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Oct

2024

What Is a Required Minimum Distribution (RMD) for IRAs

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

Individual retirement accounts (IRAs) are retirement savings accounts that offer certain tax-advantages. Some types of IRAs, including traditional and inherited Roth IRAs, are subject to required minimum distribution (RMD) rules.

What is an RMD on an IRA? In simple terms, it’s a withdrawal you make from an RMD every year once you reach a certain age. RMDs are a way for the IRS to ensure that retirement savers meet their tax obligations. Failing to take distributions when you’re supposed to could result in a tax penalty, so it’s important to know when you must take an RMD on an IRA.

Key Points

• Required minimum distributions (RMDs) are mandatory withdrawals from IRAs that account owners must start taking at age 73, as per IRS rules.

• RMDs apply to traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s, and other defined contribution plans.

• The RMD amount account holders need to withdraw is calculated using the IRS Uniform Lifetime or life expectancy tables.

• Failing to take RMDs can result in a 25% excise tax, reduced to 10% if corrected within two years.

• RMDs are taxed as ordinary income, and qualified charitable distributions (QCDs) can be used to reduce tax liability.

Required Minimum Distribution (RMD) Definition

A required minimum distribution is an amount you need to withdraw from an IRA account each year once you turn 73. (In 2023 the SECURE 2.0 Act increased the age that individuals had to start taking RMDs to age 73 for those who reach 72 in 2023 or later.) You can take out more than the minimum amount with an RMD, but you must withdraw at least the minimum to avoid an IRS tax penalty.

The minimum amount you need to withdraw when taking an RMD is based on specific IRS calculations (see more about that below).

Special Considerations for RMDs

RMD rules apply to multiple types of retirement accounts. You’re subject to RMDs if you have any of the following:

• Traditional IRA

• SEP IRA

• SIMPLE IRA

• 401(k) plan

• 403(b) plan

• 457(b) plan

• Profit-sharing plan

• Other defined contribution plans

• Inherited IRAs

You must calculate RMDs for each account separately.

Failing to take RMD distributions from IRAs or other eligible investment accounts on time can be costly. The SECURE 2.0 Act allows the IRS to assess a 25% excise tax on the amount you failed to withdraw. That penalty might drop to 10% if the RMD is properly corrected within two years.

Why Do You Have to Take an RMD?

The IRS imposes RMD rules on IRAs and other retirement accounts to prevent savers from deferring taxes on earnings indefinitely. Here’s how it works.

When you contribute to a traditional IRA, SEP IRA, SIMPLE IRA, 401(k), or a simple retirement plan, you fund your account with pre-tax dollars (meaning you haven’t yet paid tax on that money). In exchange, you may be able to deduct some or all of the contributions you make.

Your account grows tax-deferred, and when you make qualified withdrawals in retirement, you pay ordinary income tax on earnings. If you were to leave the money in your IRA untouched, the IRS couldn’t collect tax on earnings, hence the need for RMDs.

Roth IRAs generally don’t have RMDs. When you make contributions to a Roth account you use after-tax dollars — in other words, you’ve already paid taxes on that money. So you don’t have to pay taxes again when you make qualified withdrawals in retirement. However, if you inherit a Roth IRA, you will be required to take RMDs.

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

RMDs for Roth and Traditional IRAs

When you open an IRA, you will typically choose between a Roth IRA or traditional IRA. There are differences between them when it comes to RMDs. Traditional IRAs are always subject to RMD rules. If you contribute to a traditional IRA, whether you max out the annual contribution limit or not, you can expect to take RMDs from your account later. RMD rules also apply when you inherit a traditional IRA.

Are there RMDs on Roth IRA accounts? No, if you’re making original contributions to a Roth IRA that you own. But you will need to take RMDs if you inherit a Roth IRA from someone else.

The IRS determines when you must take distributions from an inherited Roth IRA. The timing depends on whether the person you inherited a Roth IRA from was your spouse and whether they died before 2020 or in 2020 or later.

If you inherit an IRA from a spouse who passed away before 2020, you may:

• Keep the account as your own, taking RMDs based on your life expectancy, or follow the 5-year rule, meaning you generally fully withdraw the account balance by the end of the 5th year following the year of death of the account holder

• Roll over the account to your own IRA

If you inherit an IRA from a spouse who passed away in 2020 or later, you may:

• Keep the account as your own, taking RMDs based on your life expectancy, delay beginning distributions until the spouse would have turned 72, or follow the 10-year rule, generally fully withdrawing the account balance by the end of the 10th year following the year of death of the account owner

• Roll over the account to your own IRA

If you inherit an IRA from someone who is not your spouse and who passed away before 2020, you may:

• Take distributions based on your own life expectancy beginning the end of the year following the year of death

• Follow the 5-year rule

If you inherited an IRA from someone who is not your spouse and who passed away in 2020 or later and you are a designated beneficiary, you may:

• Follow the 10-year rule

IRA withdrawal rules for inherited IRAs can be tricky so if you know that someone has named you as their IRA beneficiary, you may find it helpful to discuss potential tax implications with a financial advisor.

How To Calculate RMDs on an IRA

To calculate RMDs on an IRA, you divide the balance of your account on December 31 of the prior year by the appropriate life expectancy factor set by the IRS. The IRS publishes life expectancy tables for RMDs in Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs). You choose the life expectancy table that applies to your situation.

IRA Required Minimum Distribution Table Example

The IRS uses the Uniform Lifetime Table to determine RMDs for people who are:

• Unmarried account owners

• Married IRA owners whose spouses aren’t more than 10 years younger

• Married IRA owners whose spouses are not the sole beneficiaries of their account

Here’s how RMD distributions break down.

Age	Distribution Period (Years)	Age	Distribution Period (Years)
72	27.4	97	7.8
73	26.5	98	7.3
74	25.5	99	6.8
75	24.6	100	6.4
76	23.7	101	6.0
77	22.9	102	5.6
78	22.0	103	5.2
79	21.1	104	4.9
80	20.2	105	4.6
81	19.4	106	4.3
82	18.5	107	4.1
83	17.7	108	3.9
84	16.8	109	3.7
85	16.0	110	3.5
86	15.2	111	3.4
87	14.4	112	3.3
88	13.7	113	3.1
89	12.9	114	3.0
90	12.2	115	2.9
91	11.5	116	2.8
92	10.8	117	2.7
93	10.1	118	2.5
94	9.5	119	2.3
95	8.9	120 and over	2.0
96	8.4

Source: IRS Uniform Lifetime Table

And here’s an example of how you might use this table to calculate RMDs on an IRA.

Assume that you’re 75 years old and have $1 million in your IRA as of last December 31. You find your distribution period on the chart, which is 24.6, then divide your IRA balance by that number.

$1 million/24.6 = $40,650 RMD

You’ll need to recalculate your RMDs each year, based on the new balance in your IRA and your life expectancy factor. You can use an online calculator to figure out RMD on an IRA annually.

Withdrawing Required Minimum Distribution From an IRA

There are two deadlines to know when making RMDs from an IRA: when distributions must begin and when you must complete distributions for the year. The SECURE 2.0 Act introduced some changes to the timing of RMD withdrawals from an IRA.

When Do RMDs Start?

Beginning in 2023, the minimum age at which you must begin taking RMDs rose to 73 (that’s the same age you must begin taking RMDs for 401(k)s, in case you are wondering). The deadline for the very first RMD you’re required to make when you turn 73, is April 1 of the following year. So, if you turned 73 in 2025, then your first RMD would be due no later than April 1, 2026.

Once you make your first RMD, all other RMDs after that are due by December 31 each year. So, using the example above, if you make your first RMD on April 1, 2026, then you’d need to make your second RMD by December 31 of that same year to avoid a tax penalty. Just keep in mind that taking two RMDs in one year could increase your tax burden for the year.

Qualified Charitable Distributions (QCDs)

Qualified charitable distributions (QCDs) are amounts you contribute to an eligible charity from your IRA. QCDs are tax-free and count toward your annual RMD amount, and you can contribute up to $100,000 per year. Using your IRA to make QCDs can lower the amount of tax you have to pay while supporting a worthy cause.

For a distribution to count as a QCD, it must be made directly from your IRA to an eligible charity. You can’t withdraw funds from your IRA to your bank account and then use the money to write a check to your favorite charity.

Note that QCDs are not tax-deductible on Schedule A, the way that other charitable donations are.

How RMDs Are Taxed

RMDs are taxed as ordinary income, assuming that all of the contributions you made were tax-deductible. If you have a traditional IRA, your RMDs would be taxed according to whichever bracket you fall into at the time the withdrawals are made.

With an inherited Roth IRA, withdrawals of original contributions are tax-free. Most withdrawals of earnings from an inherited Roth IRA are also tax-free unless the account is less than five years old at the time of the distribution.

The Takeaway

The IRS requires you to take RMDs on certain types of IRAs, including traditional IRAs and inherited Roth IRAs. Knowing at what age you’re required to take money from an IRA and your deadline for withdrawing it can help you plan ahead and avoid a potentially steep tax penalty.

In general, coming up with a financial plan for your future can help you work toward your retirement goals. You can consider different options for saving and investing, including IRAs, 401(k)s, or other types of savings or investment vehicles, to help determine the best fit for your money.

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).

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

FAQ

What happens if you don’t take RMDs from an IRA?

Failing to take an RMD from an IRA on time can result in a tax penalty. The current penalty is generally a 25% excise tax, assessed against the amount you were required to withdraw.

Do you have to take your IRA RMD if you are still working?

You do have to take RMDs from an IRA even if you’re still working. It’s worth noting that the IRS does typically allow you to defer RMDs from a 401(k) while you’re working — however, that rule doesn’t extend to IRAs.

Are you required to use IRA RMD money for specific purposes?

You can use RMDs money in any way that you like. Some common uses for IRA RMDs include medical expenses, home repairs, and day-to-day costs. You can also use IRA RMDs to make qualified charitable donations (QCD), which could minimize some of the tax you might owe. QCDs must be made directly from your IRA to the charity.

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Oct

2024

Guide to Maxing Out Your 401(k)

By Ashley Kilroy | Budgeting & Goals, Growing Wealth, invest, Investing | No Comments

Table of Contents

What Exactly Does It Mean to ‘Max Out Your 401(k)?’
Should You Max Out Your 401(k)?
How to Max Out Your 401(k)
What Happens If You Contribute Too Much to Your 401(k)?
What to Do After Maxing Out a 401(k)?
Pros and Cons of Maxing Out Your 401(k)
FAQ

Maxing out your 401(k) involves contributing the maximum allowable to your workplace retirement account to increase the benefit of compounding and appreciating assets over time.

All retirement plans come with contribution caps, and when you hit that limit it means you’ve maxed out that particular account.

There are a lot of things to consider when figuring out how to max out your 401(k) account. And if you’re a step ahead, you may also wonder what to do after you max out your 401(k).

Key Points

• Maxing out your 401(k) contributions can help you save more for retirement and take advantage of tax benefits.

• If you want to max out your 401(k), strategies include contributing enough to get the full employer match, increasing contributions over time, utilizing catch-up contributions if eligible, automating contributions, and adjusting your budget to help free up funds for additional 401(k) contributions.

• Diversifying your investments within your 401(k) and regularly reviewing and rebalancing your portfolio can optimize your returns.

• Seeking professional advice and staying informed about changes in contribution limits and regulations can help you make the most of your 401(k).

What Exactly Does It Mean to ‘Max Out Your 401(k)?’

Maxing out your 401(k) means that you contribute the maximum amount allowed by law in a given year, as specified by the established 401(k) contribution limits. But it can also mean that you’re maxing out your contributions up to an employer’s percentage match, too.

If you want to max out your 401(k) in 2024, you’ll need to contribute $23,000 annually. If you’re 50 or older, you can contribute an additional $7,500, for an annual total of $30,500. If you want to max out your 401(k) in 2023, you’ll need to contribute $22,500 annually. If you’re 50 or older, you can contribute an additional $7,500, for an annual total of $30,000.

Should You Max Out Your 401(k)?

4 Goals to Meet Before Maxing Out Your 401(k)

Generally speaking, yes, it’s a good thing to max out your 401(k) so long as you’re not sacrificing your overall financial stability to do it. Saving for retirement is important, which is why many financial experts would likely suggest maxing out any employer match contributions first.

But while you may want to take full advantage of any tax and employer benefits that come with your 401(k), you also want to consider any other financial goals and obligations you have before maxing out your 401(k).

That doesn’t mean you should put other goals first, and not contribute to your retirement plan at all. That’s not wise. Maintaining a baseline contribution rate for your future is crucial, even as you continue to save for shorter-term aims or put money toward debt repayment.

Other goals could include:

• Is all high-interest debt paid off? High-interest debt like credit card debt should be paid off first, so it doesn’t accrue additional interest and fees.

• Do you have an emergency fund? Life can throw curveballs—it’s smart to be prepared for job loss or other emergency expenses.

• Is there enough money in your budget for other expenses? You should have plenty of funds to ensure you can pay for additional bills, like student loans, health insurance, and rent.

• Are there other big-ticket expenses to save for? If you’re saving for a large purchase, such as a home or going back to school, you may want to put extra money toward this saving goal rather than completely maxing out your 401(k), at least for the time being.

Once you can comfortably say that you’re meeting your spending and savings goals, it might be time to explore maxing out your 401(k). There are many reasons to do so — it’s a way to take advantage of tax-deferred savings, employer matching (often referred to as “free money”), and it’s a relatively easy and automatic way to invest and save, since the money gets deducted from your paycheck once you’ve set up your contribution amount.

How to Max Out Your 401(k)

Only a relatively small percentage of people actually do max out their 401(k)s, however. Here are some strategies for how to max out your 401(k).

1. Max Out 401(k) Employer Contributions

Your employer may offer matching contributions, and if so, there are typically rules you will need to follow to take advantage of their match.

An employer may require a minimum contribution from you before they’ll match it, or they might match only up to a certain amount. They might even stipulate a combination of those two requirements. Each company will have its own rules for matching contributions, so review your company’s policy for specifics.

For example, suppose your employer will match your contribution up to 3%. So, if you contribute 3% to your 401(k), your employer will contribute 3% as well. Therefore, instead of only saving 3% of your salary, you’re now saving 6%. With the employer match, your contribution just doubled. Note that employer contributions can range from nothing at all to upwards of 15%. It depends.

Since saving for retirement is one of the best investments you can make, it’s wise to take advantage of your employer’s match. Every penny helps when saving for retirement, and you don’t want to miss out on this “free money” from your employer.

If you’re not already maxing out the matching contribution and wish to, you can speak with your employer (or HR department, or plan administrator) to increase your contribution amount, you may be able to do it yourself online.

2. Max Out Salary-Deferred Contributions

While it’s smart to make sure you’re not leaving free money on the table, maxing out your employer match on a 401(k) is only part of the equation.

In order to make sure you’re setting aside an adequate amount for retirement, consider contributing as much as your budget will allow. Again, individuals younger than age 50 can contribute up to $22,500 in salary deferrals per year — and if you’re over age 50, you can max out at $30,000 in 2023.

It’s called a “salary deferral” because you aren’t losing any of the money you earn; you’re putting it in the 401(k) account and deferring it until later in life.

Those contributions aren’t just an investment in your future lifestyle in retirement. Because they are made with pre-tax dollars, they lower your taxable income for the year in which you contribute. For some, the immediate tax benefit is as appealing as the future savings benefit.

3. Take Advantage of Catch-Up Contributions

As mentioned, 401(k) catch-up contributions allow investors over age 50 to increase their retirement savings — which is especially helpful if they’re behind in reaching their retirement goals. Individuals over age 50 can contribute an additional $7,500 for a total of $30,000 for the year. Putting all of that money toward retirement savings can help you truly max out your 401(k).

As you draw closer to retirement, catch-up contributions can make a difference, especially as you start to calculate when you can retire. Whether you have been saving your entire career or just started, this benefit is available to everyone who qualifies.

And of course, this extra contribution will lower taxable income even more than regular contributions. Although using catch-up contributions may not push everyone to a lower tax bracket, it will certainly minimize the tax burden during the next filing season.

4. Reset Your Automatic 401(k) Contributions

When was the last time you reviewed your 401(k)? It may be time to check in and make sure your retirement savings goals are still on track. Is the amount you originally set to contribute each paycheck still the correct amount to help you reach those goals?

With the increase in contribution limits most years, it may be worth reviewing your budget to see if you can up your contribution amount to max out your 401(k). If you don’t have automatic payroll contributions set up, you could set them up.

It’s generally easier to save money when it’s automatically deducted; a person is less likely to spend the cash (or miss it) when it never hits their checking account in the first place.

If you’re able to max out the full 401(k) limit, but fear the sting of a large decrease in take-home pay, consider a gradual, annual increase such as 1% — how often you increase it will depend on your plan rules as well as your budget.

5. Put Bonus Money Toward Retirement

Unless your employer allows you to make a change, your 401(k) contribution will likely be deducted from any bonus you might receive at work. Many employers allow you to determine a certain percentage of your bonus check to contribute to your 401(k).

Consider possibly redirecting a large portion of a bonus to 401k contributions, or into another retirement account, like an individual retirement account (IRA). Because this money might not have been expected, you won’t miss it if you contribute most of it toward your retirement.

You could also do the same thing with a raise. If your employer gives you a raise, consider putting it directly toward your 401(k). Putting this money directly toward your retirement can help you inch closer to maxing out your 401(k) contributions.

6. Maximize Your 401(k) Returns and Fees

Many people may not know what they’re paying in investment fees or management fees for their 401(k) plans. By some estimates, the average fees for 401(k) plans are between 1% and 2%, but some plans can have up to 3.5%.

Fees add up — even if your employer is paying the fees now, you’ll have to pay them if you leave the job and keep the 401(k).

Essentially, if an investor has $100,000 in a 401(k) and pays $1,000 or 1% (or more) in fees per year, the fees could add up to thousands of dollars over time. Any fees you have to pay can chip away at your retirement savings and reduce your returns.

It’s important to ensure you’re getting the most for your money in order to maximize your retirement savings. If you are currently working for the company, you could discuss high fees with your HR team. One of the easiest ways to lower your costs is to find more affordable investment options. Typically, the biggest bargains can be index funds, which often charge lower fees than other investments.

If your employer’s plan offers an assortment of low-cost index funds or institutional funds, you can invest in these funds to build a diversified portfolio.

If you have a 401(k) account from a previous employer, you might consider moving your old 401(k) into a lower-fee plan. It’s also worth examining what kind of funds you’re invested in and if it’s meeting your financial goals and risk tolerance.

What Happens If You Contribute Too Much to Your 401(k)?

After you’ve maxed out your 401(k) for the year — meaning you’ve hit the contribution limit corresponding to your age range — then you’ll need to stop making contributions or risk paying additional taxes on your overcontributions.

In the event that you do make an overcontribution, you’ll need to take some additional steps such as letting your plan manager or administrator know, and perhaps withdrawing the excess amount. If you leave the excess in the account, it’ll be taxed twice — once when it was contributed initially, and again when you take it out.

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

What to Do After Maxing Out a 401(k)?

If you max out your 401(k) this year, pat yourself on the back. Maxing out your 401(k) is a financial accomplishment. But now you might be wondering, what’s next? Here are some additional retirement savings options to consider if you have already maxed out your 401(k).

Open an IRA

An individual retirement account (IRA) can be a good complement to your employer’s retirement plans. The pre-tax guidelines of this plan are pretty straightforward.

You can save up to $7,000 pre-tax dollars in an IRA if you meet individual IRS requirements for tax year 2024, and $6,500 for tax year 2023. If you’re 50 or older, you can contribute an extra $1,000, totaling $8,000 for 2024 and $7,500 for 2023, to an IRA.

You may also choose to consider a Roth IRA. Roth IRA accounts have income limits, but if you’re eligible, you can contribute with after-tax dollars, which means you won’t have to pay taxes on earnings withdrawals in retirement as you do with traditional IRAs.

You can open an IRA at a brokerage, mutual fund company, or other financial institution. If you ever leave your job, you can roll your employer’s 401(k) into your IRA without facing any tax consequences as long as they are both traditional accounts and it’s a direct rollover – where funds are transferred directly from one plan to the other. Doing a rollover may allow you to invest in a broader range of investments with lower fees.

Boost an Emergency Fund

Experts often advise establishing an emergency fund with at least six months of living expenses before contributing to a retirement savings plan. Perhaps you’ve already done that — but haven’t updated that account in a while. As your living expenses increase, it’s a good idea to make sure your emergency fund grows, too. This will cover you financially in case of life’s little curveballs: new brake pads, a new roof, or unforeseen medical expenses.

The money in an emergency fund should be accessible at a moment’s notice, which means it needs to comprise liquid assets such as cash. You’ll also want to make sure the account is FDIC insured, so that your money is protected if something happens to the bank or financial institution.

Save for Health Care Costs

Contributing to a health savings account (HSA) can reduce out-of-pocket costs for expected and unexpected health care expenses. For tax year 2023, eligible individuals can contribute up to $3,850 pre-tax dollars for an individual plan or up to $7,750 for a family plan.

The money in this account can be used for qualified out-of-pocket medical expenses such as copays for doctor visits and prescriptions. Another option is to leave the money in the account and let it grow for retirement. Once you reach age 65, you can take out money from your HSA without a penalty for any purpose. However, to be exempt from taxes, the money must be used for a qualified medical expense. Any other reasons for withdrawing the funds will be subject to regular income taxes.

Increase College Savings

If you’re feeling good about maxing out your 401(k), consider increasing contributions to your child’s 529 college savings plan (a tax-advantaged account meant specifically for education costs, sponsored by states and educational institutions).

College costs continue to creep up every year. Helping your children pay for college helps minimize the burden of college expenses, so they hopefully don’t have to take on many student loans.

Open a Brokerage Account

After you max out your 401(k), you may also consider opening a brokerage account. Brokerage firms offer various types of investment account brokerage accounts, each with different services and fees. A full-service brokerage firm may provide different financial services, which include allowing you to trade securities.

Many brokerage firms require you to have a certain amount of cash to open their accounts and have enough funds to account for trading fees and commissions. While there are no limits on how much you can contribute to the account, earned dividends are taxable in the year they are received. Therefore, if you earn a profit or sell an asset, you must pay a capital gains tax. On the other hand, if you sell a stock at a loss, that becomes a capital loss. This means that the transaction may yield a tax break by lowering your taxable income.

Pros and Cons of Maxing Out Your 401(k)

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Pros:

• Increased Savings and Growth: Your retirement savings account will be bigger, which can lead to more growth over time.

• Simplified Saving and Investing: Can also make your saving and investing relatively easy, as long as you’re taking a no-lift approach to setting your money aside thanks to automatic contributions.

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Cons:

• Affordability: Maxing out a 401(k) may not be financially feasible for everyone. May be challenging due to existing debt or other savings goals.

• Opportunity Costs: Money invested in retirement plans could be used for other purposes. During strong stock market years, non-retirement investments may offer more immediate access to funds.

The Takeaway

Maxing out your 401(k) involves matching your employer’s maximum contribution match, and also, contributing as much as legally allowed to your retirement plan in a given year. For 2024, that limit is $23,000, or $30,500 if you’re over age 50. For 2023, that limit is $22,500, or $30,000 if you’re over age 50. If you have the flexibility in your budget to do so, maxing out a 401(k) can be an effective way to build retirement savings.

And once you max out your 401(k)? There are other smart ways to direct your money. You can open an IRA, contribute more to an HSA, or to a child’s 529 plan. If you’re looking to roll over an old 401(k) into an IRA, or open a new one, SoFi Invest® can help. SoFi doesn’t charge commissions (the full fee schedule is here), and you can access complimentary professional advice.

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

What happens if I max out my 401(k) every year?

Assuming you don’t overcontribute, you may see your retirement savings increase if you max out your 401(k) every year, and hopefully, be able to reach your retirement and savings goals sooner.

Will You Have Enough to Retire After Maxing Out 401(k)?

There are many factors that need to be considered, however, start by getting a sense of how much you’ll need to retire by using a retirement expense calculator. Then you can decide whether maxing out your 401(k) for many years will be enough to get you there, even assuming an average stock market return and compounding built in.

First and foremost, you’ll need to consider your lifestyle and where you plan on living after retirement. If you want to spend a lot in your later years, you’ll need more money. As such, a 401(k) may not be enough to get you through retirement all on its own, and you may need additional savings and investments to make sure you’ll have enough.

About the author

Ashley Kilroy

Ashley Kilroy is a personal finance writer and content creator with a passion for providing millennials and young professionals the tools and resources they need to better manage their finances. Read full bio.

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Oct

2024

Guide to Brokerage Accounts

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

Key Points

• A brokerage account is an investment account that allows individuals to buy, sell, or trade various financial securities, including stocks and bonds.

• Different types of brokerage firms offer varying levels of service, including full-service, discount, and online brokers, each with distinct fees and features.

• Investing through a brokerage account has no contribution limits or withdrawal restrictions, but capital gains from profits are subject to taxation.

• Four main types of brokerage accounts include cash accounts, margin accounts, joint accounts, and discretionary accounts, each serving different investment needs.

• Opening a brokerage account typically requires personal information, an initial deposit, and agreement to specific terms, with options for funding through various methods.

What Is a Brokerage Account?

A brokerage account is a type of investment account typically opened with a brokerage firm. Brokerage accounts allow owners to invest their money, and buy, sell, or trade stocks, bonds, and other types of financial securities. There are different types of brokerage accounts, and they’re offered by a range of financial firms.

For prospective investors, knowing what a brokerage account is and how they work is important. For seasoned investors, learning even more about them can help deepen their knowledge, too.

What is a Brokerage Account Used For?

As noted, brokerage accounts allow owners to invest in stocks and other financial securities. They’re offered by different types of financial firms, too. In fact, there are many brokerage firms that investors can choose from. While all offer brokerage accounts, they usually come with different fees and services:

• A full-service brokerage firm usually provides a variety of financial services, including allowing you to trade securities. Full-service firms will sometimes provide financial advice and automated investing to customers.

• A discount brokerage firm doesn’t usually provide any additional financial consulting or planning services. Thanks to their pared down services, a discount brokerage firm often offers lower fees than a full-service firm.

• Online brokerage firms provide brokerage accounts via the internet, although some also have brick and mortar locations. Online brokers often offer the lowest fees and give investors freedom to trade online with ease. They also tend to make information and research available to consumers.

Opening a brokerage account generally starts out as a similar experience to opening any other type of cash account. Consumers can simply start an account either online or in person.

💡 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.

Some brokerage firms require investors to use cash to open their accounts and to have enough funding in their account to cover the cost of stocks or bonds, as well as any commission fees. There are some however, that don’t require any initial deposit.

In order to make their first investment however, consumers usually need to deposit money. They can do this by moving money from another account, such as from their checking or savings accounts. From then on, the brokerage firm can help individuals execute buy or sell orders on stocks, exchange-traded funds (ETFs), bonds, or mutual funds.

Unlike a retirement account, there are generally no restrictions on how much money a consumer can put in. There are also typically no restrictions on when individuals can withdraw their cash from brokerage accounts. Investors do need to claim any profits — or “capital gains” — as taxable income.

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

Brokerage Accounts vs Retirement Accounts

The primary difference between a retirement account and a brokerage account is if there’s any tax advantage at play.

For stocks, bonds, exchange traded funds, mutual funds, options etc, brokerage account holders are liable to pay capital gains taxes on most of their profits from trading these securities. That’s why brokerage accounts are also known in the industry as “taxable accounts.”

Retirement accounts are set up with money that has some kind of tax advantage and can be used to buy securities. For example, 401(k)s are set up by an employer and funded with money that comes from an employee’s paycheck before taxes and can be matched by an employer.

These accounts, which also include traditional and Roth IRAs, have specific rules about the amount that can be contributed and when money can be withdrawn. Meanwhile, with brokerage accounts, there are few limits on funding or withdrawals.

Brokerage Accounts vs Checking Accounts

Brokerage accounts and checking accounts have one important thing in common: they can both have cash in them. Sometimes brokerage accounts will “sweep” your cash into a money market fund managed by that same brokerage, allowing you to earn interest. Meanwhile, in a traditional bank checking account, you don’t earn any interest but you do have easy access to your cash.

An important distinction between brokerage and checking accounts is the level of protection you get from them. A checking account offered by a bank will typically have insurance provided by the Federal Deposit Insurance Corporation (FDIC), which protects the first $250,000 deposited at a bank that has a charter from the FDIC. This means that $250,000 deposited can be withdrawn even if the bank itself goes out of business.

Brokerage accounts, on the other hand, typically have insurance provided by the Securities Investors Protection Corporation (SPIC), which unlike the FDIC, is not a government agency. What SIPC insurance does is protect the custody of stocks, bonds, and other securities as well as cash in a brokerage account, not their value.

This means that if a brokerage fails, the SIPC insurance will protect cash deposited in a brokerage account up to $250,000 and securities and cash combined up to $500,000.

This simply means you get your cash deposited in the account and the securities back, not that you have insurance from the value of those securities going down.

Pros and Cons of Opening a Brokerage Account

Brokerage accounts can be powerful financial tools, but they can have their advantages and drawbacks, too.

Pros and Cons of Brokerage Accounts
Pros	Cons
Ability to trade securities	Can’t be used for transactions
High liquidity	Slow transaction times
No limits on contributions and withdrawals	No tax advantages

Pros of Brokerage Accounts

The most obvious advantage of a brokerage account is that it allows its owner to trade financial securities and invest their money. They tend to have a high degree of liquidity, too, meaning that it’s relatively easy to buy and sell securities. There are also no general requirements for contributions or withdrawals.

Cons of Brokerage Accounts

Cons of brokerage accounts include the fact that they can’t be used for traditional transactions, like, say, a checking account. While your account may have a cash balance, you can’t use it to purchase a soda from the corner store.

Further, getting your money in and out of a brokerage account may take some time. There are often fraud checks and other elements at play when transacting a cash balance in or out of an account, and it may take a couple of days. There are also no tax advantages — something that may be present for certain retirement accounts.

A couple of other things that may be worth considering, especially if you’re interested in investing for beginners.

Before you consider opening a brokerage account, make sure you have sufficient money set aside for an emergency fund. Common financial advice recommends setting aside three to 12 times your streamlined monthly expenses. It’s also good practice to contribute to your 401(k) or IRA before opening a brokerage account.

If you have an emergency fund stashed away and are making regular contributions to a retirement account, think about what types of assets you plan on investing in. A brokerage account would only be required if you plan to buy stocks, bonds, or other securities. If you only plan on investing in mutual funds, you might not need a brokerage account.

Top 3 Types of Brokerage Accounts Explained

There are also a few distinct types of brokerage accounts, though they all work in a similar fashion — trading securities, after all, is what brokers do. They are cash brokerage accounts, margin accounts, joint brokerage accounts, and discretionary accounts.

1. Cash Brokerage Accounts

A cash brokerage account is the “vanilla” option. If you open a cash brokerage account, you deposit money and start trading securities.

2. Margin Brokerage Accounts

A margin brokerage account may require approval from a brokerage. These types of accounts let owners use “margin” when trading. That means that they can effectively borrow money to trade with from the brokerage. These obviously come with a higher degree of risk, too.

3. Joint Brokerage Accounts

Joint brokerage accounts are more or less cash brokerage accounts that are opened by more than one person. It’s like a joint bank account, in many respects.

💡 Quick Tip: Are self directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

Investing with SoFi

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

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

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

How do I open a brokerage account?

Most brokerage firms allow prospective customers to open an account online or in person. Opening a brokerage account generally requires some personal information related to identity and financials, and some money to make an initial deposit.

Is there a minimum deposit to open a brokerage account?

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

Do brokerage accounts have fees?

Yes, most brokerage accounts have some sort of associated fees. There may be commission fees involved, though they’re less common today than they once were, but there can be other types of fees to be aware of, too.

SoFi Invest®

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

Oct

2024

A Guide to Bitcoin ETPs

By Inyoung Hwang | Growing Wealth, invest, Investing | Comments Off

Spot Bitcoin ETPs are a type of investment vehicle that seeks to track the spot price of Bitcoin. ETPs, or exchange-traded products, are a broader basket of investments that include both exchange-traded funds (ETFs) and exchange-traded notes (ETNs), and are listed on an exchange, and can be purchased or sold much like a stock.

But what’s critical to know is that generally, ETFs are regulated by the Investment Company Act of 1940 (the “1940 Act”). While the most common type of ETPs are structured as ETFs, not all are, and spot Bitcoin ETPs are a specific type of ETP that are not registered under the 1940 Act. As such, these ETPs are not subjected to the 1940 Act’s rules, and investors holding shares of Bitcoin ETPs do not have the same protections as those that are regulated by the 1940 Act, which means these investments have relatively higher associated risks.

What Is a Bitcoin ETP?

As noted, Bitcoin ETPs are a type of exchange-traded fund or product that allow investors to gain exposure to Bitcoin without directly owning it. These seek to track the price of Bitcoin. That means when the price of Bitcoin in U.S. dollars goes up, a spot Bitcoin ETP, trading on the stock exchange should also see its share values go up, and vice versa.

But it’s critical to note that Bitcoin ETPs have a much narrower focus than most other exchange-traded products, which started out with the aim of giving investors broad exposure to the stock market. But, like all investments, they have various risks associated with them. In fact, it’s possible that an investor could lose the entirety of their investment.

An Introduction to Bitcoin ETPs

Bitcoin ETPs are exchange-traded products that, effectively, allow investors to gain exposure to the crypto markets as easily as they would buy or sell a stock, as discussed. Again, a Bitcoin ETP seeks to track the price or value of Bitcoin, and so the value of a Bitcoin ETP share is designed to rise or fall in relation to the change in value of the underlying cryptocurrency.

It also means that investors don’t necessarily need to directly own Bitcoin to gain exposure to the market in their portfolio — they can invest in a security, the ETP, that seeks to track it, instead. Note, too, that all ETPs have related fees and expenses, which vary.

💡 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.

What Are Spot Bitcoin ETPs?

Spot Bitcoin ETPs are investment vehicles that trade at “spot” value. “Spot” value, in this case, refers to the price of the underlying asset at any given time. So, if a buyer and seller come together to make a trade, they would do so at the spot price. There are spot markets for all sorts of commodities.

Where Can Investors Buy Spot Bitcoin ETP Shares?

Investors can buy spot Bitcoin ETP shares via numerous exchanges and platforms. While previously, investors interested in Bitcoin or other cryptocurrencies would need to trade on platforms that supported cryptocurrencies, since Bitcoin ETPs are exchange-traded vehicles, investors are likely to find them available on many other platforms — that includes SoFi, which allows investors to buy spot Bitcoin ETP shares as well.

Are There Other Spot Crypto ETPs?

Spot Bitcoin ETPs seek to track the price of a fund’s Bitcoin holdings, and other spot crypto ETPs, if and when they are approved and hit exchanges, will do the same.

Spot Bitcoin ETPs were first approved for trading by regulators in early 2024. There are ETPs that seek to track Bitcoin-exposed or Bitcoin-adjacent companies, too, as well as Bitcoin futures. Spot Ethereum ETPs – or Ether ETPs, as they would actually track Ether (ETH), the Ethereum blockchain’s native cryptocurrency – could be similar vehicles to to spot Bitcoin ETPs, in that they would seek to track the price of Ether, and allow investors to gain exposure to Ether in their portfolios without owning it directly.

What Are Bitcoin Futures ETPs?

Bitcoin futures ETPs are another type of ETP that give investors exposure to the price movements of Bitcoin via futures contracts. Futures are a type of contract that dictates the terms of a trade at a future date, and typically have underlying assets such as precious metals or other commodities — including crypto.

Accordingly, Bitcoin futures ETPs are crypto futures ETPs that specifically seek to track Bitcoin futures contracts. Regulators approved Bitcoin futures contracts in 2021, but again, investors should know that they don’t seek to track the price or value of the underlying asset exactly — which differentiates them from spot Bitcoin ETPs.

💡 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.

Are There US-listed Spot Bitcoin ETPs?

There are U.S.-listed spot Bitcoin ETPs. When the Securities and Exchange Commission (SEC) first granted their approval in January 2024, it opened the door to several Bitcoin ETPs hitting the market. As a result, investors were able to start buying and selling them via the stock market.

The SEC’s approval led to new spot Bitcoin ETPs being listed on a few different exchanges. Here’s a list of the first 11 spot Bitcoin ETPs that gained approval from the SEC:

• Grayscale Bitcoin Trust (GBTC)

• Bitwise Bitcoin ETF (BITB)

• Hashdex Bitcoin ETF (DEFI)

• ARK 21Shares Bitcoin ETF (ARKB)

• Invesco Galaxy Bitcoin ETF (BTCO)

• VanEck Bitcoin Trust (HODL)

• WisdomTree Bitcoin Fund (BTCW)

• Fidelity Wise Origin Bitcoin Fund (FBTC)

• Franklin Bitcoin ETF (EZBC)

• iShares Bitcoin Trust (IBIT)

• Valkyrie Bitcoin Fund (BRRR)

Note, too, that it’s anticipated that additional spot cryptocurrency ETPs will become available.

How Are Bitcoin ETPs Regulated?

Bitcoin ETPs are regulated by the SEC, which sets out guidance in terms of legality. Regulation in the crypto space is and has been murky — it’s been largely unregulated for the entirety of the crypto space’s existence. But the advent of crypto ETPs is likely to change that to some degree, as spot Bitcoin ETPs’ underlying asset is and can be Bitcoin itself, rather than Bitcoin derivatives.

Remember, too, that Bitcoin ETPs are not regulated under the Investment Company Act of 1940, as discussed. That differentiates them from most ETFs on the market.

That’s another important distinction investors should note: Spot and futures Bitcoin ETPs may be regulated under slightly different terms, as futures are derivatives. Investors should pay attention to the space and to any SEC guidance released regarding crypto regulation, as it may impact the value of their holdings in crypto ETPs, too.

Pros & Cons of Bitcoin ETPs

Like all investments, there are pros and cons of ETFs and ETPs — including Bitcoin ETPs.

Benefits of Bitcoin ETPs

Proponents of Bitcoin ETPs appreciate that they can give investors exposure to the complicated and volatile cryptocurrency market, without the need to personally hold actual crypto.

Convenience and Ease

Buying a spot Bitcoin ETP requires little tech know-how beyond knowing how to use a computer, open a brokerage account, and place a buy order.

ETPs provide a way for investors to indirectly add exposure to certain assets — like Bitcoin, in this case — to their portfolio. That may result in a return on investment, or a possible loss of principal. On the other hand, holding actual Bitcoin may require a somewhat advanced level of technical expertise.

Secure Storage Options

Some cryptocurrency exchanges might be trustworthy, but some users have also had a controversial history of being hacked, stolen from, or defrauded. Even reliable exchanges open investors up to risk.

Securely storing cryptocurrencies — for example, storing the private keys to a Bitcoin wallet — is most often done by using either a paper wallet that has the keys written in the form of a QR code and a long string of random characters, or by using an external piece of hardware called a hardware wallet.

Risks of Bitcoin ETPs

First and foremost, investors should be aware that it’s possible that they could lose the entirety of their investment when investing in Bitcoin ETPs. There are, of course, other risks to consider as well, including volatility, costs, and the unpredictable and still largely-unregulated nature of the crypto market.

Volatility

The volatility comes from the occasional wild swings experienced in the price of Bitcoin and Bitcoin futures against most other currencies. This could scare investors that have a lower risk tolerance, enticing them to panic and sell.

Fees

One of the risks that comes from holding an ETP of any kind involves its expense ratio. This number refers to the amount of money a fund’s management charges in exchange for providing the opportunity for investors to invest in their fund.

If a fund comes with an expense ratio of 2%, for example, the fund management would take $2 out of a $100 investment each year. This figure is usually calculated after profits have been factored in, cutting into investors’ gains. In other words, some Bitcoin ETPs could be relatively expensive for investors to hold, but it’ll depend on the specific fund.

There can be other various types of fees that may apply to an investment in ETPs as well. While the specific fees will vary from ETP to ETP, investors will likely encounter one or a combination of commissions, account maintenance fees, exchange fees, and wrap fees (a type of management fee). Again, investors will want to look at an ETP’s prospectus or related documents to get a better sense of the costs associated with a specific ETP.

Fraud and Market Manipulation

Regulators have cited fraud and market manipulation as reasons for why they were cautious about approving a spot market Bitcoin ETP. It’s unclear how the SEC’s approval of spot Bitcoin ETPs may affect fraud and market manipulation in the crypto space, but it’s something investors should be aware of.

The Takeaway

Spot Bitcoin ETPs were approved for trading by the SEC in early 2024, and as a result, it’s likely that many more crypto ETPs will also hit markets and exchanges in the future — though nothing is guaranteed. Investors may use them to gain exposure to the crypto markets. For investors curious about the cryptocurrency market but not yet ready to invest in crypto itself, a Bitcoin ETP may represent another option. It may be best to speak with a financial professional before investing, too.

If you’re ready to bring crypto into your portfolio, you can invest in a Bitcoin ETP with SoFi. Along with many other types of investments, SoFi’s platform offers investors access to the crypto space through spot Bitcoin ETPs.

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

What are the options for Bitcoin ETPs?

There are Bitcoin futures ETPs and spot Bitcoin ETPs listed in the U.S., which investors can buy. Given the SEC’s approval of Bitcoin ETPs for trading in early 2024, there may soon be additional spot crypto ETPs available to investors in the future.

Are there US-listed Bitcoin ETPs?

As of July 2024, there are U.S.-listed spot Bitcoin ETPs after the SEC approved an initial batch of them, and it’s likely there will be more in the subsequent months and years.

Where can Bitcoin ETP shares be purchased?

Crypto ETPs can be purchased and traded on the stock market, alongside other ETPs.

Photo credit: iStock/JuSun

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.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
SoFi Invest may waive all, or part of any of these fees, permanently or for a period of time, at its sole discretion for any reason. Fees are subject to change at any time. The current fee schedule will always be available in your Account Documents section of SoFi Invest.

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.

SOIN-Q424-001

Oct

2024

The Pros and Cons of a Roth IRA

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

A Roth IRA offers a tax-advantaged way to save for retirement. Contributions to a Roth IRA are made with after-tax dollars, and qualified withdrawals in retirement are tax-free. Individuals with earned income up to certain limits may be eligible to contribute to a Roth IRA.

A Roth IRA also has some potential drawbacks, however. Weighing the pros and cons of a Roth IRA can help you decide whether it’s a good fit in your retirement portfolio.

What Is a Roth IRA?

A Roth IRA is an individual retirement account that’s funded with after-tax dollars. That means you can’t deduct Roth contributions from your taxes at the time you make them. But in retirement, at age 59 ½ and older, qualified withdrawals are tax-free. That’s the most straightforward way of defining a Roth IRA, and it’s also one of the reasons some investors are drawn to it.

You can have a Roth IRA in addition to a 401(k) or other workplace retirement savings plan. You could also open a Roth IRA to help save for retirement if you don’t have access to an employer-sponsored retirement plan.

The IRS sets annual contribution limits for Roth IRAs, and these limits are adjusted periodically for inflation. For the 2024 tax year, the maximum allowed contribution is $7,000. Those age 50 and older can make an additional catch-up contribution of $1,000 for a total contribution of $8,000.

Roth IRA Eligibility

To open a Roth IRA, you must have earned income, but one of the cons of a Roth IRA is that there are limits on how much you can earn to be eligible.

The chart below illustrates what you can contribute to a Roth IRA based on your modified adjusted gross income (MAGI) and tax filing status.

Filing status	2024 MAGI	Roth IRA contribution allowed
Single	Up to $146,000	$7,000 ($8,000 for those 50 and older)
	From $146,000 to $161,000	Partial contribution
	$161,000 or more	$0
Married, filing jointly	Up to $230,000	$7,000 ($8,000 for those 50 and older)
	From $230,000 to $240,000	Partial contribution
	$240,000 or more	$0
Married, filing separately	Less than $10,000	Partial contribution
	$10,000 and more	$0

As you can see, high-income earners may be ineligible for a Roth. You could, however, make contributions to a traditional IRA instead.

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

Roth IRA vs. Traditional IRA

A traditional IRA is also a tax-advantaged individual retirement account. Traditional IRAs have the same annual contribution limits as Roth IRAs. The main difference between a traditional vs. Roth IRA is their tax treatment.

Traditional IRAs are funded with pre-tax dollars. That means you may be eligible to deduct some or all of the contributions you make each year. In retirement, you’ll pay income tax on qualified withdrawals.

The amount you can deduct in traditional IRA contributions depends on your income, tax filing status, and whether you’re covered by a retirement plan at work.

What Are the Pros and Cons of a Roth IRA?

Saving for retirement in a Roth IRA has advantages, but it may not be the right option for everyone. Here are pros and cons of Roth IRAs.

Pros of a Roth IRA

There are several advantages of a Roth IRA, including:

Tax-Free Growth and Withdrawals

Because Roth IRAs are funded with after-tax dollars, you’ve already paid tax on the money you contribute. Your money grows tax-free while it’s invested, and when you withdraw it in retirement, you pay no taxes on it.

Tax-free withdrawals are beneficial if you expect your income to be higher in retirement than it is during your working years. Any money you take out of a Roth IRA at age 59 ½ or older wouldn’t increase your tax liability as long as it’s a qualified withdrawal.

No Required Minimum Distributions

With traditional IRAs, account holders must begin taking required minimum distributions (known as RMDs) from their account annually once they reach age 73 (assuming they reach age 72 in 2023 or later). If you don’t withdraw the required amount on time, you are subject to a tax penalty.

Roth IRAs do not have RMDs. You can leave the money in your account for as long as you like.

Contributions Can Be Withdrawn Penalty-Free

Ideally, the concept of a Roth IRA is to leave your money in the account until retirement. At age 59 ½ you can begin taking distributions without facing a 10% early withdrawal penalty. However, you can withdraw the contributions you make to a Roth IRA penalty-free at any time.

Your earnings are a different matter. You cannot withdraw your earnings before age 59 ½ without incurring taxes and penalties.

Cons of a Roth IRA

There are some drawbacks to an IRA, which mean these accounts may not be a good fit for everyone. These are the main cons of a Roth IRA to consider.

No Tax Deduction

Roth IRAs don’t offer a tax deduction for the contributions you make. Instead, you have to wait until retirement to reap the tax benefits. Tax-free withdrawals in your golden years could be an advantage, however, if you anticipate being in a higher tax bracket in retirement.

Income Limits Apply

Earning a higher income could put a Roth IRA out of reach for certain individuals, as our chart above indicates. If you’re not eligible for a Roth because of your earnings, you could consider a backdoor Roth IRA.

With a backdoor Roth, you make nondeductible contributions to a traditional IRA and then convert that IRA to a Roth IRA. However, since you’re moving pre-tax dollars into an after-tax account, you’ll owe income taxes on a Roth IRA conversion at the time you complete it, which could be costly.

The 5-Year Rule

Unlike traditional IRAs, Roth IRA accounts are subject to the 5-year rule. This rule says that, barring certain exceptions, your account must be open for at least five years before you can withdraw the earnings tax- and penalty-free at age 59 ½. The 5-year rule also applies to IRA conversions.

Setting Up a Roth IRA

Opening a Roth IRA is relatively easy. You choose where to open the account, fill out the required paperwork, designate a beneficiary, and fund your account.

Like many other investment accounts, you can open a Roth IRA through an online brokerage and link a bank account to it to make your first contribution.

Once you add funds to your IRA, you can decide how to invest them. Typically, brokerages offer options such as mutual funds and index funds. If you’re looking for alternative investments you may want to consider opening a self-directed IRA instead.

Roth IRA Withdrawal Rules

You can withdraw your Roth IRA contributions at any time without taxes or penalties. However, when it comes to earnings, Roth IRA withdrawal rules can be complicated since you have to factor in the five-year rule.

To help simplify things, this at-a-glance chart shows how withdrawals of earnings from a Roth IRA work and when taxes and penalties apply.

Your age	The account has been open less than five years	The account has been open for five years or more
Under 59 ½	Withdrawals of earnings are subject to taxes and penalties, unless an exception (like a disability) applies.	Withdrawals of earnings are not subject to taxes if the money is used for a first-home purchase or the account holder becomes disabled or passes away.
59 ½ or older	Withdrawals of earnings are subject to taxes, but not penalties.	Withdrawals of earnings are tax- and penalty-free.

Naming a Trust as Your Roth IRA Beneficiary

When you set up a Roth IRA, you need to name a beneficiary. Your beneficiary inherits the money in your Roth IRA after your death.

You can name an individual such as your spouse or child as your IRA beneficiary. You can also designate a trust as your beneficiary. A trust is a legal entity that you transfer your assets to. It’s administered by a trustee who manages your assets for you, according to your wishes.

For example, you might name a trust as the beneficiary of your Roth IRA if you’d like a say in what happens to your assets once you pass away. If you leave your IRA to an individual, they can do what they like with it. A trust allows you to leave specific instructions about how the assets in the trust can be used.

The Takeaway

A Roth IRA offers some unique benefits when it comes to retirement savings. With a Roth IRA, your money grows tax-free, you can make tax-free qualified withdrawals in retirement, and there’s no need for RMDs.

But not everyone is eligible to open a Roth IRA. There are income limits on these accounts, plus you must have funded a Roth for at least five years in order to make qualified withdrawals of your earnings without facing taxes and a penalty.

For those who are eligible for a Roth IRA, the prospect of tax-free withdrawals in retirement may make the potential downsides worth it. Consider all the pros and cons of a Roth IRA to make an informed decision about whether this type of retirement account is right for you.

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).

FAQs

Are Roth IRAs considered a safe investment?

A Roth IRA is not an investment; it’s an individual retirement account into which you put money that you plan to invest. Your choice of investments, and your risk tolerance, can determine how “safe” your Roth IRA may be. When comparing different investments, consider the risk and possible reward of each one to determine if you’re comfortable with it.

Do Roth individual retirement accounts have income limits?

Roth IRAs do have income limits set by the IRS and updated annually that determine who can contribute. These limits are based on your modified adjusted gross income (MAGI). If your MAGI exceeds the limit allowed for your filing status, you won’t be able to make a Roth IRA contribution. For example, in 2024, a single person with a MAGI of $161,000 or more and a person married filing jointly with a MAGI of $240,000 or more are not eligible to contribute to a Roth IRA.

How much can you contribute to a Roth IRA?

The annual Roth IRA contribution limit is set by the IRS. For the 2024 tax year, the maximum contribution allowed is $7,000, unless you’re 50 or older. In that case, you could contribute an additional $1,000 in catch-up contributions, for a total of $8,000 for the year.

Photo credit: iStock/Lusyaya

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

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

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

SoFi Invest®

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

SOIN-Q324-012

Required Minimum Distribution (RMD) Definition

Special Considerations for RMDs

Why Do You Have to Take an RMD?

Get a 1% IRA match on rollovers and contributions.

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

RMDs for Roth and Traditional IRAs

How To Calculate RMDs on an IRA

IRA Required Minimum Distribution Table Example

Withdrawing Required Minimum Distribution From an IRA

When Do RMDs Start?

Qualified Charitable Distributions (QCDs)

How RMDs Are Taxed

The Takeaway

FAQ

What happens if you don’t take RMDs from an IRA?

Do you have to take your IRA RMD if you are still working?

Are you required to use IRA RMD money for specific purposes?

What Exactly Does It Mean to ‘Max Out Your 401(k)?’

Should You Max Out Your 401(k)?

How to Max Out Your 401(k)

1. Max Out 401(k) Employer Contributions

2. Max Out Salary-Deferred Contributions

3. Take Advantage of Catch-Up Contributions

4. Reset Your Automatic 401(k) Contributions

5. Put Bonus Money Toward Retirement

6. Maximize Your 401(k) Returns and Fees

What Happens If You Contribute Too Much to Your 401(k)?

Get a 1% IRA match on rollovers and contributions.

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

What to Do After Maxing Out a 401(k)?

Open an IRA

Boost an Emergency Fund

Save for Health Care Costs

Increase College Savings

Open a Brokerage Account

Pros and Cons of Maxing Out Your 401(k)

Pros:

Cons:

The Takeaway

FAQ

What happens if I max out my 401(k) every year?

Will You Have Enough to Retire After Maxing Out 401(k)?

You may also be interested in:

What Is a Brokerage Account?

What is a Brokerage Account Used For?

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

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

Brokerage Accounts vs Retirement Accounts

Brokerage Accounts vs Checking Accounts

Pros and Cons of Opening a Brokerage Account

Pros of Brokerage Accounts

Cons of Brokerage Accounts

Top 3 Types of Brokerage Accounts Explained

1. Cash Brokerage Accounts

2. Margin Brokerage Accounts

3. Joint Brokerage Accounts

Investing with SoFi

FAQ

How do I open a brokerage account?

Is there a minimum deposit to open a brokerage account?

Do brokerage accounts have fees?

What Is a Bitcoin ETP?

An Introduction to Bitcoin ETPs

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

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

What Are Spot Bitcoin ETPs?

Where Can Investors Buy Spot Bitcoin ETP Shares?

Are There Other Spot Crypto ETPs?

What Are Bitcoin Futures ETPs?

Are There US-listed Spot Bitcoin ETPs?

How Are Bitcoin ETPs Regulated?

Pros & Cons of Bitcoin ETPs

Benefits of Bitcoin ETPs

Convenience and Ease

Secure Storage Options

Risks of Bitcoin ETPs

Volatility

Fees

Fraud and Market Manipulation

The Takeaway

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

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

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

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