TAXUPD Archives | Page 6 of 20

Dec

2023

Guide to Student Loan Transfers

By LeeMarie Kennedy | Debt Payoff, Student Loans, student_loan | Comments Off

Sometimes, student loan debt can start to feel like it’s slowing you down. Maybe the interest rate is too high, you’re not happy with your loan terms, or you’re frustrated with the lender’s customer service. If so, you have the right to look for a new lender and transfer your debt to a different company.

However, you can’t simply ask a new lender to take on your debt with the same terms. To transfer your student loan, you generally need to take out a new loan with a new lender or servicer. The process of switching will be different depending on whether your student loans are private or federal, and may involve consolidating the loan or refinancing.

If you’re thinking about a loan transfer, keep in mind that there’s no guarantee you’ll end up in a more favorable situation just by switching lenders. Here’s what you need to know about student loan transfers.

How Do I Transfer Student Loans to Another Private Lender?

If you have private student loans, the main way to transfer your debt to another lender is to refinance. This involves taking out a new loan with a different lender and using it to pay off your current student loan(s). Moving forward, you only make payments on your new loan to your new lender.

If you have multiple private student loans, refinancing can simplify repayment by giving you only one monthly payment to manage. And, if your financial picture has improved since you took out your original private student loan(s), you may be able to qualify for a lower interest rate. Another perk of refinancing is the ability to lengthen your repayment timeline to reduce your monthly payment amount. Keep in mind, though, that a longer repayment will generally end up costing you more in the long run.

You’ll need to meet certain criteria to be eligible for private student loan transfer via refinancing. Most lenders have a minimum income threshold as well as a minimum credit score (often in the upper 600s). If you don’t meet the income or credit requirements, you may be able to qualify by adding a cosigner.

Many lenders offer prequalification, which lets you see what type of rates and terms you may be able to qualify for without impacting your credit score. To find the loan with the best rate, it can be a good idea to shop around and compare lenders through prequalifying. Once you find a lender you want to work with, you’ll need to officially apply for the student loan refinance.

💡 Quick Tip: Ready to refinance your student loan? With SoFi’s no-fee loans, you could save thousands.

Can I Transfer My Sallie Mae Loans to Another Lender?

Currently, Sallie Mae only offers private student loans. Prior to 2014, however, the lender serviced federal student loans. If you want to refinance a Sallie Mae loan you took out before 2014, you’ll need to check whether it’s federal or private before moving forward.

If you took out a Sallie Mae loan after 2014, it’s a private student loan, and you can refinance the loan with another private lender. This might be a good idea if you can qualify for a lower interest rate.

What’s the Difference between a Lender and a Loan Servicer?

While the terms lender and loan servicer are often used interchangeably, they are not the same thing. Here’s a look at how they differ.

Student Loan Lender

A lender is an institution or company that originates and funds the student loan. In other words, they’re the one lending you the money. For example, if you apply for a federal student loan, the federal government is your lender. If you apply for a private student loan, you can choose between a number of private lenders.

A Student Loan Servicer

A federal student loan servicer is the middleman between you and the federal government (the lender). Servicers collect your student loan bills and keep track of whether you pay them on time. They will help you if you’re having trouble with your repayment plan or need to change your address or other personal information. You do not get to pick your servicer.

During the course of your federal student loan, your servicer might change a few times. For example, if you had a loan with Great Lakes, it was likely transferred to Nelnet some time between March 2022 and June 2023. You’ll typically get notified of a student loan transfer two two weeks prior to your transfer date.

If you have a federal student loan and you’re not sure who your servicer is, you can log in to studentaid.gov to find out.

Can I Change My Student Loan Servicer?

You can’t change your federal student loan servicer directly. However, if you’re willing to do some legwork, there are two main ways to move your federal student debt to a new servicer or lender.

If you want to keep your federal loan status but switch to a different loan servicer, you can transfer your loans through consolidation. If your main objective is to save on interest, you may want to look into refinancing your student loans with a private lender. Read below to learn more about each scenario.

What about Consolidating My Student Loans?

One way to switch loan servicers is to consolidate your federal student loan(s). This allows you to transfer the debt to a different servicer but keep your federal student loan status, since the lender will still be the federal government.

The consolidation process lets you combine several federal student loans into a single, easier-to-manage Direct Consolidation Loan. While it does not reduce your interest rate, it can lower your payment by extending the term. The downside is that the extended term will mean you pay more in interest over time.

Since not all federal loans have the same interest rate, the interest rate on a new Direct Consolidation Loan will be a weighted average based on your current loan amounts and interest rates. Any unpaid interest is added to your principal balance. The combined amount will be your new loan’s principal balance. You’ll then pay interest on the new principal balance.

Consolidation can be a good option if you are unhappy with your servicer or have several servicers and want to simplify your student debt by having only one payment.

If you have Federal Family Education Program or parent PLUS loans, you need to consolidate to be eligible for income-driven repayment, public service loan forgiveness, and other relief programs.

You can complete a consolidation loan application at studentaid.gov.

What About Student Loan Refinancing?

Another way to change your federal student loan servicer is to refinance your federal student loans with a private lender. If you also have private student loans, you can refinance them together with federal loans, giving you a single loan payment each month.

Generally, refinancing federal student loans only makes sense if you can qualify for a lower interest rate. If you have higher-interest federal student loans, such as graduate PLUS loans or Direct Unsubsidized Loans, you may be able to get a lower rate by refinancing. To qualify for the best rates on a private student refinance, you generally need to have strong financials (or can recruit a cosigner who does).

It’s important to note that refinancing federal student loans with a private lender means losing federal protections, such as income-driven repayment plans, federal deferment and forbearance programs, and loan forgiveness options like Public Service Loan Forgiveness (PSLF).

If you’re interested in refinancing your federal loans, it’s a good idea to review offers from multiple lenders to find the best deal. Many private lenders will allow you to prequalify via a soft credit check so you can see your likely new interest rate without negatively impacting your credit score.

💡 Quick Tip: It might be beneficial to look for a refinancing lender that offers extras. SoFi members, for instance, can qualify for rate discounts and have access to financial advisors, networking events, and more — at no extra cost.

What About Transferring My Student Loan Balance to a Credit Card?

You generally can’t pay federal student loans with a credit card. If you have private loans, however, another option for student loan transfer is to move the balance onto a credit card and pay your monthly bills there. Some credit card issuers allow student transfers, but not all.

Generally speaking, this tactic only makes sense if you can qualify for a card with a 0% introductory rate and can pay off the entire balance before that promotional period expires (often 15-21 months). Otherwise, you could be left paying even more in interest than you would with the original loan.

To see if you can manage this repayment schedule, simply divide your loan balance by the number of months you would need to pay it off before interest applies. Also check to make sure the credit card offers a high enough credit limit to accommodate your loan, and find out if there are any transfer fees.

If you decide it’s a good deal and are confident you can make it work, you would apply for the credit card and, once approved, give your credit card account details to your loan servicer. Your credit card issuer would then pay off your private student loan debt and move the balance to your credit card account. Moving forward, you only make payments to the credit card issuer.

Is It Possible to Transfer Student Loans From Parent to Student?

The federal government does not offer a way to transfer Parent PLUS loans to the child. However, if you’re looking to have your Parent PLUS loans transferred to your child, refinancing the loans with a private lender allows you to do that.

To make this type of loan transfer, you’ll first need to identify Parent PLUS refinance lenders that allow loan transfers. After that, your child may want to prequalify with a few of these lenders to see where they can get the best rate.

If your child meets the lender’s qualifications on their own, you can fully transfer the loan to them. If they don’t, you can serve as a cosigner on the refinanced loan and work with them to meet the lender’s cosigner release requirements. Many lenders allow cosigner release after a set number of successful payments.

The Takeaway

If you’re interested in transferring your student loans to a new servicer or lender, you have some options. If you have federal student loans, you can consolidate your loans to get a different servicer. If you have federal, private, or a mix of both types of student loans, another option for loan transfer is to refinance your loans with a private lender.

Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.

With SoFi, refinancing is fast, easy, and all online. We offer competitive fixed and variable rates.

SoFi Student Loan Refinance
If you are a federal student loan borrower, you should consider all of your repayment opportunities including the opportunity to refinance your student loan debt at a lower APR or to extend your term to achieve a lower monthly payment. Please note that once you refinance federal student loans you will no longer be eligible for current or future flexible payment options available to federal loan borrowers, including but not limited to income-based repayment plans or extended repayment plans.

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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.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

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.

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.

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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Dec

2023

Solo 401(k): The Retirement Plan Built for the Self-Employed

Navigating Solo 401(k) Plans: A Complete Guide for the Self-Employed

By Rebecca Lake | invest, Investing, Preparing for Retirement | Comments Off

Being self-employed offers many perks, including freedom and flexibility. What it doesn’t offer is an employer-sponsored retirement plan. But when you don’t have access to a 401(k) at work, opening a solo 401(k) can make it easier to stay on track with retirement planning.

Before you establish a solo 401(k) for yourself, it’s important to understand how these plans work and the pros and cons involved.

What Is a Solo 401(k)?

A solo 401(k) is a type of 401(k) that’s designed specifically with self-employed individuals in mind. This retirement savings option follows many of the same rules as workplace 401(k) plans in terms of annual contribution limits, tax treatment, and withdrawals. But it’s tailored to individuals who run a business solo or only employ their spouses.

It’s one of several self-employed retirement options you might consider when planning a long-term financial strategy.

Definition and Overview

A solo 401(k) is a tax-advantaged retirement account that’s for self-employed individuals and business owners who have zero employees, or no employees other than their spouse. This type of 401(k) plan is also known by a few other names:

• Solo-k

• Uni-k

• One-participant plan

Traditional solo 401(k) contributions are made using pre-tax dollars. However, it’s possible to open a Roth solo 401(k) instead. In the case of a Roth solo 401(k), you’d make contributions using after-tax dollars and be able to withdraw the money tax-free in retirement.

A self-employed 401(k) plan works much the same as a regular 401(k). For instance, you may be able to take loans from your savings if needed. Catch-up contributions are also allowed. The biggest difference is that there is no matching contribution from an outside employer.

You can start investing in a solo 401(k) for yourself through an online brokerage. There’s some paperwork you’ll need to fill out to get the process started, but once your account is open you can make contributions year-round.

At the end of the year, the IRS requires solo 401(k) plan owners to file a Form 5500-EZ if the account has $250,000 or more in assets.

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

Contribution Limits in Solo 401(k) Plans

Much like workplace 401(k)s, there are annual contribution limits that apply to solo 401(k) plans.

The IRS caps total contributions to a solo 401(k) account at $66,000 for 2023 and $69,000 for 2024. That doesn’t include catch-up contributions for those age 50 and over, which are an additional $7,500 for each year.

As both the employee and employer of your own business, you can contribute both elective salary deferrals and employer nonelective contributions (you are both the employer and the employee in this scenario). Each has different contribution caps.

Annual Contribution Limits

As an employee, you can contribute up to 100% of your earned income up to the annual contribution limit: $22,500 in 2023 and $23,000 in 2024, plus an additional $7,500 for those age 50+ in elective salary deferrals.
In addition, you can make employer nonelective contributions. These come directly from the “employer” (aka you) and are not deducted from the employee’s (your) salary. As an employer, you can contribute up to 25% of your self-employment income (business income – ½ self-employment tax and elective salary deferrals), in pre-tax dollars.

Setting Up a Solo 401(k) Plan

If you’re interested in setting up a solo 401(k) for yourself, you can do so through an online brokerage. Here’s a step-by-step guide for how to open a solo 401(k).

Steps to Establish Your Plan

1. Choose a Plan Administrator

A plan administrator is the person responsible for managing your solo 401(k). It’s their job to make sure the plan is meeting reporting and other requirements established by the IRS. If you’re self-employed, you can act as your own plan administrator or you could choose your accountant instead.

2. Choose a Brokerage

Once you know who’s going to manage the plan, the next step is deciding where to open it. A number of brokerages offer solo 401(k) plans so you may want to spend some time comparing things like:

• Account setup process

• Investment options

• Fees

You may be able to start the solo 401(k) account setup process online, though some brokerages require you to call and speak to a representative first. And you may need to finalize your account opening by mailing or faxing in any supporting documents the brokerage needs to complete the application.

3. Fill Out a Solo 401(k) Application

Before you can start a 401(k) account for yourself, you’ll need to give your brokerage some information about your business. A typical solo 401(k) application may ask for your:

• First and last name

• Employer Identification Number (EIN)

• Plan administrator’s name and contact information

• Social Security number

• Mailing address

• Citizenship status

• Income information

You’ll also need to disclose any professional associations or affiliations that might result in a conflict of interest with the brokerage. In completing the application, you’ll be asked to name one or more beneficiaries. You may also be asked to provide bank account information that will be used to make your initial contribution to the plan.

4. Choose Your Investments

Once you’ve returned your solo 401(k) account application and it’s been approved, you can choose your investments. The type of investments offered can depend on the brokerage and the plan. But typically, you may be able to choose from:

• Target-date funds

• Index funds

• Actively managed funds

• Exchange-traded funds (ETFs)

Whether you have access to individual stocks, bonds, CDs, or alternative investments such as commodities can depend on the platform that’s offering the plan.

5. Decide How Much to Contribute

You may choose to schedule automatic investments or make them manually according to a schedule that works for you.

Choosing Between Traditional and Roth Solo 401(k)s

You can opt for a traditional solo 401(k), which is made with pre-tax dollars, or a Roth solo 401(k), which is made with after-tax dollars. Which plan is better for you may depend on what you expect your income to be in retirement.

If you believe your income will be higher in retirement than it is now, in general, a Roth could be a better choice since you can take the distributions tax-free at that time. But if you think your income may be less in retirement than it is now, you might be better off with a traditional solo 401(k), which allows you to take the tax deduction now and have your distributions taxed in retirement.

Advantages and Disadvantages of Solo 401(k) Plans

When considering retirement account options, it can be helpful to look at the pros and cons to determine what works best for your personal situation.

Benefits of Having a Solo 401(k)

There are different reasons why opening a 401(k) for self employed individuals could make sense.

• Bigger contributions. Compared to other types of self-employed retirement plans, such as a SEP IRA or SIMPLE IRA, solo 401(k) contribution limits tend to be more generous. Neither a SEP IRA or SIMPLE IRA, for instance, allows for catch-up contributions.

• Roth contributions. You also have the option to open a Roth solo 401(k). If you anticipate being in a higher tax bracket when you retire, you may prefer being able to withdraw contributions tax-free with a Roth.

• Flexible withdrawal rules. A solo 401(k) can also offer more flexibility with regard to early withdrawals than a SEP IRA, SIMPLE IRA, traditional IRA, or Roth IRA. If your solo 401(k) plan allows it, you could take out a loan in place of an early withdrawal. This could help you to avoid early withdrawal penalties and taxes. An IRA-based plan wouldn’t allow for loans.

Considerations and Potential Drawbacks

There are also a few potential downsides of investing in a solo 401(k).

• Eligibility restrictions. If you run a small business and you have at least one employee other than a spouse, you won’t be able to open a solo 401(k) at all.

• Complicated reporting. Calculating contributions and filing can be more complicated with a solo 401(k) vs. a SEP IRA or SIMPLE IRA. If your plan has more than $250,000 in assets you’ll need to file Form 5500-EZ with the IRS each year.

• Administrative costs. Depending on where you open a solo 401(k) plan, the cost of maintaining it year to year may be higher compared to other self employed retirement plans. And an early 401(k) withdrawal can trigger taxes and penalties.

It’s important to consider the range of investment options offered through a solo 401(k). What you can invest in at one brokerage may be very different from another. The individual cost of those investments can also vary if some mutual funds or exchange-traded funds offered come with higher expense ratios than others.

💡 Quick Tip: Did you know that you must choose the investments in your IRA? Once you open a new IRA and start saving, you get to decide which mutual funds, ETFs, or other investments you want — it’s totally up to you.

Withdrawals and Loan Provisions

There are certain requirements for withdrawals and/or loans from a solo 401(k).

Rules for Withdrawing Funds

You can make withdrawals from a solo 401(k) without penalty at age 59 ½ or older. Distributions may be allowed before that time in the case of certain “triggering events,” such as a disability, but you may owe a 10% penalty as well as income taxes on the withdrawal.

Loan Options and Conditions

Some solo 401(k) plans may be set up to allow loans. If yours does, you could take out a loan in place of an early withdrawal. This could help you to avoid early withdrawal penalties and taxes. Just be sure to find out the loan terms and conditions, which can vary by plan.

Testing and Compliance for Solo 401(k)s

Unlike workplace 401(k)s, solo 401(k)s have no testing compliance requirements involved.

Alternatives to Solo 401(k) Plans

Instead of a solo 401(k), self employed individuals can consider another type of retirement account. Here’s how different options stack up.

Comparing a Solo 401(k) to a SEP IRA and Other Retirement Options

A SEP IRA is designed for small businesses. However, unlike a solo 401(k), a SEP IRA allows no catch-up contributions and there is no Roth version of the plan.

A SIMPLE IRA is for businesses with no more than 100 employees. It has much lower contribution limits than a solo 401(k) and once again, there is no Roth option.

Pros and Cons of a Solo 401(k)

A solo 401(k) has advantages and disadvantages. Here’s a side-by-side comparison of the benefits and drawbacks.

Solo 401(k) Pros	Solo 401(k) Cons
Catch-up contributions may allow older investors to save more for retirement versus a SEP IRA or SIMPLE IRA.	Only self-employed individuals who have no employees or just employee their spouses can contribute.
It’s possible to choose between a traditional solo 401(k) or Roth solo 401(k), based on your investing goals and tax situation.	Annual reporting requirements may be more complicated for a solo 401(k) compared to other self employed retirement plans.
Solo 401(k) plans may allow for loans, similar to workplace plans.	Early withdrawals from a solo 401(k) are subject to taxes and penalties.

The Takeaway

A solo 401(k) can be a worthwhile investment vehicle for self-employed people who want to save for retirement. It has more generous contribution limits than some other retirement options. In addition, there is a Roth version of the plan, and a solo 401(k) plan may also offer flexibility in terms of early withdrawals. For individuals who are self-employed, opening a solo 401(k) is one potential way to start saving for their golden years.

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

Easily manage your retirement savings with a SoFi IRA.

FAQ

Can I contribute 100% of my salary to a solo 401(k)?

As an employee, you can contribute up to 100% of your earned income to a solo 401(k) up to the annual contribution limit, which is $22,500 in 2023, and $23,000 in 2024, plus an additional $7,500 for those age 50 and up in elective salary deferrals.

Is a solo 401(k) taxable income?

You will pay taxes with a solo 401(k), but the type of plan you open determines when you’ll pay those taxes. If you have a traditional 401(k), your contributions are tax-deferred, and they reduce your taxable income for the year in which you make them. However, you will pay taxes on distributions when you take them in retirement. If you have a Roth 401(k), you pay taxes on your contributions when you make them, but your distributions in retirement are tax-free.

What is the average return on a solo 401(k)?

The return on a solo 401(k) depends on the investments in your portfolio. However, in general, a solo 401(k) invested in a mix of bonds, stocks, and cash assets can have an average rate of return ranging between 3% and 8%. But again, it depends on what your investments are, and how much you allocate to those different assets. You may want to compare your plan’s performance to plans with similar funds to get a general sense of what the average return might be.

Who qualifies for a solo 401(k)?

To be eligible for a solo 401(k), you must be self-employed or a small business owner with no employees other than a spouse. To open a solo 401(k) you will need an Employee Identification Number (EIN), which is available from the IRS.

Photo credit: iStock/visualspace

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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.

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Nov

2023

IRA Withdrawal Rules: All You Need to Know

Guide to IRA Withdrawal Rules

By Sheryl Nance-Nash | invest, Investing, Preparing for Retirement | Comments Off

The purpose of Individual Retirement Accounts (IRAs) is to allow you to save for your golden years, so there are strict IRA withdrawal rules meant to make it harder to access that money for other reasons.

Ideally you sock away money consistently and your investment grows over time. You also get the benefit of tax breaks. But it’s important to keep the IRA rules for withdrawals in mind to make the most of your accounts.

Key Points

• Traditional and Roth IRAs have specific withdrawal rules and penalties to protect retirement savings.

• Roth IRA withdrawal rules include the five-year rule for penalty-free withdrawals, and required minimum distributions for inherited IRAs.

• Traditional IRA withdrawals before age 59 ½ incur regular income taxes and a 10% penalty.

• There are exceptions to the penalty, such as using funds for medical expenses, health insurance, disability, education, and first-time home purchases.

• Many experts recommend that early IRA withdrawals should be a last resort due to the potential impact on retirement savings and tax implications.

Roth IRA Withdrawal Rules

When can you withdraw from a Roth IRA? The rules for IRA withdrawals are different for Roth IRAs and traditional IRAs. For instance, qualified withdrawals from a Roth IRA are tax free, since you make contributions with after-tax funds. And there are some other rules about Roth IRAs to keep in mind as well.

The Five-year Rule

If you have a Roth IRA, you may face a Roth IRA withdrawal penalty if you withdraw funds you deposited less than five years ago. This is known as the “five-year rule“. These Roth IRA withdrawal rules also apply to the funds in a Roth rolled over from a traditional IRA. In those cases, if you make a withdrawal from a Roth IRA account that you’ve owned for less than five years, you’ll owe a 10% tax penalty on the account’s gains.

For inherited Roth IRAs, the five-year rule applies to the age of the account, so if your benefactor opened the account more than five years ago, you can access the funds penalty-free. If you tap into the money before that, you’ll owe taxes on the gains.

Required Minimum Distributions (RMDs) on Inherited Roth IRAs

If you’re wondering about Roth IRA distribution rules, in most cases, you do not have to pay required minimum distributions on money in a Roth IRA account. However, for inherited Roths, IRA withdrawal rules mandate that you take required minimum distributions.

There are two ways to do that without penalty:

• Withdraw funds by December 31 of the fifth year after the original holder died. You can do this in either partial distributions or a lump sum. If the account is not emptied by that date, you could owe a 50% penalty on whatever is left.

• Take withdrawals each year, based on your life expectancy.

💡 Quick Tip: Did you know that you must choose the investments in your IRA? Once you open a new IRA and start saving, you get to decide which mutual funds, ETFs, or other investments you want — it’s totally up to you.

Traditional IRA Withdrawal Rules

If you take funds out of a traditional IRA before you turn 59 ½, you’ll owe regular income taxes on the contributions and the gains, per IRA tax deduction rules, plus a 10% penalty. Brian Walsh, CFP® at SoFi specifies, “When you make contributions to a traditional retirement account, that money is going to grow without paying any taxes. But when you take that money out—say 30 or 40 years from now—you’re going to pay taxes on all of the money you take out.”

RMDs on a Traditional IRA

The rules for withdrawing from an IRA mean that required minimum distributions kick in the year you turn 73. After that, you have to take distributions each year, based on your life expectancy. If you don’t take the RMD, you’ll owe a 50% penalty on the amount that you did not withdraw.

When Can You Withdraw from an IRA Without Penalties?

You can make withdrawals from an IRA once you reach age 59 ½ without penalties.

In addition, there are other situations in which you may be able to make withdrawals without having to pay a penalty. These include having medical expenses that aren’t covered by health insurance (as long as you meet certain qualifications), having a permanent disability that means you can no longer work, and paying for qualified education expenses for a child, spouse, or yourself.

Read more about these and other penalty-free exceptions below.

9 Exceptions to the 10% Early-Withdrawal Penalty on IRAs

Whether you’re withdrawing from a Roth within the first five years or you want to take money out of a traditional IRA before you turn 59 ½, there are some instances where you don’t have to pay the 10% penalty on your IRA withdrawals.

1. Medical Expenses

You can avoid the early withdrawal penalty if you use the funds to pay for unreimbursed medical expenses that total more than 7.5% of your adjusted gross income (AGI).

2. Health Insurance

If you’re unemployed for at least 12 weeks, IRA withdrawal rules allow you to use funds from an IRA penalty-free to pay health insurance premiums for yourself, your spouse, or your dependents.

3. Disability

If you’re permanently disabled and can no longer work, you can withdraw IRA funds without penalty. In this case, your plan administrator may require you to provide proof of the disability before signing off on a penalty-free withdrawal.

4. Higher Education

IRA withdrawal rules allow you to use IRA funds to pay for qualified education expenses, such as tuition and books for yourself, your spouse, or your child without penalty.

5. Inherited IRAs

IRA withdrawal rules state that you don’t have to pay the 10% penalty on withdrawals from an IRA, unless you’re the sole beneficiary of a spouse’s account and roll it into your own, non-inherited IRA. In that case, the IRS treats the IRA as if it were yours from the start, meaning that early withdrawal penalties apply.

6. IRS Levy

If you owe taxes to the IRS, the agency may take it directly out of your IRA account. In that case, the IRS will not assess the 10% penalty. If you take the money out of the account yourself, however, to pay taxes, you’d also have to pay the 10% penalty.

7. Active Duty

If you’re a qualified reservist, you can take distributions without owing the 10% penalty. This goes for a military reservist or National Guard member called to active duty for at least 180 days after September 11, 2001.

8. Buying a House

While you can’t take out IRA loans, you can use up to $10,000 from your traditional IRA toward the purchase of your first home — and if you’re purchasing with a spouse, that goes for each of you. The IRS defines first-time homebuyers as someone who hasn’t owned a principal residence in the last two years. You can also withdraw money to help with a first home purchase for a child or your spouse’s child, grandchild, or parent.

In order to qualify for the penalty-free withdrawals, you’ll need to use the money within 120 days of the distribution.

9. Substantially Equal Periodic Payments

Another way to avoid penalties under IRA withdrawal rules, is by starting a series of distributions from your IRA, spread equally over your life expectancy. To make this work, you must take at least one distribution each year and you can’t alter the distribution schedule until five years have passed or you’ve reached age 59 ½, whichever is later.

The amount of the distributions must use an IRS-approved calculation that involves your life expectancy, your account balance, and interest rates.

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

Is Early IRA Withdrawal Worth It?

While there may be cases where it makes sense to take an early withdrawal, most advisors agree that it should be a last resort. These are disadvantages and advantages to consider.

Pros of IRA Early Withdrawal

• If you have a major expense and there are no other options, taking an early withdrawal from an IRA could help you cover the cost.

• An early withdrawal may help you avoid taking out a loan you would then have to repay with interest.

Cons of IRA Early Withdrawal

• By taking money out of an IRA account early, you’re robbing your own nest egg not only of the current value of the money but also future years of compound growth.

• Money taken out of a retirement account now can have a big impact on your financial security in the future when you retire.

• You may owe taxes and penalties, depending on the specific situation.

Opening an IRA With SoFi

Like 401(k)s, IRAs are powerful, tax-advantaged accounts you can use to save for retirement. However, it is possible to take money out of an IRA if you need it before retirement age. Just remember, even if you’re able to do so without an immediate tax penalty, the withdrawals could leave you with less money for retirement later.

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

Easily manage your retirement savings with a SoFi IRA.

FAQ

Can you withdraw money from a Roth IRA without penalty?

You can withdraw your own contributions to a Roth IRA without penalty no matter what your age. However, you cannot withdraw the earnings on your contributions before age 59 ½, or before the account has been open for at least five years, without incurring a penalty.

What are the rules for withdrawing from a Roth IRA?

You can withdraw your own contributions to a Roth IRA at any time penalty-free. But to avoid taxes and penalties on your earnings, withdrawals from a Roth IRA must be taken after age 59 ½ and once the account has been open for at least five years.

However, there are a number of exceptions in which you typically don’t have to pay a penalty for an early withdrawal, including: some medical expenses that aren’t covered by health insurance, being permanently disabled and unable to work, or if you’re on qualified active military duty.

What are the 5 year rules for Roth IRA withdrawal?

Under the 5-year rule, if you make a withdrawal from a Roth IRA that’s been open for less than five years, you’ll owe a 10% penalty on the account’s earnings. If your Roth IRA was inherited, the 5-year rule applies to the age of the account. So if you inherited the Roth IRA from a parent, for instance, and they opened the account more than five years ago, you can withdraw the funds penalty-free. If the account has been opened for less than five years, however, you’ll owe taxes on the gains.

Photo credit: iStock/Fly View Productions

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

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

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.

SOIN0723096

Nov

2023

What Is a Dead Cat Bounce and How Can You Spot It?

By Ashley Kilroy | Growing Wealth, invest, Investing | Comments Off

A “dead cat bounce” is a colorful way of describing an unexpected price jump that occurs after a long, slow decline — and typically just before another price drop.

A dead cat bounce carries that morbid name because the price spike in a particular stock or market sector isn’t “live” (i.e. it’s not a real rebound), and characteristically it doesn’t last.

The danger can be that the apparent rebound creates false value, or optimism. That said, some investors may be able to take advantage of a dead cat bounce to create a short position. Unfortunately, it’s hard to identify a dead cat bounce until after the fact.

Nonetheless, investors may want to know some of the signs of this price pattern, as it can help them gauge certain market movements.

Key Points

• A dead cat bounce refers to a temporary price jump after a decline, often followed by another drop.

• It is difficult to identify a dead cat bounce in real-time, making it challenging for investors to take advantage of it.

• Dead cat bounces can occur in individual stocks, bonds, or entire markets.

• Investors should be cautious when interpreting price movements and consider other factors before making investment decisions.

• Active investors may use technical analysis and market indicators to help identify potential dead cat bounces.

What Is a Dead Cat Bounce?

The meaning of “dead cat bounce” comes from a bleak saying among traders that even a dead cat will bounce if it’s dropped from a high enough height.

Thus, when a security or market experiences a steady decline, and then appears to bounce back, only to decline again — it’s known as a dead cat bounce. The “recovery” doesn’t have a rhyme or reason; it’s merely part of a short-term market variation, perhaps driven by market sentiment or other economic factors.

Sometimes what appears to be a dead cat bounce can turn into a stock market crash.

A Dead Cat Bounce Is Specific

If you’re learning how to invest in stocks, bear in mind that a dead cat bounce is not used to describe the ups and downs of a typical trading day — it refers to a longer-term drop, rebound, and continued drop. The term wouldn’t apply to a security that’s continuing to grow in value. The revival must be brief, before the price continues to fall.

It’s also important to point out that this financial phenomenon can pertain to individual securities such as stocks or bonds, to stock trading as a whole, or to a market.

Why Identify a Dead Cat Bounce?

Even for experienced traders or short-term investors using sophisticated technical analysis, it can be difficult. Sometimes a rally is actually a rally; sometimes a drop indicates a bottom.

The point of trying to distinguish whether the rise in price will continue or reverse is because it can influence your strategy. If you have a short position, and you anticipate that a rally in stock price will end in a reversal, you may want to hold steady. If you think the rally will continue, you’ll want to exit a short position.

Example of a Dead Cat Bounce

To illustrate a dead cat bounce, let’s suppose company ABC trades for $70 on June 5, then drops in value to $50 per share over the next four months. Between Oct. 7 and Oct. 14, the price rises to $65 per share — but then starts to rapidly decline again on Oct. 15. Finally, ABC’s stock price settles at $30 per share on Oct. 16.

This pattern is how a dead cat bounce might appear in a real-life trading situation. The security quickly paused the decline for a swift revival, but the price recovery was temporary before it started falling again and eventually steadied at an even lower price.

History of Dead Cat Bounces

There are countless examples of the dead cat bounce pattern in stocks and other securities, as well as whole markets. One of the most recent affected the entire stock market during the Covid pandemic.

The U.S. stock market lost about 12% during one week in February 2020, and appeared to revive the following week with a 2% gain. But it turned out to be a false recovery, and the market dipped back down again until later that summer.

Why Does a Dead Cat Bounce Happen?

A dead cat bounce is often the result of investors believing the market or security in question has hit its low point and they try to buy in to ride the turnaround. It can also occur as a result of investors closing out short positions.

Since these trends aren’t driven by technical factors, that’s why the bounce is typically short-lived — usually lasting a couple of days, or maybe a couple of months on the outside.

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How to Spot A Dead Cat Bounce

Because a dead cat bounce is often an illusion of actual intrinsic value, investors may be tempted to jump on an investment opportunity before it makes sense to do so.

The following typical sequence of events may help an investor correctly identify a dead cat bounce as it might occur with a specific stock.

1. There is a gap down.

Typically the stock opens lower than the previous close, usually a significant amount like 5% (or perhaps 3% if the stock isn’t prone to volatility).

2. The security’s price steadily declines.

In a true dead cat bounce scenario, that initial gap down will be followed by a sustained decline.

3. The price sees a monetary gain for a short time.

At some point during the price drop, there will be a turnaround as the price appears to bounce back, close to its previous high.

4. A security’s price begins to regress again.

The rally is short, however, and the stock completes its dead cat bounce pattern with a final decline in price.

Dead Cat Bounce vs Other Patterns

How do you know whether the pattern you’re seeing is really a classic dead cat bounce versus other types of movements? Here are some clues.

Dead Cat Bounce or Rally?

One way to stay alert for a dead cat bounce with a particular stock is to consider whether the now-rising stock is still as weak as it was when its price was falling. If there’s no market indicator as to why the stock is rebounding, it might make sense to suspect a dead cat bounce.

Dead Cat Bounce or Lowest Price?

Since investors are looking for opportunities to profit, they try to find investment opportunities that allow them to buy low and sell high.

Therefore, when assessing investment opportunities, a successful investor might try to recognize emerging companies, and buy shares of their stock while the price is low and before other investors get wind of the lucrative company.

Since companies go through business cycles where stock prices fluctuate, pinpointing the lowest price point might be hard to determine. There’s no way to know if a dead cat bounce is happening, until the prices have resumed their descent.

Dead Cat Bounce or Bottom of a Bear Market?

Investors may also confuse a dead cat bounce for the actual bottom of a bear market. It’s not uncommon for stocks to significantly rebound after the bear market hits bottom.

History shows that the S&P 500 often sees substantial gains within the first few months of hitting bottom after a bear market. But these rallies have been sustained, and thus are not a dead cat bounce.

Investing Strategies to Avoid a Dead Cat Bounce

For investors who want a more hands-on investing approach — meaning active investing vs. passive — it’s generally better to use investing fundamentals to evaluate a security instead of attempting to time the market (and risk mistaking a dead cat bounce for an opportunity).

Investors who are just starting may want to consider building a portfolio of a dozen or so securities. Picking a few stocks allows investors to monitor performance while giving their portfolio a little diversification. This means the investor distributes their money across several different types of securities instead of investing all of their money in one security, which in turn can help to minimize risk.

Active investors could also consider selecting stocks across varying sectors to give their portfolio even more diversification instead of sticking to one niche.

Investors with restricted funds might consider investing in just a few stocks while offsetting risk by investing in mutual funds or exchange-traded funds (ETFs).

For investors who would prefer not to execute an active investing strategy alone, they can speak with a professional manager. Working with a professional manager may help the investors better navigate the intricacies of various market cycles.

Limitations in Identifying a Dead Cat Bounce

As noted several times here, a dead cat bounce can’t really be identified with 100% certainty until after the fact. While some traders may believe they can predict a dead cat bounce by using certain fundamental or technical analysis tools, it’s impossible to do so every single time.

If there were a way to accurately predict market movements or different patterns, people would always try to time the market. But there are no crystal balls in investing, as they say.

The Takeaway

With 20-20 hindsight, investors and analysts can clearly see that an individual security or market has experienced a steady drop in value, a brief rebound, and then a further drop — a phenomenon known as a dead cat bounce.

Unfortunately, though, it can be too hard for most investors to distinguish between a dead cat bounce and a bona fide rally, or the bottom of a given market or security’s price. Still, knowing what to look for may help investors make more informed choices, especially when it comes to making a choice around keeping or closing out a short position.

For investors who want to take an active role in investing, an online trading platform like SoFi Invest® offers the opportunity to manage your money the way you want. When you open an Active Invest account with SoFi, you can trade stocks you’re familiar with or explore different investment opportunities, including IPO shares, fractional shares, and more.

Build your portfolio with SoFi Active Investing, starting with as little as $5.

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.

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 [email protected]. 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.

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.

SOIN0922044

Nov

2023

Tax Loss Carryforward

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

A tax loss carryforward is a special tax rule that allows capital losses to be carried over from one year to another. In other words, an investor can take capital losses realized in the current tax year to offset gains or profits in a future tax year.

Investors can use a capital loss carryforward to minimize their tax liability when reporting capital gains from investments. Business owners can also take advantage of loss carryforward rules when deducting losses each year. Knowing how this tax provision works and when it can be applied is important from an investment tax savings perspective.

Key Points

• Tax loss carryforward allows investors to offset capital losses against future gains, reducing tax liability.

• Investors can take advantage of tax loss carryforward by deducting capital losses from taxable income, reducing their overall tax liability.

• Capital loss carryforward rules prohibit violating the wash-sale rule and have limitations on deductions.

• Net operating loss carryforward is similar to capital loss carryforward for businesses operating at a loss.

• Losses can be carried forward indefinitely at the federal level, but capital losses must be used to offset capital gains in the same year.

What Is Tax Loss Carryforward?

Tax loss carryforward, sometimes called capital loss carryover, is the process of carrying forward capital losses into future tax years. A capital loss occurs when you sell an asset for less than your adjusted basis. Capital losses are the opposite of capital gains, which are realized when you sell an asset for more than your adjusted basis.

Adjusted basis means the cost of an asset, adjusted for various events (i.e., increases or decreases in value) through the course of ownership.

Whether a capital gain or loss is short-term or long-term depends on how long you owned it before selling. Short-term capital losses and gains apply when an asset is held for one year or less, while long-term capital gains and losses are associated with assets held for longer than one year.

The Internal Revenue Service (IRS) allows certain capital losses, including losses associated with personal or business investments, to be deducted from taxable income.

There are limits on the amount that can be deducted each year, however, depending on the type of losses being reported. For example, the IRS allows investors to deduct up to $3,000 from their taxable income if the capital loss is from the sales of assets like stocks, bonds, or real estate. If capital losses exceed $3,000, the IRS allows investors to carry capital losses forward into future years and use them to reduce potential taxable income.

💡 Recommended: SoFi’s Guide to Understanding Your Taxes

How Tax Loss Carryforwards Work

A tax loss carryforward generally allows you to report losses realized on assets in one tax year on a future year’s tax return. Realized losses differ from unrealized losses or gains, which are the change in an investment’s value compared to its purchase price before an investor sells it.

IRS loss carryforward rules apply to both personal and business assets. The main types of capital loss carryovers allowed by the Internal Revenue Code are capital loss carryforwards and net operating loss carryforwards.

Capital Loss Carryforward

IRS rules allow investors to “harvest” tax losses, meaning they use capital losses to offset capital gains. An investor could sell an investment at a capital loss, then deduct that loss against capital gains from other investments to reduce taxable income, assuming they don’t violate the wash-sale rule.

The wash-sale rule prohibits investors from buying substantially identical investments within the 30 days before or 30 days after the sale of a security for the purpose of tax-loss harvesting.

If capital losses are equal to capital gains, they will offset one another on your tax return, so there’d be nothing to carry over. For example, a $5,000 capital gain would cancel out a $5,000 capital loss and vice versa.

However, if capital losses exceed capital gains, investors can deduct a portion of the losses from their ordinary income to reduce 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). But 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.

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) .

💡 Recommended: A Guide to Tax-Efficient Investing

Net Operating Loss Carryforward

A net operating loss (NOL) occurs when a business has more deductions than income. Rather than posting a profit for the year, the company operates at a loss. Business owners may be able to claim a NOL deduction on their personal income taxes. Net operating loss carryforward rules work similarly to capital loss carryforward rules in that businesses can carry forward losses from one year to the next.

According to the IRS, for losses arising in tax years after December 31, 2020, the NOL deduction is limited to 80% of the excess of the business’s taxable income. To calculate net operating loss deductions for your business, you first have to omit items that could limit your loss, including:

• Capital losses that exceed capital gains

• Nonbusiness deductions that exceed nonbusiness income

• Qualified business income deductions

• The net operating loss deduction itself

These losses can be carried forward indefinitely at the federal level.

Note, however, that the rules for NOL carryforwards at the state level vary widely. Some states follow federal regulations, but others do not.

How Long Can Losses Be Carried Forward?

According to IRS tax loss carryforward rules, capital and net operating losses can be carried forward indefinitely. Before the Tax Cuts and Jobs Act of 2017, business owners were limited to a 20-year window when carrying forward net operating losses.

It’s important to remember that capital loss carryforward rules don’t allow you to roll over losses. IRS rules state that you must use capital losses to offset capital gains in the year they occur. You can only carry capital losses forward if they exceed your capital gains for the year. The IRS also requires you to use an apples-to-apples approach when applying capital losses against capital gains.

For example, you’d need to use short-term capital losses to offset short-term capital gains. You couldn’t use a short-term capital loss to balance out a long-term capital gain or a long-term capital loss to offset a short-term capital gain. This rule applies because short- and long-term capital gains are subject to different tax rates.

Example of Tax Loss Carryforward

Assume that you purchase 100 shares of XYZ stock at $50 each for a total of $5,000. Thirteen months after buying the shares, their value has doubled to $100 each, so you decide to sell, collecting a capital gain of $5,000.

Suppose you also hold 100 shares of ABC stock, which have decreased in value from $70 per share to $10 per share over that same period. If you decide to sell ABC stock, your capital losses will total $6,000 – the difference between the $7,000 you paid for the shares and the $1,000 you sold them for.

You could use $5,000 of the loss of ABC stock to offset the $5,000 gain associated with selling your shares in XYZ to reduce your capital gains tax. Per IRS rules, you could also apply the additional $1,000 loss to reduce your ordinary income for the year.

Now, say you also have another stock you sold for a $6,000 loss. Because you already have a $1,000 loss and there is a $3,000 limit on deductions, you could apply up to $2,000 to offset ordinary income in the current tax year, then carry the remaining $4,000 loss forward to a future tax year, per IRS rules. This is an example of tax loss carryforward. All of this assumes that you don’t violate the wash-sale rule when timing the sale of losing stocks.

💡 Recommended: What to Know about Paying Taxes on Stocks

The Takeaway

If you’re investing in a taxable brokerage account, you must include tax planning as part of your strategy. Selling stocks to realize capital gains could result in a larger tax bill if you’re not deducting capital losses at the same time. With tax-loss harvesting, assuming you don’t violate the wash sale rule, it’s possible to carry forward investment losses to help reduce the tax impact of gains over time. This applies to personal as well as business gains and losses. Thus, understanding the tax loss carryforward provision may help reduce your personal and investment taxes.

If you’re interested in building a portfolio with financial guidance, it may help to open an online brokerage account with SoFi Invest®. With SoFi, you can trade stocks, exchange-traded funds (ETFs), and fractional shares with no commissions. Even better, as a SoFi Member, you have access to financial professionals who can offer complimentary guidance and answer your most pressing investing questions.

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