Investing Archives | Page 70 of 191

Mar

2024

Stock Buyback: What It Means & Why It Happens

By Michael Flannelly | Growing Wealth, invest, Investing, Terminology | No Comments

One of the most popular ways a company can use its cash is through a stock buyback. Over the past five years, according to S&P Dow Jones Indices, big companies have spent more than $3.9 trillion repurchasing their own shares to boost shareholder value. Because of this significant activity, investors need to know the basics of stock buybacks and how they work to feel confident in making investment decisions.

Table of Contents

What Is A Stock Buyback?
How Do Companies Buy Back Stock?
Why Do Companies Buy Back Stock?
What Happens to Repurchased Stock?
The Pros and Cons of a Stock Buyback for Investors

What Is A Stock Buyback?

A stock buyback, also known as a share repurchase, is when a company buys a portion of its previously issued stock, reducing the total number of outstanding shares on the market. Because there are fewer total shares on the market after the buyback, each share owned by investors represents a greater portion of company ownership.

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How Do Companies Buy Back Stock?

Companies can repurchase stock from investors through the open market or a tender offer.

Open market

A company may buy back shares on the open market at the current market price, just like a regular investor would. These stock purchases are conducted with the company’s brokers.

Tender offers

A company may also buy back shares through a tender offer. One type of tender offer, the fixed-price offer, occurs when a company proposes buying back shares from investors at a fixed price on a specific date. This process usually values the shares at a higher price than the current price per share on the open market, providing an extra benefit to shareholders who agree to sell back the shares.

Another type of tender offer, the dutch auction offer, will specify to investors the number of shares the company hopes to repurchase and a price range. Shareholders can then counter with their own proposals, which would include the number of shares they’re willing to give up and the price they’re asking. When the company has all of the shareholders’ offers, it decides the right mix to buy to keep its costs as low as possible.

Why Do Companies Buy Back Stock?

Stock buybacks are one of several things a company can do with the cash it has in its coffers, including paying the money out to shareholders as a dividend, reinvesting in business operations, acquiring another company, and paying off debt. There are several reasons why a company chooses to buy back its stock rather than some of these other options.

1. Increases Stock Value

One of the most common reasons a company might conduct a share buyback is to increase the value of the stock, especially if the company considers its shares undervalued. By reducing the supply of shares on the market, the stock price will theoretically go up as long as the demand for the stock remains the same. The rising stock price benefits existing shareholders.

2. Puts Money Into Shareholders’ Hands

A company’s stock buyback program can be used as an alternative to dividend payments to return cash to shareholders, specifically those investors who choose to sell back their shares to the company. With dividend payments, companies usually pay them regularly to all shareholders, so investors may not like it if a company reduces or suspends a dividend. Stock buybacks, in contrast, are conducted on a more flexible basis that may benefit the company because investors do not rely on the payments.

3. Takes advantage of tax benefits

Many investors prefer that companies use excess cash to repurchase stock rather than pay out dividends because buybacks have fewer direct tax implications. With dividends, investors must pay taxes on the payout. But with stock buybacks, investors benefit from rising share prices but do not have to pay a tax on this benefit until they sell the stocks. And even when they sell the stock, they usually pay a lower capital gains tax rate.

4. Offsets dilution from stock options

Companies will often offer employee stock options as a part of compensation packages to their employees. When these employees exercise their stock, the number of shares outstanding increases. To maintain an ideal number of outstanding shares after employees exercise their options, a company may buy back shares from the market.

5. Improves financial ratios

Another way stock buybacks attract more investors is by making the company’s financial ratios look much more attractive. Because the repurchases decrease assets on the balance sheet and reduce the number of outstanding shares, it can make financial ratios like earnings per share (EPS), the price-to-earnings ratio (PE Ratio), and return on equity (ROE) look more attractive to investors.

What Happens to Repurchased Stock?

When a company repurchases stock, the shares will either be listed as treasury stock or the shares will be retired.

Treasury stocks are the shares repurchased by the issuing company, reducing the number of outstanding shares on the open market. The treasury stock remains on its balance sheet, though it reduces the total shareholder equity. Shares that are listed as treasury stock are no longer included in EPS calculations, do not receive dividends, and are not part of the shareholder voting process. However, the treasury stock is still considered issued and, therefore, can be reissued by the company through stock dividends, employee compensation, or capital raising.

In contrast, retired shares are canceled and cannot be reissued by the company.

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The Pros and Cons of a Stock Buyback for Investors

When a company announces a stock buyback, investors may wonder what it means for their investment. Stock buybacks have pros and cons worth considering depending on the company’s underlying reasoning for the share repurchase and the investor’s goal.

Pros of a Stock Buyback

Tender offer premium

Investors who accept the company’s tender offer could have an opportunity to sell the stock at a greater value than the market price.

Increased total return

Investors who hold onto the stock after a buyback will likely see a higher share price since fewer outstanding shares are on the market. Plus, each share now represents a more significant portion of company ownership, which may mean an investor will see higher dividend payments over time. A higher stock price and increased dividend boosts an investor’s total return on investment.

Tax benefits

As mentioned above, a stock buyback might also mean a lower overall tax burden for an investor, depending on how long the investor owned the stock. Money earned through a stock market buyback is taxed at the capital gains tax rate. If the company issued a dividend instead of buying back shares, the dividends would be taxed as regular income, typically at a higher rate.

Cons of a Stock Buyback

Cash could be spent elsewhere

As mentioned above, when companies have cash, they can either reinvest in business operations, acquire a company, pay down debt, pay out a dividend, or buy back stock. Engaging in a share repurchase can starve the business of money needed in other areas, such as research and development or investment into new products and facilities. This hurts investors by boosting share price in the short term at the expense of the company’s long-term prospects.

Poorly timed

Companies may sometimes perform a stock buyback when their stocks are overvalued. Like regular investors, companies want to buy the stock when the shares are valued at an attractive price. If the company buys at a high stock price, it could be a bad investment when the company could have spent the money elsewhere.

Benefits executives, not shareholders

Stock buybacks might also be a convenient tactic to benefit company executives, who are often compensated by way of stock options. Also, some executives earn bonuses for increasing key financial ratios like earnings per share, so buying back stock to improve those ratios potentially benefits insiders and not all shareholders.

The Takeaway

Like almost everything else to do with the stock market, the benefits and drawbacks of stock buybacks aren’t exactly straightforward. Investors need to ask themselves a few questions when analyzing the share repurchases of a company, like “why is the company conducting the buyback?” and “does the company have a history of delivering good returns?” Answering these questions can help investors decide whether a stock buyback is the best thing for a company.

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FAQ

Is a stock buyback positive or negative?

Stock buybacks have advantages and disadvantages for investors and companies. For instance, buybacks may increase the stock value and increase dividend payments to shareholders over time. However, stock buybacks may not be the best way for a company to spend its money in the long-term, and they may potentially benefit company executives more than shareholders.

When should a company do a stock buyback?

A company may do a stock buyback when it has the cash available and wants to increase the value of the stock, improve financial ratios, consolidate ownership, or drive demand for the stock.

Do I lose my shares in a buyback?

You won’t lose your shares in a buyback unless you want to sell them. The way a buyback works is that a company buys back stock from any investors who want to sell it. But you are under no obligation to sell your stock back to the company — it’s up to you whether to keep your stock or sell it back.

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.

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Mar

2024

Profit Sharing 401(k) Plans Guide: Rules, Limits, Basics: Woman with calculator

What is a 401(k) Profit Sharing Plan?

By Anna Davies | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

Like a traditional 401(k) plan, a profit-sharing 401(k) plan is an employee benefit that can provide a vehicle for tax-deferred retirement savings. But the biggest difference between an employer-sponsored 401(k) and a profit-sharing 401(k) plan is that in a profit share plan, employers have control over how much money—if any—they contribute to the employee’s account from year to year.

In other ways, the profit-sharing 401(k) plan works similarly to a traditional employer-sponsored 401(k). Under a 401(k) profit share plan, as with a regular 401(k) plan, an employee can allocate a portion of pre-tax income into a 401(k) account, up to a maximum of $22,500 in 2023, and up to $23,000 in 2024. Those 50 and older can contribute up to $30,000 in 2023 and $30,500 in 2024, thanks to catch-up contributions.

At year’s end, employers can choose to contribute part of their profits to employees’ plans, tax-deferred. As with a traditional 401(k), maximum total contributions to an account must be the lesser of 100% of the employee’s salary or $66,000 a year in 2023 and $69,000 in 2024, per the IRS. Those numbers jump to $73,500 for older employees who are making catch-up contributions in 2023 and $76,500 in 2024.

How Does 401(k) Profit Sharing Work?

There are several types of 401(k) profit-sharing setups employers can choose from. Each of these distributes funds in slightly different ways.

Pro-Rata Plans

In this common type of plan, all employees receive employer contributions at the same rate. In other words, the employer can make the decision to contribute 3% (or any percentage they choose) of an employee’s compensation as an employer contribution. The amount an employer can contribute is capped at 25% of total employee compensation paid to participants in the plan.

New Comparability 401(k) Profit Sharing

In this plan, employers can group employees when outlining a contribution plan. For example, executives could receive a certain percentage of their compensation as contribution, while other employees could receive a different percentage. This might be an option for a small business with several owners that wish to be compensated through a profit-sharing plan.

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Age-Weighted Plans

This plan calculates percentage contributions based on retirement age. In other words, older employees will receive a greater percentage of their salary than younger employees, by birth date. This can be a way for employers to retain talent over time.

Integrated Profit Sharing

This type of plan uses Social Security (SS) taxable income levels to calculate the amount the employer shares with employees. Because Social Security benefits are only paid on compensation below a certain threshold, this method allows employers to make up for lost SS compensation to high earners, by giving them a larger cut of the profit sharing.

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.

Pros and Cons of 401(k) Profit Sharing

There are benefits and drawbacks for both employers and employees who participate in a profit-sharing 401(k) plan.

Employer Pro: Flexibility of Employer Contributions

Flexibility with plan contribution amounts is one reason profit share plans are popular with employers. An employer can set aside a portion of their pre-tax earnings to share with employees at the end of the year. If the business doesn’t do well, they may not allocate any dollars. But if the business does do well, they can allow employees to benefit from the additional profits.

Employer Pro: Flexibility in Distributions

Profit sharing also gives employers flexibility in how they wish to distribute funds among employees, using the Pro-Rata, New Comparability, Age-Weighted, or Integrated profit sharing strategy.

Employer Pro: Lower Tax Liability

Another advantage of profit share plans is that they allow employers to lower tax liability during profitable years. A traditional employer contribution to a 401(k) does not have the flexibility of changing the contribution based on profits, so this strategy can help a company maintain financial liquidity during lean years and lower tax liability during profitable years.

Employee Pro: Larger Contribution Potential

Some employees might appreciate that their employer 401(k) contribution is tied to profits, as the compensation might feel like a more direct reflection of the hard work they and others put into the company. When the company succeeds, they feel the love in their contribution amounts.

Additionally, depending on the type of distribution strategy the employer utilizes, certain employees may find a profit-sharing 401(k) plan to be more lucrative than a traditional 401(k) plan. For example, an executive in a company that follows the New Compatibility approach might be pleased with the larger percentage of profits shared, versus more junior staffers.

Employee Con: Inconsistent Contributions

While employers may consider the flexibility in contributions from year to year a positive, it’s possible that employees might find that same attribute of profit-sharing 401(k) plans to be a negative. The unpredictability of profit share plans can be disconcerting to some employees who may have previously worked for an employer who had a traditional, consistent employer match set up.

Employee/Employer Pro: Solo 401(k) Contributions

A profit share strategy can be one way solo business owners can maximize their retirement savings. Once a solo 401(k) is set up with profit sharing, a business owner can put up to $22,500 a year into the account, plus up to 25% of net earnings, up to a total of $66,000 in 2023. In 2024, they can put up to $23,000 into a solo 401(k) account, plus up to 25% of net earnings, for a total of up to $69,000. This retirement savings vehicle also provides flexibility from year to year, depending on profits.

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Withdrawals and Taxes on 401(k) Profit Share Plans

A 401(k) with a generous profit share plan can help you build your retirement nest egg. So what about when you’re ready to take out distributions? A 401(k) withdrawal will have penalties if you withdraw funds before you’re 59 ½ (barring certain circumstances laid out by the IRS) but the money will still be taxable income once you reach retirement age.

Additionally, like traditional 401(k) plans, a profit-sharing 401(k) plan has required minimum distribution requirements (RMDs) once an account holder turns 73.

Investors who anticipate being in a high tax bracket during their retirement years may consider different strategies to lower their tax liability in the future. For some, this could include converting the 401(k) into a Roth IRA when doing a rollover. This is sometimes called a “backdoor Roth IRA” because rolling over the 401(k) generally does not subject an investor to the income limitations that cap Roth contributions.

An investor would need to pay taxes on the money they convert into a Roth IRA, but distributions in retirement years would not be taxed the way they would have if they were kept in a 401(k). In general, any 401(k) participant who qualifies for a Roth IRA can do this, but the additional funds in a 401(k) profit share account could make these moves that much more impactful in the future.

The Takeaway

A 401(k) profit-sharing plan allows employees to contribute pre-tax dollars to their retirement savings, as well as benefit from their employer’s profitability. But because profit share plans can take multiple forms, it’s important for employees to understand what their employer is offering. That way, employees can work to create a robust retirement savings strategy that makes sense for them.

Another step that could also help you manage your retirement savings is doing a 401(k) rollover, where you move funds from an old account to a rollover IRA. You may want to consider this option if you have a 401(k) from a previous employer, for instance.

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FAQ

Can I cash out my profit-sharing?

You can cash out your profit-sharing 401(k) without penalty once you reach age 59 ½. Withdrawals taken before that time are subject to penalty. However, if you leave the company, you can roll over the profit-sharing 401(k) into an IRA without penalty as long as you follow the IRS rollover rules.

How much tax do you pay on profit-sharing withdrawal?

You pay regular income tax on profit-sharing withdrawals. Depending on what tax bracket you’re in, you might pay anywhere from 10% to 37%.

Is profit-sharing 100% vested?

Depending on your company, your profit-sharing contributions may be 100% vested right away, or they may follow a vesting schedule. If your employer requires you to work for the company for two years before you’re eligible to participate in a profit-sharing plan, your contributions must be fully vested right away.

Can I roll my profit-sharing plan into an IRA?

You can roll over your profit sharing plan into an IRA when you leave your company. You can choose to have the funds directly transferred from your profit-sharing plan to an IRA, or you can have the money paid to you and then deposit the funds into an IRA yourself. Just be sure to complete the rollover within 60 days to avoid being taxed.

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

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Mar

2024

Guide To Employee Stock Ownership Plans

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

You may have come across the term “ESOP” and wondered, what does ESOP stand for? An employee stock ownership plan (ESOP) is a type of defined contribution plan that allows workers to own shares of their company’s stock. While these plans are covered by many of the same rules and regulations that apply to 401(k) plans, an ESOP uses a different approach to help employees fund their retirement.

The National Center for Employee Ownership estimates that there are approximately 6,533 ESOPs covering nearly 15 million workers in the U.S. But what is an employee stock ownership plan exactly? How is an ESOP a defined contribution plan? And how does it work?

If you have access to this type of retirement plan through your company, it’s important to understand the ESOP meaning and where it might fit into your retirement strategy.

What Is an Employee Stock Ownership Plan (ESOP)?

An ESOP as defined by the IRS is “an IRC section 401(a) qualified defined contribution plan that is a stock bonus plan or a stock bonus/money purchase plan.” (IRC stands for Internal Revenue Code.) So what is ESOP in simpler terms? It’s a type of retirement plan that allows you to own shares of your company’s stock.

Though both ESOPs and 401(k)s are qualified retirement plans, the two are different in terms of how they are funded and what you’re investing in. For example, while employee contributions to an ESOP are allowed, they’re not required. Plus, you can have an ESOP and a 401(k) if your employer offers one. According to the ESOP Association, 93.6% of employers who offer an ESOP also offer a 401(k) plan for workers who are interested in investing for retirement.

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How Employee Stock Ownership Plans Work

In creating an ESOP, the company establishes a trust fund for the purpose of holding new shares of stock or cash to buy existing shares of stock in the company. The company may also borrow money with which to purchase shares. Unlike employee stock options, with an ESOP employees don’t purchase shares themselves.

Shares held in the trust are divided among employee accounts. The percentage of shares held by each employee may be based on their pay or another formula, as decided by the employer. Employees assume ownership of these shares according to a vesting schedule. Once an employee is fully vested, which must happen within three to six years, they own 100% of the shares in their account.

ESOP Distributions and Upfront Costs

When an employee changes jobs, retires, or leaves the company for any other reason, the company has to buy back the shares in their account at fair market value (if a private company) or at the current sales price (if a publicly-traded company). Depending on how the ESOP is structured, the payout may take the form of a lump sum or be spread over several years.

For employees, there are typically no upfront costs for an ESOP.

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.

Employee Stock Ownership Plan Examples

A number of companies use employee stock ownership plans alongside or in place of 401(k) plans to help employees save for retirement, and there are a variety of employee stock ownership plan examples. Some of the largest companies that are at least 50% employee-owned through an ESOP include:

• Publix Super Markets

• WinCo Foods

• Amsted Industries

• Brookshire Grocery Company

• Houchens Industries

• Performance Contracting, Inc.

• Parsons

• Davey Tree Expert

• W.L. Gore & Associates

• HDR, Inc.

Seven of the companies on this list are 100% employee-owned, meaning they offer no other retirement plan option. Employee stock ownership plans are popular among supermarkets but they’re also used in other industries, including engineering, manufacturing, and construction.

Pros & Cons of ESOP Plans

ESOPs are attractive to employees as part of a benefits package, and can also yield some tax benefits for employers. Whether this type of retirement savings plan is right for you, however, can depend on your investment goals, your long-term career plans, and your needs in terms of how long your savings will last. Here are some of the employee stock ownership plans pros and cons.

Pros of ESOP Plans

With an ESOP, employees get the benefit of:

• Shares of company stock purchased on their behalf, with no out-of-pocket investment

• Fair market value for those shares when they leave the company

• No taxes owed on contributions

• Dividend reinvestment, if that’s offered by the company

An ESOP can be an attractive savings option for employees who may not be able to make a regular payroll deduction to a 401(k) or similar plan. You can still grow wealth for retirement as you’re employed by the company, without having to pay anything from your own pocket.

Cons of ESOP Plans

In terms of downsides, there are a few things that might make employees think twice about using an ESOP for retirement savings. Here are some of the potential drawbacks to consider:

• Distributions can be complicated and may take time to process

• You’ll owe income tax on distributions

• If you change jobs means you’ll only be able to keep the portion of your ESOP that you’re vested in

• ESOPs only hold shares of company stocks so there’s no room for diversification

Pros and Cons of ESOP Plan Side-by-Side Comparison

Pros	Cons
• Shares of company stock purchased on employees’ behalf, with no out-of-pocket investment • Fair market value for those shares when they leave the company • No taxes owed on contributions • Dividend reinvestment, if that’s offered by the company	• Distributions can be complicated and may take time to process • You’ll owe income tax on those distributions • Changing jobs means you’ll only be able to keep the portion of your ESOP that you’re vested in • ESOPs only hold shares of company stocks so there’s no room for diversification

Pros

Cons

• Shares of company stock purchased on employees’ behalf, with no out-of-pocket investment

• Fair market value for those shares when they leave the company

• No taxes owed on contributions

• Dividend reinvestment, if that’s offered by the company

• Distributions can be complicated and may take time to process

• You’ll owe income tax on those distributions

• Changing jobs means you’ll only be able to keep the portion of your ESOP that you’re vested in

• ESOPs only hold shares of company stocks so there’s no room for diversification

By comparison, a 401(k) could offer more flexibility in terms of what you invest in and how you access those funds when changing jobs or retiring. But it’s important to remember that the amount you’re able to walk away with in a 401(k) largely hinges on what you contribute during your working years, whereas an ESOP can be funded without you contributing a single penny.

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ESOP Contribution Limits

The IRS sets contribution limits on other retirement plans, and ESOPs are no different. In particular, there are two limits to pay attention to:

• Limit for determining the lengthening of the five-year distribution period

• Limit for determining the maximum account balance subject to the five-year distribution period

Like other retirement plan limits, the IRS raises ESOP limits regularly through cost of living adjustments. Here’s how the ESOP compares for 2023 and 2024.

ESOP Limits	2023	2024
Limit for determining the lengthening of the five-year distribution period	$265,000	$275,000
Limit for determining the maximum account balance subject to the five-year distribution period	$1,330,000	$1,380,000

Cashing Out of an ESOP

In most cases, you can cash out of an ESOP only if you retire, leave the company, lose your job, become disabled, or pass away.

Check the specific rules for your plan to find out how the cashing-out process works.

Can You Roll ESOPs Into Other Retirement Plans?

You can roll an ESOP into other retirement plans such as IRAs. However, there are possible tax implications, so you’ll want to plan your rollover carefully.

ESOPs are tax-deferred plans. As long as you roll them over into another tax-deferred plan such as a traditional IRA, within 60 days, you generally won’t have to pay taxes.

However, a Roth IRA is not tax-deferred. In that case, if you roll over some or all of your ESOP into a Roth IRA, you will owe taxes on the amount your shares are worth.

Because rolling over an ESOP can be a complicated process and could involve tax implications, you may want to consult with a financial professional about the best way to do it for your particular situation.

ESOPs vs 401(k) Plans

Although ESOPs and 401(k)s are both retirement plans, the funding and distribution is different for each of them. Both plans have advantages and disadvantages. Here’s a side-by-side comparison of their pros and cons.

	ESOP	401(k)
Pros	• Money is invested by the company, typically, and requires no contributions from employees. • Employees get fair market value for shares when they leave the company. • Company may offer dividend reinvestment.	• Many employers offer matching funds. • Choice of options to invest in. • Generally easy to get distributions when an employee leaves the company.
Cons	• ESOPs are invested in company stock only. • Value of shares may fall or rise based on the performance of the company. • Distribution may be complicated and take time.	• Some employees may not be able to afford to contribute to the plan. • Employees must typically invest a certain amount to qualify for the employer match. • Employees are responsible for researching and choosing their investments.

ESOP

401(k)

Pros

• Money is invested by the company, typically, and requires no contributions from employees.

• Employees get fair market value for shares when they leave the company.

• Company may offer dividend reinvestment.

• Many employers offer matching funds.

• Choice of options to invest in.

• Generally easy to get distributions when an employee leaves the company.

Cons

• ESOPs are invested in company stock only.

• Value of shares may fall or rise based on the performance of the company.

• Distribution may be complicated and take time.

• Some employees may not be able to afford to contribute to the plan.

• Employees must typically invest a certain amount to qualify for the employer match.

• Employees are responsible for researching and choosing their investments.

3 Other Forms of Employee Ownership

An ESOP is just one kind of employee ownership plan. These are some other examples of plans an employer might offer.

Stock options

Stock options allow employees to purchase shares of company stock at a certain price for a specific period of time.

Direct stock purchase plan

With these plans, employees can use their after-tax money to buy shares of the company’s stock. Some direct stock purchase plans may offer the stock at discounted prices.

Restricted stock

In the case of restricted stock, shares of stock may be awarded to employees who meet certain performance goals or metrics.

Investing for Retirement With SoFi

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FAQ

Can employees contribute to an ESOP?

In most cases, the employer makes contributions to an ESOP on behalf of employees. Rarely, employers may allow for employee contributions to employee stock ownership plans.

What is the maximum contribution to an ESOP?

The maximum account balance allowed in an employee stock ownership plan is determined by the IRS. For 2024, this limit is $1,380,000, though amounts are increased periodically through cost of living adjustments.

What does ESOP stand for?

ESOP stands for employee stock ownership plan. This is a type of qualified defined contribution plan which allows employees to own shares of their company’s stock.

How does ESOP payout work?

When an employee changes jobs, retires, or leaves the company for any other reason, the company has to buy back the shares in their account at fair market value or at the current sales price, depending if the company is private or publicly-traded. The payout to the employee may take the form of a lump sum or be spread over several years. Check with your ESOP plan for specific information about the payout rules.

Is an ESOP better than a 401(k)?

An ESOP and a 401(k) are both retirement plans, and they each have pros and cons. For instance, the employer generally funds an ESOP while an employee contributes to a 401(k) and the employer may match a portion of those contributions. A 401(k) allows for more investment options, while an ESOP consists of shares of company stock.

It’s possible to have both an ESOP and a 401(k) if your employer gives you that option. Currently, almost 94% of companies that offer ESOPs also offer a 401(k), according to the ESOP Association.

Photo credit: iSTock/pixelfit

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

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

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

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

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Mar

2024

How Does Inflation Affect Retirement?

By Paulina Likos | invest, Investing, Preparing for Retirement | Comments Off

For retirees on a fixed income, inflation can have a significant influence on their ability to maintain their budget. That’s because as inflation rises over time, that fixed income will lose value.

That could mean that retirees need to scale back their spending or even make drastic changes to ensure that they don’t run out of money. The average rate of inflation was 8% in 2022, the highest inflation rate in 40 years. By January 2024, the inflation rate had dropped to 3.1%.

When it comes to their retirement money, 90% of Americans ages 60 to 65 say inflation is their biggest concern, according to a 2023 survey by Nationwide. However, by planning ahead, it is possible to minimize some of the impact of inflation on your nest egg.

Read on to learn more about inflation and retirement and what you can do to help protect your savings.

What Is Inflation?

Inflation is the rate at which prices of goods and services increase in an economy over a period of time. This can include daily costs of living such as gas for your car, groceries, home expenses, medical care, and transportation. Inflation may occur in specific segments of the economy or across all segments at once.

There are multiple causes for inflation but economists typically recognize that inflation occurs when demand for goods and services exceeds supply. In an expanding economy where more consumers are spending more money, there tends to be higher demand for products or services which can exceed its supply, putting upward pressure on prices.

When inflation increases, the purchasing power of money, or its value, decreases. This means as the price of things in the economy goes up, the number of units of goods or services consumers can buy goes down.

How does inflation affect retirement? When purchasing power declines, the value of your savings and investments goes down. While the dollar amount does not change, the amount of goods or services those dollars can buy falls. In retirement, inflation can be especially harmful, since retirees typically don’t have an income that goes up over time.

Concerns about inflation and retirement may even push back the age at which some people think they can afford to retire.

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.

5 Ways that Could Potentially Minimize the Impact of Inflation on Retirement

While inflation can seem like a challenging or even scary part of retirement, there are several investment opportunities that may help you maintain purchasing power and reduce the risk of inflation.

1. Invest in the Stock Market

Investing in stocks is one way to potentially fight inflation. A diversified portfolio that includes equities may generate long-term returns that are higher than long-term inflation. While past performance does not guarantee future returns, over the past 10 years, the average annualized return for the S&P 500 has been 12.39%. Even when inflation is factored in, investors still have substantial returns when investing in stocks. When adjusted for inflation, the average annualized return over the past 10 years is 9.48%.

However, stocks are risk assets, which means they are sensitive to market volatility. These price swings may not feel comfortable to investors who are in retirement so retirees tend to allocate a smaller portion of their portfolio to stocks to help manage market risk.

How much you may decide to allocate to stocks depends on a number of factors such as your risk tolerance and other sources of income.

2. Use Tax-Advantaged Retirement Vehicles

To maximize the amount of savings you have by the time you reach retirement, start investing as early as you can in young adulthood in retirement accounts such as employer-sponsored 401(k)s or Individual Retirement Accounts (IRA). The more time your money has to grow, the better.

With 401(k)s and traditional IRAs, the money in them grows tax-deferred; you pay income tax on withdrawals in retirement, when you might be in a lower tax bracket than you were during your working years.

Another option is a Roth IRA. With this type of IRA, you pay taxes on the money you contribute, and then you can withdraw it tax-free in retirement.

3. Do Not Over-Allocate Long-Term Investments With a Low Rate of Return

Risk averse investors may be tempted to keep their nest egg invested in securities that are not subject to major price swings, or even to keep their money in a savings account. However, theoretically, the lower the risk investors take, the lower the reward may be. When factoring in fees and inflation, ultra-conservative investments may only break even or perhaps lose value over time.

While they offer a guaranteed return, high-yield savings accounts, for example, typically don’t earn enough interest to beat inflation in the long run. Since savings account rates are not higher than inflation rates, the buying power of your savings will continue to decline. That’s particularly important for retirees who are often living off their savings and investments, rather than off of an income that rises with inflation.

Because of this, retirees may want to consider keeping a portion of their investments in the stock market.

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

4. Make Sure You Understand Inflation-Protected Securities

Treasury inflation-protected securities or TIPS, which are backed by the federal government, are designed to help protect investments against inflation. The principal value of the investment increases when inflation goes up and if there’s deflation, the principal adjusts lower per the Consumer Price Index.

However, for some investors, TIPS may have disadvantages. TIPS typically pay lower interest rates than other government or corporate securities. That generally makes them less than ideal for individuals like retirees who are looking for investment income. Also, unless inflation is quite high, and unless they are held for the long-term, TIPS may not offer much inflation-protection. There are also potential tax consequences to consider when the bonds are sold or reach maturity.

Finally, because they are more sensitive to interest rate fluctuation than other bonds, if an investor sells TIPS before they reach maturity, that individual could potentially lose money depending on the interest rates at the time.

Be sure to carefully weigh all the pros and cons of TIPS to decide if they make sense for your portfolio.

5. Buy Real Estate or Invest in REITs

Retirees may also consider investing in real assets. Real estate is typically an inflation hedge because it holds intrinsic value. During periods of inflation, real estate may not only be able to preserve its value, but it might also increase in value. One of the daily costs impacted by inflation is the cost of housing.

That’s why rental income from real estate historically has kept up with inflation. Investing in real estate investment trusts (REITs), may be another way for retirees to diversify their investment portfolio, reduce volatility, and add to their fixed-income. Just be sure to understand the potential risks involved in these investments.

Inflation Calculator for Retirement

It’s important to factor inflation into your plans as you’re saving for retirement. One way to do that is using a retirement calculator, like this one from the Department of Labor, which accounts for how inflation will impact your purchasing power in the future. That calculator uses a 3% inflation rate for retirement planning, but inflation fluctuates and could be higher or lower in any given year.

The Takeaway

While inflation can have an impact on a retirement portfolio, there are ways to protect the purchasing power of your money over time. Allocating a portion of your portfolio to stocks and other investments aimed at minimizing the impact of inflation may help.

Another way to curb the impact of inflation during retirement is to reduce expenses, which allows the money that you have to go further.

And starting to save for retirement as early as possible could help you accrue the compounded returns necessary to counteract rising prices in the future.

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

Help grow your nest egg with a SoFi IRA.

FAQ

Is inflation good or bad for retirees?

A small amount of inflation each year is a normal part of the economic cycle. But over time, inflation eats away at the value of the dollar and purchasing power of your nest egg is diminished. This can have a negative effect on a retirement investment portfolio or savings.

How can I protect my retirement savings from inflation?

There are several Investing strategies you can use to protect retirement savings from inflation. These include diversifying your portfolio with inflation hedges including TIPS (treasury inflation-protected securities) and investments that typically provide a high rate of return. It’s important to keep saving for retirement even if you don’t have a 401(k).

Does your pension increase with inflation?

Some pensions have a cost of living adjustment on their monthly payments, so they increase over time. However, this is not the case for all pensions. When inflation increases this can affect your benefits.

Photo credit: iStock/RgStudio

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.

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.

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.

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

SoFi Invest®

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

Feb

2024

Aiming to Become a Millionaire? These Steps Could Help

By Samuel Becker | Financial Independence, Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

Do you find yourself dreaming about what you would do if you were a millionaire? Maybe you fantasize about retiring early and traveling the world. Or perhaps what excites you is the thought of being able to donate to causes you care about.

But, you might be wondering, how to become a millionaire? You may suspect the only way you’ll ever be that rich is if you win the lottery.

Fortunately, the road to wealth isn’t that narrow — there are many ways to become a millionaire. For instance, some individuals retire with over a million dollars in savings because they made good financial decisions.

Others may have started businesses that brought them success, advanced their careers so that they made enough to save seven figures, or made smart investments.

Read on to learn more about how to become a millionaire, and strategies that could help get you there.

Introduction to the Millionaire Mindset and Goals

You may have a certain image of a millionaire in your mind. Maybe it’s a jetsetter or a celebrity. But many millionaires are not born into wealthy families or individuals who suddenly struck it rich. In fact, many millionaires are people who work for a living every day. In general, what tends to set them apart is that they have a millionaire mindset. They are smart and disciplined when it comes to their money. And they stay focused on their financial goals.

Defining What it Means to be a Millionaire

The true definition of a millionaire is someone with a net worth of at least $1 million. That means that their assets, minus any debt, is $1 million or more.

So, if you have $500,000 in savings and investments, plus a house that’s worth at least $500,000, are you a millionaire? Yes, if you own the house outright and don’t have a lot of debt such as car loans, student loans, or credit cards to pay off. But if you still owe money on your house and you’ve got a fair amount of debt to repay, you probably aren’t a millionaire. At least, not yet.

To do the math for your situation, total up your assets. Then subtract your debts from that amount. This will show you how close you are to reaching millionaire status, and possibly give you a sense of what you might have to do to get there.

Following these eight strategies can help when it comes to how to become a millionaire.

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

Step 1: Stay Away From Debt

As we just saw in the example above, one thing that could be holding you back from becoming a millionaire is debt — especially if that debt is “bad debt,” a term often used for high-interest debt. Eliminating your debt is key because it’s difficult to build wealth if you’re paying a significant portion of your income toward interest.

Paying off debt could help free up money to invest and build wealth. One way to repay debt is to use the debt avalanche method. With this technique, you pay off your debts with the highest interest rates first and then focus on debts with the next highest interest rates (while still making minimum payments on all of your debt, of course).

Eliminating debt isn’t just about paying off existing debt, though, it’s also about avoiding the chances of going into debt in the future. Part of a debt payoff strategy could involve spending less so that you don’t need to rely on credit. You can also set a strict budget and pay with cash whenever possible.

In addition, you may want to create an emergency fund by setting aside a certain amount of money every month. That way, if you have a financial setback, you don’t have to go into credit card debt.

Recommended: Ready to build your emergency fund? Use our emergency fund calculator to determine the right amount.

Step 2: Invest Early and Consistently

Investing successfully doesn’t happen overnight. It takes time. That’s why you need to start early. There are a few rules to know that could help you improve your chances of becoming a millionaire.

Benefits of Compounding Returns

First, compounding returns can make all the difference. They can help your money grow, as long as the returns are reinvested.

Here’s how they work: Compounding returns depend on how much an investment gains or loses over time, which is known as the rate of return. The longer your money is invested, the more compounding it can do. That’s why some individuals start saving aggressively when they’re young.

Saving $100,000 by the time you’re 30 might not be possible for everyone, but the more you save early on, the greater impact it could have on your net worth.

And here’s the thing: Even if you’re in your 30s, 40s, or 50s now, it’s never too late to start saving. The important thing is that you start, period. And that you keep saving.

There are other investing strategies that could help as you work on how to become a millionaire. For instance, you could reduce the amount you spend on investment fees. High investment fees can have a big impact on your returns, so you might want to look into low-fee investments.

Also, you should make sure that you invest in a way that’s right for you throughout your life. That may mean investing more aggressively when you’re younger and gradually becoming more conservative in your investments as you get older and closer to retirement.

Step 3: Make Saving a Priority

Your savings is the amount of money you have left after paying taxes and spending money.

Many Americans aren’t saving enough to become a millionaire — in October 2023, the average personal savings rate was 3.8%, according to the Bureau of Economic Analysis. You’ll likely need to save more than three times that amount to become a millionaire.

Effective Saving Strategies for Long-term Wealth

To save for your goals, start by investing in your company’s 401(k). Max out your 401(k) if you can. At the very least, invest at least enough to earn the employer match, if there is one. That way your employer is contributing to your savings.

In addition, consider opening a traditional IRA or a Roth IRA and contribute as much as possible — up to the limit set by the IRS. These IRAs are tax-advantaged, so they’ll help with your tax bill, too.

And investigate other savings options as well. For instance, you could open a high-yield savings account rather than a regular savings account for a higher return.

Step 4: Increase Your Income

You can’t join the ranks of millionaires if you’re not bringing in more money than you need for your basic necessities. The more money you make, the more you can save and invest.

Tips for Boosting Earnings and Maximizing Income

Some ways to boost your income include asking for a raise or looking for a new higher-paying job. You could also go back to school to earn an advanced degree that could lead to a position with a higher income. Your current employer might even help you cover the cost; check with your HR department.

Another one of the ways to earn extra money is to take on a side hustle. You could tutor students on evenings or weekends, do freelance writing, or dog sit. And those are just some of the options to consider.

Step 5: Cut Unnecessary Expenses

Getting control of your spending is critical to building wealth. That doesn’t mean you have to cut back on everything that gives you pleasure, but you could consider the happiness return on investment you get from the money that you spend. How big of an apartment or home do you truly need to be content? What kind of car do you need? Do you have to buy lunch out every day or could you bring your own lunch from home?

Identifying and Eliminating Non-Essential Spending

You could find ways to cut back on the things that don’t matter so much, but not skimping to the point that you miss out on things you love. For example, maybe you need your gym sessions (and there are plenty of low-cost gyms out there), but you can do without a $5 latte every morning.

Also, you could focus on cutting back on big expenses instead of those that won’t have a huge impact on your budget. For example, dining out only once a month, adjusting your thermostat higher or lower depending on the season, or finding a less expensive, smaller home could help you save a significant amount of money over time.

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

Step 6: Keep Your Financial Goals in Focus

To become a millionaire, you’ll need to stay laser-focused on your financial goals. When everyone else around you is spending money, going on fancy vacations, and buying expensive cars, remind yourself what’s truly important to you. Keep your spending in check, continue to save and invest, and avoid taking on debt.

It takes discipline. But instead of thinking about the stuff you don’t have, appreciate all the good things in your life, like your family and friends. Remember that you’re saving for your future. You’ll be able to enjoy yourself then if you have the money you need to live comfortably and happily.

Think of it this way: You’re making yourself and your financial security the priority. Make that your mantra.

Step 7: Consult with Investment Professionals

Investing can be complicated because there are so many options to choose from. If you need help figuring out what investments are right for you, consider working with a qualified financial advisor.

Leveraging Advice for Wealth Building

A good financial advisor could help you select the right investments and the best investing strategies for your situation. They can also help you plan and budget to reach your goals. But be sure to be an active participant in the process. Ask questions, be involved. Why are they suggesting a specific investment? And if you don’t feel comfortable with something, say so.

Finally, be sure to check your investment performance regularly. Know what you are investing in, how much, and why.

Step 8: Repeat and Refine Your Financial Plan

The final step to becoming a millionaire is to stay committed to your goal and your plan. Keep saving and investing your money. Stay out of debt. Let time and the power of compounding returns kick in. Be patient.

But also, don’t be afraid to refine or change your plan if need be. For instance, as you get closer to retirement, you will likely want to choose safer, less aggressive investments. You can keep saving and growing money throughout different ages and stages, but your method for doing so can evolve to make sense for where you are in your life.

Additional Tips for Wealth Building

In addition to all of the strategies above, there are a few other techniques that may help you reach millionaire status.

Lifestyle Considerations and Spending Habits

As you work your way up the ladder and earn more money throughout your career, you may be tempted to increase your lifestyle spending, too. After all, you have more money now, so you may feel the urge to spend it.

But here’s the thing: Giving in to these temptations can be a slippery slope. It might start with a bigger house in a nice neighborhood, and then grow to taking extravagant vacations and driving a luxury car. Before you know it, you could be spending way more than you’re saving.

Try to avoid lifestyle splurging if you want to be a millionaire. Instead, take the extra money and save and invest it. That way, you’ll be able to reach your goal even faster.

The Takeaway

Becoming a millionaire is possible if you take the right approach. It involves saving and investing your money, spending wisely, and avoiding debt. You need to be disciplined and focused, and it won’t always be easy. But staying committed to your goals can reward you with financial security and success.

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

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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.

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

Stock Buyback: What It Means & Why It Happens

What Is A Stock Buyback?

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How Do Companies Buy Back Stock?

Open market

Tender offers

Why Do Companies Buy Back Stock?

1. Increases Stock Value

2. Puts Money Into Shareholders’ Hands

3. Takes advantage of tax benefits

4. Offsets dilution from stock options

5. Improves financial ratios

What Happens to Repurchased Stock?

The Pros and Cons of a Stock Buyback for Investors

Pros of a Stock Buyback

Tender offer premium

Increased total return

Tax benefits

Cons of a Stock Buyback

Cash could be spent elsewhere

Poorly timed

Benefits executives, not shareholders

The Takeaway

FAQ

Is a stock buyback positive or negative?

When should a company do a stock buyback?

Do I lose my shares in a buyback?

What is a 401(k) Profit Sharing Plan?

How Does 401(k) Profit Sharing Work?

Pro-Rata Plans

New Comparability 401(k) Profit Sharing

Age-Weighted Plans

Integrated Profit Sharing

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Pros and Cons of 401(k) Profit Sharing

Employer Pro: Flexibility of Employer Contributions

Employer Pro: Flexibility in Distributions

Employer Pro: Lower Tax Liability

Employee Pro: Larger Contribution Potential

Employee Con: Inconsistent Contributions

Employee/Employer Pro: Solo 401(k) Contributions

Withdrawals and Taxes on 401(k) Profit Share Plans

The Takeaway

FAQ

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How much tax do you pay on profit-sharing withdrawal?

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Can I roll my profit-sharing plan into an IRA?

Guide To Employee Stock Ownership Plans

What Is an Employee Stock Ownership Plan (ESOP)?

How Employee Stock Ownership Plans Work

ESOP Distributions and Upfront Costs

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Employee Stock Ownership Plan Examples

Pros & Cons of ESOP Plans

Pros of ESOP Plans

Cons of ESOP Plans

Pros and Cons of ESOP Plan Side-by-Side Comparison

ESOP Contribution Limits

Cashing Out of an ESOP

Can You Roll ESOPs Into Other Retirement Plans?

ESOPs vs 401(k) Plans

3 Other Forms of Employee Ownership

Stock options

Direct stock purchase plan

Restricted stock

Investing for Retirement With SoFi

FAQ

Can employees contribute to an ESOP?

What is the maximum contribution to an ESOP?

What does ESOP stand for?

How does ESOP payout work?

Is an ESOP better than a 401(k)?

How Does Inflation Affect Retirement?

What Is Inflation?

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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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