros and cons of a safe harbor 401(k) plan because, in some cases, it can be expensive for a company to maintain.

But no matter what type of 401(k) an employer decides to go with, having a retirement plan in place, with different savings and investment options, can help employees — and business owners themselves — save for the future.

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FAQ

Is a safe harbor 401(k) worth it?

Whether a safe harbor 401(k) is worth it depends on the goals of the business owner. A safe harbor 401(k) allows a company to skip the expense of nondiscrimination testing. And by creating a safe harbor 401(k) plan, a business owner may be able to attract and maintain highly skilled employees because of the higher contributions. However, the matching employer contribution requirements can add up to a high expense. A business owner needs to weigh the pros and cons of these plans.

Can I cash out my safe harbor 401(k)?

You can withdraw safe harbor 401(k) funds without penalty at age 59 ½ or if you leave your job. However, hardship withdrawals for immediate and heavy financial need may be allowed in certain circumstances. You can learn more at irs.gov.

Why would a company use a safe harbor 401(k)?

A company might use a safe harbor 401(k) to avoid the expense of nondiscrimination testing and to simplify the administration of a 401(k) plan. They might also use a safe harbor 401(k) to help attract and keep highly skilled employees.

What is an example of a safe harbor 401(k) match?

If an employer with a safe harbor 401(k) chooses to offer non-elective matching contributions, that means they contribute at least 3% of each employee’s annual salary. So if an employee makes $70,000 a year, for example, the employer would contribute $2,100 to their safe harbor 401(k) account.

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Feb
26
2024

Guide to Tax-Loss Harvesting

By | Investing, Terminology | Comments Off on Guide to Tax-Loss Harvesting

Tax-loss harvesting enables investors to use investment losses to help reduce the tax impact of investment gains, thus potentially lowering the amount of taxes owed. While a tax loss strategy – sometimes called tax loss selling — is often used to offset short-term capital gains (which are taxed at a higher federal tax rate), tax-loss harvesting can also be used to offset long-term capital gains.

Of course, as with anything having to do with investing and taxes, tax-loss harvesting is not simple. In order to carry out a tax-loss harvesting strategy, investors must adhere to specific IRS rules and restrictions. Here’s what you need to know.

What Is Tax-Loss Harvesting?

Tax-loss harvesting is a strategy that enables an investor to sell assets that have dropped in value as a way to offset the capital gains tax they may owe on the profits of other investments they’ve sold. For example, if an investor sells a security for a $25,000 gain, and sells another security at a $10,000 loss, the loss could be applied so that the investor would only see a capital gain of $15,000 ($25,000 – $10,000).

This can be a valuable tax strategy for investors because you owe capital gains taxes on any profits you make from selling investments, like stocks, bonds, properties, cars, or businesses. The tax only hits when you profit from the sale and realize a profit, not for simply owning an appreciated asset.

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How Tax-Loss Harvesting Works

In order to understand how tax-loss harvesting works, you first have to understand the system of capital gains taxes.

Capital Gains and Tax-Loss Harvesting

As far as the IRS is concerned, capital gains are either short term or long term:

•   Short-term capital gains and losses are from the sale of an investment that an investor has held for one year or less.

•   Long-term capital gains and losses are those recognized on investments sold after one year.

Understanding Short-Term Capital Gains Rates

The one-year mark is crucial, because the IRS taxes short-term investments at the investor’s much-higher marginal or ordinary income tax rate. There are seven ordinary tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.

For high earners, gains can be taxed as much as 37%, plus a potential 3.8% net investment income tax (NIIT), also known as the Medicare tax. That means the taxes on those quick gains can be as high as 40.8% — and that’s before state and local taxes are factored in.

Understanding Long-Term Capital Gains Rates

Meanwhile, the long-term capital gains taxes for an individual are simpler and lower. These rates fall into three brackets, according to the IRS: 0%, 15%, and 20%. Here are the rates for tax year 2023, per the IRS.

The following table breaks down the long-term capital-gains tax rates for the 2023 tax year (for taxes that are filed in 2024) by income and filing status.

Capital Gains Tax Rate

 Income – Single

 Married, filing separately

 Head of household

 Married, filing jointly
0% Up to $44,625 Up to $44,625 Up to $59,750 Up to $89,250
15% $44,626 – $492,300 $44,626 – $276,900 $59,751 – $523,050 $89,251 – $553,850
20% More than $492,300 More than $276,900 More than $523,050 More than $553,850

Source: Internal Revenue Service

So if you’re an individual filer, you won’t pay capital gains if your total taxable income is $44,625 or less. But if your income is between $44,626 to $492,300, your investment gains would be subject to a 15% capital gains rate. The rate is 20% for single filers with incomes over $492,300.

As with all tax laws, don’t forget the fine print. As noted above, the additional 3.8% NIIT may apply to single individuals with a modified adjusted gross income (MAGI) of $200,000 or married couples with a MAGI of at least $250,000.

Also, long-term capital gains from sales of collectibles (e.g, coins, antiques, fine art) are taxed at a maximum of 28% rate. This is separate from regular capital gains tax, not in addition to it.

Short-term gains on collectibles are taxed at the ordinary income tax rate, as above.

Recommended: Everything You Need to Know About Taxes on Investment Income

Rules of Tax-Loss Harvesting

The upshot is that investors selling off profitable investments can face a stiff tax bill on those gains. That’s typically when investors (or their advisors) start to look at what else is in their portfolios. Inevitably, there are likely to be a handful of other assets such as stocks, bonds, real estate, or different types of investments that lost value for one reason or another.

While tax-loss harvesting is typically done at the end of the year, investors can use this strategy any time, as long as they follow the rule that long-term losses apply to long-term gains first, and short-term losses to short-term gains first.

Bear in mind that although a capital loss technically happens whenever an asset loses value, it’s considered an “unrealized loss” in that it doesn’t exist in the eyes of the IRS until an investor actually sells the asset and realizes the loss.

The loss at the time of the sale can be used to count against any capital gains made in a calendar year. Given the high taxes associated with short-term capital gains, it’s a strategy that has many investors selling out of losing positions at the end of the year.

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Tax-Loss Harvesting Example

If you’re wondering how tax-loss harvesting works, here’s an example. Let’s say an investor is in the top income tax bracket for capital gains. If they sell investments and realize a long-term capital gain, they would be subject to the top 20% tax rate; short-term capital gains would be taxed at their marginal income tax rate of 37%.

Now, let’s imagine they have the following long- and short-term gains and losses, from securities they sold and those they haven’t:

Securities sold:

•   Stock A, held for over a year: Sold, with a long-term gain of $175,000

•   Mutual Fund A, held for less than a year: Sold, with a short-term gain of $125,000

Securities not sold:

•   Mutual Fund B: an unrealized long-term gain of $200,000

•   Stock B: an unrealized long-term loss of $150,000

•   Mutual Fund C: an unrealized short-term loss of $80,000

The potential tax liability from selling Stock A and Mutual Fund A, without tax-loss harvesting, would look like this:

•   Tax without harvesting = ($175,000 x 20%) + ($125,000 x 37%) = $35,000 + $46,250 = $81,250

But if the investor harvested losses by selling Stock B and Mutual Fund C (remember: long-term losses apply to long-term gains and short term losses to short term gains first), the tax picture would change considerably:

•   Tax with harvesting = (($175,000 – $150,000) x 20%) + (($125,000 – $80,000) x 37%) = $5,000 + $16,650 = $21,650

Note how the tax-loss harvesting strategy not only reduces the investor’s tax bill, but potentially frees up some money to be reinvested in similar securities (restrictions may apply there; see information on the wash sale rule below).

💡 Quick Tip: It’s smart to invest in a range of assets so that you’re not overly reliant on any one company or market to do well. For example, by investing in different sectors you can add diversification to your portfolio, which may help mitigate some risk factors over time.

Considerations Before Using Tax-Loss Harvesting

As with any investment strategy, it makes sense to think through a decision to sell just for the sake of the tax benefit because there can be other ramifications in terms of your long-term financial plan.

The Wash Sale Rule

For example, if an investor sells losing stocks or other securities they still believe in, or that still play an important role in their overall financial plan, then they may find themselves in a bind. That’s because a tax regulation called the wash sale rule prohibits investors from receiving the benefit of the tax loss if they buy back the same investment too soon after selling it.

Under the IRS wash sale rule, investors must wait 30 days before buying a security or another asset that’s “substantially identical” to the one they just sold. If they do buy an investment that’s the same or substantially identical, then they can’t claim the tax loss.

For an investment that’s seen losses, that 30-day moratorium could mean missing out on growth — and the risk of buying it again later for a higher price.

Matching Losses With Gains

A point that bears repeating: Investors must also be careful which securities they sell. Under IRS rules, like goes with like. So, long-term losses must be applied to long-term gains first, and the same goes for short-term losses and short-term gains. After that, any remaining net loss can be applied to either type of gain.

How to Use Net Losses

The difference between capital gains and capital losses is called a net capital gain. If losses exceed gains, that’s a net capital loss.

•   If an investor has an overall net capital loss for the year, they can deduct up to $3,000 against other kinds of income — including their salary and interest income.

•   Any excess net capital loss can be carried over to subsequent years and deducted against capital gains, and up to $3,000 of other kinds of income — depending on the circumstances.

•   For those who are married filing separately, the annual net capital loss deduction limit is only $1,500.

How to Use Tax-Loss Harvesting to Lower Your Tax Bill

When an investor has a diversified portfolio, every year will likely bring investments that thrive and others that lose money, so there can be a number of different ways to use tax-loss harvesting to lower your tax bill. The most common way, addressed above, is to apply capital losses to capital gains, thereby reducing the amount of tax owed. Here are some other strategies:

Tax-Loss Harvesting When the Market Is Down

For investors looking to invest when the market is down, capital losses can be easy to find. In those cases, some investors can use tax-loss harvesting to diminish the pain of losing money. But over long periods of time, the stock markets have generally gone up. Thus, the opportunity cost of selling out of depressed investments can turn out to be greater than the tax benefit.

It also bears remembering that many trades come with trading fees and other administrative costs, all of which should be factored in before selling stocks to improve one’s tax position at the end of the year.

Tax-Loss Harvesting for Liquidity

There are years when investors need access to capital. It may be for the purchase of a dream home, to invest in a business, or because of unforeseen circumstances. When an investor wants to cash out of the markets, the benefits of tax-loss harvesting can really shine.

In this instance, an investor could face bigger capital-gains taxes, so it makes sense to be strategic about which investments — winners and losers — to sell by year’s end, and minimize any tax burden.

Tax-Loss Harvesting to Rebalance a Portfolio

The potential benefits of maintaining a diversified portfolio are widely known. And to keep that portfolio properly diversified in line with their goals and risk tolerance, investors may want to rebalance their portfolio on a regular basis.

That’s partly because different investments have different returns and losses over time. As a result, an investor could end up with more tech stocks and fewer energy stocks, for example, or more government bonds than small-cap stocks than they intended.

Other possible reasons for rebalancing are if an investor’s goals change, or if they’re drawing closer to one of their long-term goals and want to take on less risk.

That’s why investors check their investments on a regular basis and do a tune-up, selling some stocks and buying others to stay in line with the original plan. This tune-up, or rebalancing, is an opportunity to do some tax-loss harvesting.

How Much Can You Write Off on Your Taxes?

If capital losses exceed capital gains, under IRS rules investors can then deduct a portion of the net losses from their ordinary income to reduce their personal tax liability. Investors can deduct the lesser of $3,000 ($1,500 if married filing separately), or the total net loss shown on line 21 of Schedule D (Form 1040).

In addition, any capital losses over $3,000 can be carried forward to future tax years, where investors can use capital losses to reduce future capital gains. This is known as a tax loss carryforward. So in effect, you can carry forward tax losses indefinitely.

To figure out how to record a tax loss carryforward, you can use the Capital Loss Carryover Worksheet found on the IRS’ Instructions for Schedule D (Form 1040).

Benefits and Drawbacks of Tax-Loss Harvesting

While tax-loss harvesting can offer investors some advantages, it comes with some potential downsides as well.

Benefits of Tax-Loss Harvesting

Obviously the main point of tax-loss harvesting is to reduce the amount of capital gains tax on profits after you sell a security.

Another potential benefit is being able to literally cut some of your losses, when you sell underperforming securities.

Tax-loss harvesting, when done with an eye toward an investor’s portfolio as a whole, can help with balancing or rebalancing (or perhaps resetting) their asset allocation.

As noted above, investors often sell off assets when they need cash. Using a tax-loss harvesting strategy can help do so in a tax-efficient way.

Drawbacks of Tax-Loss Harvesting

While selling underperforming assets may make sense, it’s important to vet these choices as you don’t want to miss out on the gains that might come if the asset bounces back.

Another of the potential risks of tax-loss harvesting is that if it’s done carelessly it can leave a portfolio imbalanced. It might be wise to replace the securities sold with similar ones, in order to maintain the risk-return profile. (Just don’t run afoul of the wash-sale rule.)

Last, it’s possible to incur excessive trading fees that can make a tax-loss harvesting strategy less efficient.

Pros of Tax-Loss Harvesting Cons of Tax-Loss Harvesting
Can lower capital gains taxes Investor might lose out if the security rebounds
Can help with rebalancing a portfolio If done incorrectly, can leave a portfolio imbalanced
Can make a liquidity event more tax efficient Selling assets can add to transaction fees

Creating a Tax-Loss Harvesting Strategy

Interested investors may want to create their own tax-loss harvesting strategy, given the appeal of a lower tax bill. An effective tax-loss harvesting strategy requires a great deal of skill and planning.

It’s important to take into account current capital gains rates, both short and long term. Investors would be wise to also weigh their current asset allocation before they attempt to harvest losses that could leave their portfolios imbalanced.

All in all, any strategy should reflect your long-term goals and aims. While saving money on taxes is important, it’s not the only rationale to rely on for any investment strategy.

The Takeaway

Tax loss harvesting, or selling off underperforming stocks and then potentially getting a tax reduction for the loss, can be a helpful part of a tax-efficient investing strategy.

There are many reasons an investor might want to do tax-loss harvesting, including when the market is down, when they need liquidity, or when they are rebalancing their portfolio. It’s an individual decision, with many considerations for each investor — including what their ultimate financial goals might be.

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).

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FAQ

Is tax-loss harvesting really worth it?

When done carefully, with an eye toward tax efficiency as well as other longer-term goals, tax-loss harvesting can help investors save money that they can invest for the long term.

Does tax-loss harvesting reduce taxable income?

Yes. The point of tax-loss harvesting is to reduce income from investment gains (profits). But also when net losses exceed gains, the strategy can reduce your taxable income by $3,000 per year.

Can you write off 100% of investment losses?

It depends. Investment losses can be used to offset a commensurate amount in gains, thereby lowering your potential capital gains tax bill. If there are still net losses that cannot be applied to gains, up to $3,000 per year can be applied to reduce your ordinary income. Net loss amounts in excess of $3,000 would have to be carried forward to future tax years.

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.

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

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.

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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Feb
22
2024
scale

Overweight Stock, Explained

By | Growing Wealth, invest, Investing, Terminology | Comments Off on Overweight Stock, Explained

When a financial analyst rates a stock as overweight, it means that the analyst believes an overweight stock will likely outperform other stocks in its industry over the next six to 12 months. Conversely, if they describe a stock as underweight, they believe that it will perform poorly in the future.

It may be helpful to think of these terms as pointers: as if an industry specialist were saying, “You might want to overweight Stock X in your portfolio” or “maybe you should under-weight Stock Y.” These ratings are typically the result of factors in the news or pertaining to a specific company’s prospects. But the terms “overweight” and “underweight” also refer to a stock’s weighting in a relevant index or benchmark.

What Is an Overweight Stock?

As noted, an overweight stock is one that analysts believe will outperform others in its sector or market segment in the near future. Similarly, overweight stock is a moniker that may also describe a specific security’s weighting in a portfolio, and one that analysts think investors should buy more of – so, its meaning can be contextual in certain situations.

💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

Types of Ratings and Where They Came From

To understand stock ratings related to weight, it’s important to know that market indexes assign a weight to the investments they track to be sure that the index accurately reflects the performance of that market sector.

For example, the S&P 500® tracks 500 large-cap U.S. companies. The companies in the index — called the constituents — are weighted by market capitalization. A company’s market cap is calculated by multiplying the current share price by the total number of outstanding shares.

Companies in that index are weighted based on the proportion of the overall index their market cap represents. Other indexes may use a different weighting system. The Dow Jones Industrial Average, for example, tracks 30 blue chip companies and weights them based on stock price. Companies with a higher share price are given more weight than those with lower prices.

Because of these different weighting systems, it’s important to understand that an overweight to a particular stock with regards to one index may not be the same when it comes to another.

Overweight Stocks

When an analyst rates Stock X as overweight, it’s generally a positive sign. First, they believe Stock X is likely to outperform its benchmark index, or even the market as a whole, depending on market conditions, so investors should consider holding more of the stock.

Bear in mind that an “overweight stock” rating doesn’t necessarily mean that stock is a juggernaut. In a down market, being overweight could simply mean the company might not lose as much ground as its peers, or it might grow less slowly than its peers.

Underweight Stocks

When an analyst rates Stock Y as underweight, the analyst believes that Stock Y is likely to underperform its benchmark, and investors should consider holding less of this stock.

Equal Weight Stocks

When an analyst gives an equal weight rating to a stock, that simply means it’s in line with the overall benchmark. Again, when considering these ratings it’s important to keep in mind the overall context of the market, and what these ratings mean to analysts.

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Example of an Overweight Stock

A very simple example of an overweight stock could be when a stock, Stock X, is selling for $50, but experts and analysts think it’s undervalued and should trade for $75, it could be overweight.

Further, an overweight stock rating can be taken in two ways: First, that the stock will outperform its benchmark index and second that investors may want to take advantage of the increase in price.

When an analyst indicates their belief that a stock will appreciate, they may also state a potential time frame and price target for the stock. So, if Stock X is trading at $75 per share, and the company releases new earnings data that’s positive, an analyst might rate the stock as overweight, with a price target of $100 per share in the coming year.

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The Downside of Weighting Stocks

One critique of this rating system is that no analyst, of course, can recommend how many shares investors should buy. It’s simply not possible for analysts to know whether Investor A’s portfolio might benefit from an additional 100 shares of Stock X, while Investor B might want to buy 1,000 shares of Stock X.

As a result, it’s incumbent on individual investor’s themselves to keep an eye on how relevant an overweight stock rating might be for their specific allocation. Buying more of Stock X could, in theory, create an imbalance and reduce a portfolio’s overall diversification. So while an overweight stock might be a good thing, an overweight portfolio usually is not.

How Can Investors Interpret Overweight Stocks?

At first glance, the terms overweight and underweight may seem more or less synonymous with “buy” and “sell” — in that case, why don’t analysts use these more straightforward terms?

In fact, the terms overweight and underweight do have a slightly different connotation than simply to buy or sell a security. Rather, the terms suggest a recommendation that a portfolio hold more or less of a particular position than an index or other benchmarks would suggest.

It may mean acquiring more, or selling some, of a particular investment. But it wouldn’t necessarily mean buying something new or selling all of a position. For example, if your portfolio has an allocation to tech stocks, and an analyst recommends overweighting one of those stocks, you may want to buy more of that company. Or you may not need more growth in your tech holdings, so you might look for an overweight stock.

Also, analysts aren’t always comfortable giving specific directions to buy or sell certain securities. The terms overweight and underweight are more like offering guidance: “Here’s what I think of Stock X or Stock Y. I’ll let the investor take it from here.”

In many cases an overweight or underweight recommendation might not be very useful for investors. For example, if an analyst recommends an overweight to a certain commodity but an investor’s portfolio doesn’t hold any commodities, this information may not have much bearing on their situation.

Can a Portfolio Be Considered Overweight?

Overweight can refer to a portfolio that holds more of a stock or other investments than it theoretically should. For individual investors, this might mean that more of a portfolio is allocated to stock than the investor intended.

For example, say an investor has a portfolio allocation in which 70% of its allocation is held in stock and 30% is held in bonds. If the stock market goes up, the proportion of the portfolio held in stock may grow beyond the 70% mark. At that point, the portfolio may be described as overweight in stocks, and an investor may want to rebalance to bring it in line with their initial allocation plan.

It may come as no surprise that the opposite of an overweight allocation is an underweight allocation. For example, if the stock allocation in the portfolio above fell below 70%, that allocation could be described as underweight in stocks.

The term can also apply in a narrower sense. For example, a stock portfolio could hold too much stock in one company, sector, or geographical region. In each case the holding could be described as overweight.

Professional fund managers may also use overweight to describe portfolios they work with that are off track with their index, including mutual funds, exchange-traded funds, and index funds. From time to time, a fund may get out of line with its benchmark index by holding more or less of an investment that index tracks.

For example, say an index fund is built to track the S&P 500. To track the index, fund managers will usually attempt to hold every stock in the index. Additionally, they will try to match the proportion of each individual company their fund holds to the index as well. So if stock A represents 5% of the original index, the fund will also hold 5% of stock A.

Some funds have a little bit of wiggle room in terms of how far they can stray from the index. Some might be allowed to hold more or less stocks if they think the stocks will outperform or underperform. When they hold more than the index, the managers are taking an overweight position. And when they hold less than the index, the managers are taking an underweight position.

The Takeaway

Overweight stocks are those that may be undervalued by the market. When an analyst gives a stock an overweight rating, broadly speaking it could be a good thing. If the analyst is correct, and the stock is indeed poised to perform better than its benchmark — maybe even better than the market as a whole — investors may want to buy that stock.

But the necessary caveat is that it all depends on context — the context of the market, and the context of an investor’s portfolio overall. You don’t want to buy a stock that could throw your allocation off, and make your portfolio overweight in a way that’s not ideal.

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

Is overweight stock good?

An overweight stock can be good for investors looking for a relative deal, but it may not be a good thing if the investor already owns shares of the stock.

What is the difference between overweight and outperform stocks?

Outperform stocks and overweight stocks are similar, and the terms are often used interchangeably. But generally, “outperform” may describe a stock that’s undervalued or expected to offer solid returns in the future, but perhaps perform not quite as well as an “overweight” stock.

What is the difference between buy and overweight?

On an analysts’ rating system, “buy” and “overweight” stocks are rated differently, with “buy” being a higher rating – though both ratings are positive.

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.

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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Feb
21
2024
A Guide to Callable Bonds

Callable Bonds (or Redeemable Bonds), Explained

By | Growing Wealth, invest, Investing | Comments Off on Callable Bonds (or Redeemable Bonds), Explained

Callable bonds give issuers the option to redeem the bond before it matures. They’re also referred to as redeemable bonds. Bond investors lend their money to entities or issuers for a certain period of time and in return investors receive interest on the principal. These entities typically return the borrowed principle to the bond investors by the bond’s maturity date.

An exception to this process of bond investing is using callable bonds, which allows the issuer to pay off its loans early by buying back its bonds before they reach their date of maturity. You can define a callable bond as one with a built-in call option.

What Is a Callable Bond?

Callable bonds, also referred to as redeemable bonds, allow the issuer the right, but not the obligation, to redeem the bond before it reaches its maturity date. The entity that issues callable bonds has the right to prepay, or in other words, the bond is callable before its maturity date.

Issuers may use callable bonds when they expect interest rates to fall. That way, they can redeem their bonds and issue new ones at a lower coupon rate, reducing their overall interest expenses.


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How Do Callable Bonds Work?

When the issuer calls the bond, it pays investors the call price or the face value of the bond, along with the accrued interest to date. After that, the issuer no longer has to make payments on the bond.

Businesses may prefer callable bonds, since they have built-in flexibility that could lower costs in the future. For example, if market rates are 5% when a company first issues its bonds but they drop to 2.5%, a bond issuer paying 5% would call their bonds and get new ones at 2.5%.

Some bonds have call protection which forbids the issuer to buy it back for a certain period of time. During this period, the company can not call their bonds. However, at the end of this period, the issuer can redeem the bond at its specified call date.

Callable bond prices correlate to interest rates, since falling interest rates make callable bonds less valuable.

Finding the Value of Callable Bonds

The main difference between a non-callable bond and a callable bond is that a callable bond has the call option feature. This feature impacts the calculation of the value of the bond. To find the value of callable bonds, take the bond’s coupon rate and add 1 to it.

For example, a callable bond with a 7% coupon would be 1.07. Next, raise 1.07 to the number of years until the bond is callable. If the bond is callable in two years, you would raise 1.07 to the power of two, which would be 1.1449. Then, multiply that number by the bond’s par value or face value.

If the bond’s par value is $10,000, you would multiply $10,000 by 1.1449 to get 11,449, which is the value of the callable bond.

Recommended: How to Buy Bonds: A Guide for Beginners

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Types of Callable Bonds

Bonds have different types of issuers. Municipalities and corporations both may issue callable bonds. Here’s a look at three common types of callable bonds.

1. Optional Redemption Callable Bonds

Some municipal bonds have a redeemable option 10 years after the issue of the bond was issued. However, bonds with higher yields might have a protection or waiting period according to the bond’s maturity date. For example, a five-year bond might not be able to be recalled until two years after it is issued.

2. Sinking Fund Redemption Callable Bonds

This requires the issuer to recall a certain amount or all of the bonds according to a fixed schedule. A sinking fund is money that a company reserves on the side to pay off a bond.

3. Extraordinary Redemption Callable Bonds

Extraordinary redemption is when the issuer recalls the bond before maturity if certain specified events in the bond contract occur such as a business scenario that impacts bond revenue.

Callable Bond Example

A callable bond with a par value of $1,000 and a 5% coupon rate issued on January 1, 2022 has a maturity date of January 1, 2030. The annual interest payments investors would receive is $50. This bond has a protection feature which doesn’t allow the issuer to recall the bond until January 1, 2026, but after that date, the bond can be redeemed.

The issuer believes interest rates will decrease within the next four years and decides to recall the bond on January 1, 2026. If the investor bought the callable bond through their broker at its $1,000 par value, and the issuer chooses to redeem it when the protection period expires in 2026, they would calculate the value of the callable bond as follows:

•   Take the coupon rate and add 1 to it, to make 1.05.

•   Next, multiply 1.05 to the fourth power since the issuer will hold on to it for four years.

•   This calculation will yield 1.2155.

•   Next, multiply 1.255 by the bond’s par value of $1,000 to get $1,215, the value of the callable bond.

Interest and Callable Bonds

From the perspective of the callable bond issuer, falling interest rates are an opportunity to recall your bonds and lower your interest rate. While the investor is compensated at the outset with a higher yield or coupon rate for investing in callable bonds, they must be aware of the added risks associated with this investment.

If interest rates stay the same or increase, there’s a lower chance the issuer will recall its bonds. But if investors believe interest rates will drop prior to the bond’s maturity date, they should be compensated for this additional risk. The investor must determine if the higher yield from callable bonds is worth the risk of investment because the call feature is an advantage to the issuer, not the investor.


💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

Pros and Cons of Callable Bonds

Like any other investment, callable bonds have benefits and risks. It’s important to keep in mind the pros and cons of investing in callable bonds when considering a long-term investing strategy.

Callable bonds are financial instruments that may carry more risk for investors than noncallable bonds (bonds only paid out at maturity) because there is the chance of the bond being called prior to it reaching maturity.

Pros

 Cons
Companies issue callable bonds at higher interest rates to compensate for the risk of early redemption. This means the possibility of greater investment returns. If an issuer calls its bonds early as a result of lower interest rates, bond investors risk not being able to find bonds with lower coupon rates. This could pose a challenge for income-seeking investors who want a reliable stream of passive income from bond investing.
One of the benefits of callable bonds is the option to call the bond early. Instead of waiting until the bond reaches maturity, the issuer can recall the bond earlier to suit their financial business needs. Callable bond investors who pay a premium, or more than a bond’s face value risk only getting back the face value of the bond. This means the investor would lose their money on the premium they already paid.
Callable bonds have benefits that mostly favor the issuer. When interest rates fall, the company can redeem the bonds early and issue new bonds at a lower rate to save on interest payments. Another risk is the bond’s maturity. The longer it takes for the bond to mature, the greater the likelihood for the bond to be called early, especially if there is a change in interest rates. Investing in bonds with a shorter maturity date carries lower interest rate risk.

The Takeaway

Again, callable bonds give issuers the option to redeem the bond before it matures. They’re also referred to as redeemable bonds. Callable bond investors lend their money to entities or issuers for a certain period of time and in return investors receive interest on the principal.

Some investors might consider buying callable bonds as one way to diversify an investment portfolio or to achieve higher yield, however, it’s important for investors to keep the risks associated with this investment top of mind. In an environment where interest rates are falling, callable bonds may not work for long-term investors looking for income.

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 callable bonds a good investment?

Callable bonds may be a good investment depending on an investor’s strategy, risk tolerance, and time horizon, but the overriding interest rate environment may also determine how good of an investment they are as well.

What does it mean if a bond is callable?

If a bond is callable, it means that bonds can be redeemed or paid off by their issuer before they reach their maturity date.

What is the call rule on a callable bond?

The call rule on callable bonds refers to the ability of a bond to be redeemed or repaid by its issuer prior to its maturity date.

What happens to callable bonds when interest rates rise?

When interest rates rise, callable bonds are less likely to be called, though there are no guarantees.

Are callable bonds cheaper?

Generally, callable bonds tend to be less expensive than normal bonds because of the call option, which are of value to their issuer, and may lead to a relative discount for the buyer.

Do callable bonds have higher yields?

Callable bonds do tend to have higher yields, but often not greatly so, and there’s no guarantee that the yields would be higher than those of other types of bonds.

Photo credit: iStock/undefined undefined

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.

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

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.

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.

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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Feb
20
2024

How Much a $1 Million Mortgage Will Cost You

By | Family Finances, Home Ownership, mortgage | Comments Off on How Much a $1 Million Mortgage Will Cost You

What is the monthly payment on a $1 million mortgage at recent interest rates? If we remove property taxes, property insurance, and mortgage insurance from the equation, you can expect to spend between $6,653 and $8,988 a month on principal and interest alone depending on which loan term you choose. But that’s not the whole story. There’s more you’ll need to know about a $1 million mortgage payment.

Cost of a $1 Million Mortgage

The cost of a $1 million mortgage varies depending on which home mortgage loan you choose and a few other factors, such as interest rate and property taxes. As you may know, different types of mortgage loans have different expenses, such as mortgage insurance, which can change your monthly payment.

Monthly Payments for a $1 Million Mortgage

The monthly payment on a $1 million mortgage is influenced by a variety of factors, which include:

•   Interest rate

•   Fixed vs variable interest rate

•   Mortgage insurance

•   Property insurance

•   Loan term

•   Type of loan

•   Property taxes

Removing all variables except a 7% interest rate, a $1 million mortgage payment would be between $6,653 and $8,988 per month. If you’re a first time home buyer considering a $1 million mortgage, make sure you understand the true cost of buying and owning a home. Remember that your property taxes and some insurance costs may be dictated by your home’s location. (You may want to analyze the cost of living by state. Some of the best affordable places to live in the U.S. may surprise you.)

If these variables are new to you, a home loan help center may smooth out any confusion you may have.

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Where to Get a $1 Million Mortgage

You can get a $1 million mortgage with mortgage lenders such as banks, credit unions, and online lenders. However, they’ll need to offer jumbo home loans since $1 million exceeds the conventional loan limit of $766,550 in most areas. When comparing lenders, look at both interest rates and fees. Loan origination fees, in particular, can vary greatly between lenders.


💡 Quick Tip: A major home purchase may mean a jumbo loan, but it doesn’t have to mean a jumbo down payment. Apply for a jumbo mortgage with SoFi, and you could put as little as 10% down.

What to Consider Before Applying for a $1 Million Mortgage

The monthly payment for a $1 million mortgage isn’t the only thing you should consider. Also keep in mind the total amount you’ll spend on interest for each loan term. For a 30-year loan with a 7% interest rate, you’ll spend $1,395,086 on interest. If you opt for a 15-year loan, you’ll spend just $617,890. This means if you can afford a 15-year loan, you’ll save $777,196.

While you’re home shopping, use a mortgage calculator to see the amount of money you’ll spend monthly and over the life of the loan. You may also want to use a home affordability calculator to incorporate your monthly debts and spending habits into the equation. While you may be able to technically afford a large monthly payment, would the expense leave room for dining out, vacations, and retirement contributions?

During the early years of your mortgage loan, more of your monthly payment typically goes toward paying off the interest on the loan, with a smaller proportion paying down the principal you owe. An amortization schedule shows how the proportions shift and you build equity more quickly in the second half of the loan term. Here are sample schedules for 30-year and 15-year loan terms:

Amortization Schedule, 30-year, 7%

Year Beginning Balance Monthly Payment Total Interest Paid Total Principal Paid Remaining Balance
1 $1,000,000 $6,653.02 $69,678.20 $10,158.10 $989,841.90
2 $989,841.90 $6,653.02 $68,943.87 $10,892.43 $978,949.47
3 $978,949.47 $6,653.02 $68,156.46 $11,679.84 $967,269.63
4 $967,269.63 $6,653.02 $67,312.12 $12,524.18 $954,745.45
5 $954,745.45 $6,653.02 $66,406.75 $13,429.55 $941,315.90
6 $941,315.90 $6,653.02 $65,435.92 $14,400.38 $926,915.52
7 $926,915.52 $6,653.02 $64,394.92 $15,441.38 $911,474.14
8 $911,474.14 $6,653.02 $63,278.66 $16,557.64 $894,916.50
9 $894,916.50 $6,653.02 $62,081.71 $17,754.59 $877,161.91
10 $877,161.91 $6,653.02 $60,798.23 $19,038.07 $858,123.83
11 $858,123.83 $6,653.02 $59,421.96 $20,414.34 $837,709.50
12 $837,709.50 $6,653.02 $57,946.21 $21,890.09 $815,819.40
13 $815,819.40 $6,653.02 $56,363.77 $23,472.53 $792,346.88
14 $792,346.88 $6,653.02 $54,666.94 $25,169.36 $767,177.52
15 $767,177.52 $6,653.02 $52,847.44 $26,988.85 $740,188.66
16 $740,188.66 $6,653.02 $50,896.42 $28,939.88 $711,248.78
17 $711,248.78 $6,653.02 $48,804.35 $31,031.95 $680,216.83
18 $680,216.83 $6,653.02 $46,561.05 $33,275.25 $646,941.58
19 $646,941.58 $6,653.02 $44,155.58 $35,680.72 $611,260.86
20 $611,260.86 $6,653.02 $41,576.22 $38,260.08 $573,000.78
21 $573,000.78 $6,653.02 $38,810.39 $41,025.91 $531,974.88
22 $531,974.88 $6,653.02 $35,844.63 $43,991.67 $487,983.20
23 $487,983.20 $6,653.02 $32,664.47 $47,171.83 $440,811.37
24 $440,811.37 $6,653.02 $29,254.41 $50,581.89 $390,229.48
25 $390,229.48 $6,653.02 $25,597.84 $54,238.46 $335,991.02
26 $335,991.02 $6,653.02 $21,676.94 $58,159.36 $277,831.66
27 $277,831.66 $6,653.02 $17,472.59 $62,363.71 $215,467.96
28 $215,467.96 $6,653.02 $12,964.32 $66,871.98 $148,595.97
29 $148,595.97 $6,653.02 $8,130.14 $71,706.16 $76,889.81
30 $76,889.81 $6,653.02 $2,946.49 $76,889.81 $0

Amortization Schedule, 15-year, 7%

Year Beginning Balance Monthly Payment Total Interest Paid Total Principal Paid Remaining Balance
1 $1,000,000 $8,988.28 $68,761.41 $39,097.98 $960,902.02
2 $960,902.02 $8,988.28 $65,935.02 $41,924.38 $918,977.65
3 $918,977.65 $8,988.28 $62,904.30 $44,955.09 $874,022.55
4 $874,022.55 $8,988.28 $59,654.49 $48,204.90 $825,817.65
5 $825,817.65 $8,988.28 $56,169.76 $51,689.64 $774,128.02
6 $774,128.02 $8,988.28 $52,433.11 $55,426.28 $718,701.74
7 $718,701.74 $8,988.28 $48,426.34 $59,433.05 $659,268.68
8 $659,268.68 $8,988.28 $44,129.92 $63,729.47 $595,539.21
9 $595,539.21 $8,988.28 $39,522.91 $68,336.48 $527,202.73
10 $527,202.73 $8,988.28 $34,582.86 $73,276.53 $453,926.19
11 $453,926.19 $8,988.28 $29,285.69 $78,573.70 $375,352.50
12 $375,352.50 $8,988.28 $23,605.59 $84,253.80 $291,098.70
13 $291,098.70 $8,988.28 $17,514.88 $90,344.51 $200,754.19
14 $200,754.19 $8,988.28 $10,938.87 $96,875.52 $103,878.66
15 $103,878.66 $8,988.28 $3,980.73 $103,878.66 $0

How to Get a $1 Million Mortgage

Anyone who has ever bought a home will tell you there are tips to qualify for a mortgage. The biggest ones include saving up for a large down payment, paying down your debts, and working on your credit score before applying for a mortgage. Paying off balances lowers your debt to income (DTI) ratio and helps you qualify for better mortgage terms. The maximum DTI is usually around 43%, but it can vary with each lender and borrower.


💡 Quick Tip: Lowering your monthly payments with a mortgage refinance from SoFi can help you find money to pay down other debt, build your rainy-day fund, or put more into your 401(k).

The Takeaway

If you need to borrow $1 million to buy a home, a 15-year mortgage will require around a $9,000 a month mortgage payment, whereas a 30-year mortgage requires around $6,650. Assuming a 7% interest rate, homebuyers can expect to spend between $617,890 and $1,395,086 on interest alone.

Keep in mind that property taxes, home insurance, and mortgage insurance will increase your monthly payment. If you’re in the market to buy a $1 million house, principal and interest will comprise a majority of your monthly costs.

When you’re ready to take the next step, consider what SoFi Home Loans have to offer. Jumbo loans are offered with competitive interest rates, no private mortgage insurance, and down payments as low as 10%.

SoFi Mortgage Loans: We make the home loan process smart and simple.

FAQ

How much is $1,000,000 mortgage a month?

You can expect to spend around $6,653 a month with a 30-year mortgage term and $8,988 a month with a 15-year term. This assumes you have a 7% interest rate (and doesn’t take into account property taxes, mortgage insurance, and property insurance).

How much income is required for a $1,000,000 mortgage?

Housing costs should be at or below 30% of your income. If you were to choose a 30-year mortgage, this suggests that your income should be around $265,000 a year. Choose a 15-year mortgage, and your income should be around $360,000.

How much is a down payment on a $1,000,000 mortgage?

Because a $1,000,000 mortgage typically means a jumbo loan, you may need to make a down payment of at least 10%. That means your minimum down payment would be $111,112 on a home priced around $1,112,000.

Can I afford a $1,000,000 house with $70K salary?

No, a $70,000 salary would not be enough to cover the cost of a mortgage on a $1,000,000 house. Assuming you make around $5,800 a month (before taxes), this would not be enough to cover the minimum payment required of either loan term.

Photo credit: iStock/Paul Bradbury

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

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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