Dec
30
2024
What Is a Self Directed IRA (SDIRA)?

Guide to Self-Directed IRAs (SDIRA)

By | Growing Wealth, invest, Investing | Comments Off on Guide to Self-Directed IRAs (SDIRA)

Individual retirement accounts, or IRAs, typically allow for a lot of flexibility in the kinds of investments you can make, from stocks and bonds to mutual funds and exchange-traded funds (ETFs).

However, most IRAs don’t allow certain alternative investments like precious metals and real estate. If you want to hold assets like these in your retirement account, you’ll need a self directed IRA (SDIRA), a specific type of Roth or traditional IRA.

Key Points

•   A self-directed IRA (SDIRA) allows individuals to invest in a broader array of assets, including real estate, cryptocurrency, and precious metals, compared to traditional IRAs.

•   Account holders of SDIRAs manage their investments independently, which involves conducting research and due diligence on potential assets, thus increasing their responsibility.

•   While SDIRAs can offer high potential returns, they also carry higher fees and risks, particularly due to the illiquidity of many alternative investments.

•   Contribution limits for SDIRAs mirror those of traditional IRAs, allowing up to $7,000 annually, or $8,000 for individuals aged 50 and older.

•   Opening an SDIRA requires finding an approved custodian, selecting investments, completing transactions through a reputable dealer, and planning for less liquid withdrawals.

What Is a Self-Directed IRA (SDIRA)?

Self directed IRAs and self directed Roth IRAs allow account holders to buy and sell a wider variety of investments than regular traditional IRAs and Roth IRAs. Experienced investors, familiar with sophisticated or risky investments, often use these.

While a custodian or a trustee administers the SDIRA, the account holder typically manages the allocation themselves, taking on responsibility for researching investments and due diligence. These accounts may also come with higher fees than regular IRAs, which can cut into the size of your retirement nest egg over time.

What Assets Can You Put in a Self-Directed IRA or a Self-Directed Roth IRA?

Individuals can hold a number of unique alternative investments in their SDIRA, including but not limited to:

•   Real estate and land

•   Cryptocurrency

•   Precious metals

•   Mineral, oil, and gas rights

•   Water rights

•   LLC membership interest

•   Tax liens

•   Foreign currency

•   Startups through crowdfunding platforms

Recommended: Types of Alternative Investments

Types of SDIRAs

There are specific kinds of SDIRAs customized to investors looking for certain types of investments. The different types include:

Self-directed SEP IRAs

Simplified Employee Pension IRAs (SEP IRAs) are for small business owners or those who are self-employed so that they can make contributions that are tax deductible for themselves and any eligible employees they might have. This type of retirement account gives them the flexibility to invest in alternative investments.

Self-directed SIMPLE IRAs

A Savings Incentive Match Plan IRA (SIMPLE IRA) is a tax-deferred retirement plan for employers and employees of small businesses. Both the employer and the employees can make contributions to this plan. It allows for some alternative kinds of investments.

Recommended: SIMPLE IRA vs Traditional

Self-directed Precious Metal IRAs

Similarly, there are self-directed IRAs for those who would like to invest in precious metals like gold. However, be aware that some precious metal IRAs may charge higher fees than the market price for precious metals.

How Do Self-Directed IRAs Work?

Now that you know the answer to the question, what is a self directed IRA?, it’s important to understand how these accounts work and the self directed IRA rules. You’ll also want to familiarize yourself with the guidelines regarding opening an IRA if you have a 401(k).

Aside from their ability to hold otherwise off-limits alternative investments, SDIRAs work much like their traditional counterparts. SDIRAs are tax-advantaged retirement accounts, and they can come in two flavors: traditional SDIRAs and Roth SDIRAs.

Traditional IRA Contributions and Withdrawal Rules

IRA contributions to traditional accounts goes in before taxes, which reduces investors’ taxable income, lowering their income tax bill in the year they make the contribution. For both 2024 and 2025, individuals can contribute up to $7,000 in total across accounts. Those age 50 and up can make an extra $1,000 catch-up contribution for a total of $8,000. Investments inside the account grow tax-deferred.

It’s important to pay close attention to self directed IRA rules, particularly rules for IRA withdrawals. Once individuals begin to make withdrawals at age 59 ½, they are taxed at normal income tax rates. Account holders who make withdrawals before that age may owe taxes and a possible 10% early withdrawal penalty. Traditional SDIRA account holders must begin making required minimum distributions (RMDs) after age 73.

Roth IRA Contributions and Withdrawal Rules

Roth SDIRAs have the same contribution limits as traditional SDIRAs. However, retirement savers contribute to Roths with after-tax dollars. Investments inside the account grow tax-free, and withdrawals after age 59 ½ aren’t subject to income tax.

Roths are also not subject to RMD rules. As long as an individual has had the account for at least five years (as defined by the IRS), they can withdraw Roth contributions at any time without penalty, though earnings may be subject to tax if withdrawn before age 59 ½.

There are also rules restricting who can contribute to a Roth IRA, based on their income. In 2024, Roth eligibility begins phasing out at $146,000 for single people, and $230,000 for people who are married and file their taxes jointly.

Individuals can maintain both traditional and Roth IRA accounts, however, contribution limits are cumulative across accounts, and cannot exceed $7,000, or $8,000 for those 50 and over.

Traditional vs Roth SDIRA

There are some differences between a self-directed traditional IRA and a self-directed Roth IRA.

With a traditional SDIRA, you save pre-tax money for your retirement, just like you do with a traditional IRA plan. You pay taxes on the money when you withdraw it, which you can do without penalty starting at age 59 ½. However, a self-directed traditional IRA gives you the flexibility to invest in alternative assets, like real estate or precious metals.

With a self-directed Roth IRA, just like a regular Roth IRA, you make after-tax contributions to the plan. The withdrawals you make starting at age 59 ½ are tax-free, as long as you have had the account for at least five years, according to the five-year rule. With this type of self-directed IRA, you can invest in alternative investments, such as private equity, real estate, and precious metals.

💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.

Pros and Cons of Self-Directed IRAs

Self-directed IRAs offer unique perks for the right investor. However, those interested must weigh those benefits against potential drawbacks.

Benefits of Self-Directed IRAs

An SDIRA allows investors to branch out into different types of investments to which they might otherwise not have access. This allows investors to seek out potentially higher returns and diversify their portfolios beyond the offerings in traditional IRAs.

Alternative investments have the potential to offer higher returns than investors might achieve with stock market investments. However, investors beware: These opportunities for higher rewards come at the price of higher risk.

Also, investors’ ability to hold a broader spectrum of investments that can help them diversify their portfolio and potentially manage risks, such as inflation risk or longevity risk, the chance an investor will run out of money before they die. For example, some SDIRAs allow investors to hold gold, a traditional hedge against inflation.

Drawbacks of Self-Directed IRAs

While there are some very real advantages to using SDIRAs, these must be weighed against their disadvantages.

For starters, investments like stocks and shares of ETFs are highly liquid. Investors who need their money quickly can sell them in a relatively short period of time, usually a matter of days.

However, some of the investments available in SDIRAs are not liquid. For example, real estate and physical commodities like precious metals may take quite a bit of time to sell if you need to access your money. Individuals who need to sell these assets quickly may find themselves in a situation in which they must accept less than they believe the asset is worth.

SDIRAs may also carry higher fees. Individuals who hold regular IRA accounts may not have to pay management or investment fees. However, SDIRA holders may have to pay fees associated with holding the account and with the purchase and maintenance of certain assets.

Finally, SDIRAs place a lot of responsibility in the hands of their account holders. Investors must research investments themselves and perform due diligence to make sure that whatever they’re buying is legitimate and matches their risk tolerance.

What’s more, investors must make sure the assets they hold meet IRS rules. Running afoul of these rules can be costly, in some cases causing investors to pay taxes and penalties.
Here’s a look at the pros and cons of SDIRAs at a glance:

Pros

 Cons
Tax-advantaged growth. Contributions to traditional accounts are tax deductible. Investments grow tax-deferred in traditional accounts and tax-free in Roth accounts. Not liquid. Selling alternative investments may be slow and difficult.
Same contribution limits as regular IRAs. In 2024, individuals can contribute up to $7,000 a year, or $8,000 for those aged 50 and up. Higher fees. Individuals may be on the hook for account fees and fees associated with alternative investments.
Higher returns. Alternative investments may offer higher returns than those available in the stock market. Increased responsibility. Investors must research investments carefully themselves and ensure they stay within rules for approved IRA investments.
Diversification. SDIRAs offer investors the ability to invest in assets beyond the stock and bond markets. Higher risk. Alternative investments tend to be riskier than more traditional investments.

4 Steps to Opening a Self-Directed IRA

Investors who want to open an SDIRA will need to take the following steps:

1. Find a custodian or trustee.

This can be a bank, trust company, or another IRS-approved entity. You’ll need to follow their requirements for opening an IRA account. Some SDIRAs specialize in certain asset classes, so look for a custodian that allows you to invest in the asset classes in which you’re interested.

2. Choose investments.

Decide which alternatives you want to hold in your SDIRA. Perform necessary research and due diligence.

3. Complete the transaction.

Find a reputable dealer from which your custodian can purchase the assets, and ask them to complete the sale.

4. Plan withdrawals carefully.

Because alternative assets have less liquidity than other types of investments, you may need to plan sales well in advance of needing retirement income or meeting any required minimum distributions.

Investing in Your Retirement With SoFi

If you’re opening your first IRA account, you’re likely best served with a traditional or Roth IRA. Because of the complications involved in using an SDIRA, only sophisticated investors should consider it.

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


Easily manage your retirement savings with a SoFi IRA.

FAQ

Are self-directed IRAs a good idea?

There are advantages and disadvantages to self-directed IRAs. Benefits include the fact that you can make alternative types of investments you might not otherwise be able to. That could help you diversify your portfolio and potentially increase your returns.

However, there are drawbacks to SDIRAs, including higher risk because alternative investments tend to be riskier, and potentially higher fees for maintenance of investments in the plan and account fees. In addition, investors need to research the investments themselves and follow the IRS rules carefully to make sure they comply. Finally, many alternative investments are not liquid, which means they could take longer and be more difficult to sell.

Can you set up a self-directed IRA yourself?

To set up a self-directed IRA, find a custodian or trustee such as a bank or trust company to open an account, research and choose your investments, find a reputable dealer for the investments you’d like to make, and have your custodian complete the transactions.

How much money can you put in a self-directed IRA?

In 2024, you can contribute up to $7,000 to a traditional or Roth self-directed IRA, plus an additional $1,000 if you’re 50 or older.

Photo credit: iStock/Andres Victorero


An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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

SoFi Invest®

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

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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Dec
30
2024

Guide to the Average Savings in America by Age

By | Budgeting & Goals, Preparing for Retirement | Comments Off on Guide to the Average Savings in America by Age

How much does the average American have in savings? Age tends to have a lot to do with it. Generally, as people get older, they are likely to have more savings.

But what the average person has in a savings account also depends on their financial goals and personal circumstances.

If you’re looking for a benchmark of just how much you should save by a specific age, or how much you should start contributing right now, read on for average savings by age and some tips that could help.

Key Points

•   The average savings for individuals under 35 is $11,200.

•   Individuals between the ages of 35 and 44 have an average savings of $27,900.

•   Those aged 45 to 54 have an average savings of $48,200.

•   The average savings for individuals between 55 and 64 is $57,800.

•   Individuals aged 65 and older have an average savings of $60,400.

The Importance of Saving for the Future

Life can happen fast. For example, the average cost of having a new baby can run parents approximately $3,000 in out-of-pocket expenses for pregnancy and delivery. And then there’s the cost of caring for a child, which some estimates put at more than $18,000 for raising them through age 17.

And, if that baby wants to get a college degree, you’re looking at a whole new realm of savings. The cost of a college education can range from about $44,000 to well past $150,000.

There’s one other big reason to save for the future: People are living longer. According to a 2023 survey by the Employee Benefit Research Institute, only 18% of American workers are “very confident they will be able to retire comfortably.” Four in 10 workers say their lack of confidence is because they have little to no savings.


💡 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.

A Savings Shortfall

More than half of Americans can’t cover an unexpected $1,000 expense, according to Bankrate’s 2023 emergency savings report. Only 43% say they could cover it.

And 37% of all Americans don’t have enough cash in savings to cover even a $400 emergency, the Federal Reserve found in its “Economic Well-Being of U.S. Households in 2022” report.

Recommended: Try our emergency fund calculator to see how much you should save for an emergency fund.

Get a 1% IRA match on rollovers and contributions.

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

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

Average Savings by Age in the USA

The Fed’s latest Survey of Consumer Finances shows that the typical American household has $5,300 in a savings account at a bank or credit union. But this number varies greatly by age and number of people in a household. Here’s what savings by age looks like.

Average Savings for Those 35 and Younger

Americans under the age of 35 had an average savings account balance of $11,200, according to the Fed’s survey.

This is a large age bracket that can range from those just graduating high school to recent college grads to young professionals well into a decade’s worth of work.

It’s wise to have three to six months of expenses in an emergency fund. At the very least, aiming to have $1,000 handy in a savings account for unexpected expenses is recommended.

For those who have started their careers, employer-sponsored retirement funds such as an IRA or a 401(k) can be good options to start saving for long-term retirement goals.

It makes sense to contribute at least enough to get matching funds from an employer, if that’s an option with your company’s plan. For reference, the average 401(k) savings for someone between the ages of 20 and 29 in the Fed’s survey was $10,500.

Recommended: Why You Should Start Retirement Planning in Your 20s

Average Savings by Age: 35 to 44

Americans between the ages of 35 and 44 had an average savings account balance of $27,900, according to the Federal Reserve Survey of Consumer Finances. Those in this age bracket are now well into adulthood. At this stage of life, it’s prudent to have that three-to six-months’ worth of savings in an emergency fund, to cover the cost of everything from an accident to a lost job.

This may also be the time to think about diversifying a financial portfolio and possibly investing in the stock or bond market.

And, of course, keep contributing to your 401(k). For reference, the average 401(k) savings for someone between the ages of 30 and 39 was $38,400.

Average Savings by Age: 45 to 54

People between the ages of 45 and 54 had an average savings account balance of $48,200, according to the Fed’s survey.

At this point, general financial advice dictates that a 50-year-old should have at least six times their annual salary if their intention is to retire at 67.

And by the age of 40 to 49, a person may want to have the average amount of retirement savings, which sits at $93,400.

average savings for people in their 40s

Average Savings by Age: 55 to 64

The Fed survey found that Americans between the ages of 55 and 64 had an average savings account balance of $57,800.

Since this is the time when most Americans are staring down retirement in a few years, it’s generally a good idea to boost retirement savings into high gear.

That’s because while younger people in 2024 are capped at contributing $23,000 a year to a 401(k) account, those age 50 and up are allowed to contribute an additional $7,500.This is known as a catch-up contribution.

For 2025, those under age 50 can contribute up to $23,500, and those 50 and up can contribute an additional $7,500. Also for 2025, those aged 60 to 63 may contribute an additional $11,250 instead of $7,500, thanks to SECURE 2.0.

The average retirement savings account for a person between the ages of 50 and 59 is $160,000. It’s important to note that taking a withdrawal from such a plan before the age of 59 ½ could mean tax penalties.

average savings for people in their 50s

Average Savings by Age: 65 and Older

This is when savings really peaks for the average American. The latest Federal Reserve Survey of Consumer Finances found that Americans between the ages of 65 and 74 had an average savings account balance of $60,400.

However, that savings number does drop over time. According to the survey, Americans above the age of 75 had an average savings account balance of $55,600.

This underscores the importance of creating a retirement budget and sticking to it in order to have enough savings for as long as needed.

But before retirement, try to hit the average retirement savings amount for those ages 60 to 69, which was $182,100.

This chart offers an at-a-glance comparison of the average American savings by age.

Age

 Average savings
Under 35 $11,200
35-44 $27,900
45-54 $48,200
55-64 $57,800
65+ $60,400

💡 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.

Median Savings by Age

Median savings is different from average savings. The median is the number in the middle of all the other numbers, meaning half the numbers are higher and half are lower. So with median savings, half the people in an age category will have saved more and half will have saved less.

These are the median savings by age, according to the latest Federal Reserve Survey of Consumer Finances:

•   Under 35: $3,240

•   35-44: $4,710

•   45-54: $5,620

•   55-64: $6,400

Savings vs Retirement Savings

What Americans have saved for emergencies, expenses, and other near-future goals is different from what they have in their retirement savings accounts, as you can see from all the information above. And it’s critical to have both types of savings at the same time.

And keep this in mind: As you get older, and closer to retirement, it’s important that your retirement savings grow even more. It’s a good idea to contribute the maximum amount allowed to your retirement accounts at this time, if you can. This is one of the ways to save for retirement.

Recommended: Average Retirement Savings By State

Saving a Little Bit More

Reaching specific savings goals doesn’t have to be complicated. It just means doing a bit of homework, strategizing, and staying diligent about personal finances.

The first step in saving more is to analyze current expenses to see what can be cut back on or cut out altogether to make more room for saving. This means creating a monthly personal budget and tracking current personal spending.

To track spending, a person could create an excel spreadsheet and list all expenditures by categories like groceries, phone bill, car expenses, housing, medical, entertainment and others over the course of a month, filling it in with every single dollar spent to see where the money is going. Or you can use an online tracker like SoFi, which allows users to connect all their accounts to one dashboard and track spending habits in real time.

After the month is up, the next step is to look back on the expenditures list. Was there anything that surprised you? Do you need all those streaming subscriptions? How about that gym membership — did it actually get used? This is the time to get a little ruthless.

After figuring out what’s left, try implementing a general financial outline like the 50/30/20 rule. This means that approximately 50% of your after-tax income goes toward essential expenses like food and rent, while 30% goes toward discretionary expenses like nights out at the movies or concerts. The last 20% belongs to savings and retirement account goals.

Next, it’s time to get creative about saving even more for the future. This can be done by putting more cash into a savings or retirement account via direct deposit right from a paycheck.

Those looking to save a few more bucks every month could also do so by getting rid of unnecessary expenses. But, instead of pocketing that cash, consider using mobile deposit to direct that cash right to savings.

Still feeling the pinch and don’t really have room to save more from a budget? Working part-time for, say, a ride-sharing company could allow you to set your own hours and earn extra income based on how much time you can dedicate to it. Other options might include freelance work in photography, writing, or other creative arts.

Saving and Investing With SoFi

Along with all these savings strategies to help put away extra money, investing for your future goals is also important to help your money grow.

For instance, you may want to consider setting up an investment account. Investing a little now could go a long way in saving for tomorrow, next year, and your life after retirement.

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).


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

FAQ

How much should a 30 year old have in savings?

By age 30, you should have the equivalent of your annual salary saved. So if you make $60,000 a year, you should have $60,000 in savings.

How much money does an average person have in savings?

The average American has $65,100 in savings, according to a 2023 study by Northwestern Mutual.

How many Americans have $100,000 in savings?

According to one 2023 survey, only 14% of Americans have at least $100,000 in savings.

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

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

SoFi Invest®

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

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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Dec
30
2024
top view working on desk with flowers

25 Tax Deductions for Freelancers

By | Budgeting & Goals, Financial Independence, money | Comments Off on 25 Tax Deductions for Freelancers

Are you a freelancer? If so, you are in good company. Last year, almost 40% of the U.S. population did freelance work.

As the gig economy surges and more people participate, it’s important to be aware of the taxes you owe and the deductions you can take. Those deductions can help lower the amount of taxes you owe and help you keep more of your hard-earned money, so you’ll want to claim what’s due to you.

Taxes for those who are self-employed can get complex, and tax laws can change frequently. It’s therefore wise to do your research or hire a tax professional who focuses on freelance taxes.

But whether you choose to work with a tax pro, or go it on your own, it can be very helpful to know about the self-employed tax deductions that are usually allowed. To help you get up to speed, read on for 25 tax deductions that many freelancers can take.

Self-Employed Tax Deductions You Won’t Want to Miss

When considering whether an expense is deductible or not, you may want this rule of thumb in mind: The Internal Revenue Service (IRS) guideline for freelancer tax deductions is that expenses must be ordinary and necessary.

If you purchase an item or incur an expense even if you weren’t running your freelance business, it likely would not qualify for a deduction.

Below are some key deductions you may be able to qualify for. Knowing and noting them can help you with financial planning for freelancers.

1. Home Office

Are you earning money from home? If so, one of the most common deductions for freelancers is claiming a home office on your taxes. To take this deduction, the designated space must be used regularly and exclusively for business operations, and must be the principal location where business is conducted.

You can take this deduction whether your own or rent. You can use the simplified method, which has a rate of $5 per square foot for business use of the home, with a maximum deduction of $1,500 (or 300 square feet), according to the IRS .

Or, you can use the regular method, which divides expenses of operating the home (including mortgage/rent, real estate taxes, utilities, home insurance) between personal and business use.

Calculating Home Office Tax Deductions

To maximize your deduction for a home office you may want to calculate both the simplified and the regular techniques to see which is higher.

•   As mentioned above, the simplified method involves calculating your home office’s square footage (up to a cap of 300 square feet), and multiplying that by five.

•   For the regular method, you would use IRS Form 8829 to figure out the number. While this is a more involved calculation, it might yield a higher number.

💡 Quick Tip: Tired of paying pointless bank fees? When you open a bank account online you often avoid excess charges.

2. Office Supplies

Looking for more tax deductions for freelancers? The materials you purchase to work in your home office, such as paper, pens, pencils, pads, printer ink, staples, paper clips, etc, can typically be deducted at full cost as long as the items are used for business.

3. Hardware and Equipment

If you require specific hardware, such as a laptop, personal computer, tablet, or other types of equipment to run your business, these purchases may count as deductions.

Or maybe you earn money from a side hustle like photography or jewelry making, which requires specialized equipment.

You may want to talk to your accountant about the best way to deduct these expenses, as some bigger purchases that will be used beyond one year may need to be depreciated over a set number of years, rather than deducted in full.

4. Web Hosting and Online Tools

If you have a website and pay fees for web hosting, these expenses can likely be deducted from your taxes. If you use other online tools for your business (such as Dropbox or Zoom), fees you pay for these services can also usually be deducted.

5. Phone And Internet Service

If you use the internet, a landline phone, or a cell phone for business at least some of the time, these services may qualify for a deduction.

You may want to keep in mind, however, that you can generally only deduct a portion based on your business usage.

6. Start-Up Costs

Here’s another freelance tax deduction: You may be able to deduct up to $5,000 of initial purchases and investments made to get your business up and running in its first year. Purchases that exceed that amount can often be deducted over time.

7. Employee Salaries

The cost of paying employees to work within a business can usually be deducted. These costs generally include both wages and benefits.

8. Self-Employment Tax

Are you a 1099 worker? Self-employment taxes cover freelancer contributions toward Social Security and Medicare. You can generally deduct the employer-equivalent portion of your self-employment tax, which is half the total self-employment tax.

💡 Quick Tip: Your money deserves a higher rate. You earned it! Consider opening a high-yield checking account online and earn 0.50% APY.

9. Your Car

The entire cost of ownership and maintenance of any vehicle used strictly for business purposes can typically be deducted from business income (subject to some limits). The IRS mileage rate for tax year 2024 is 67 cents per mile driven for business use.

Cars driven for both business and personal use can also be deducted, but only for costs incurred while conducting business. It’s wise to set up a system to keep track of when you are driving for personal vs. professional purposes.

10. Unpaid Invoices

Also known as bad debt, unpaid invoices (meaning your business is owed money that it has no hope of reclaiming) may be deductible.

However, in order for the deduction to be allowed, it must be clear to both parties that the transaction was not a gift.

11. Business License

Depending on the industry, certain state and federal licenses may be required for a business to operate. However, there may be an amortization schedule to be aware of, meaning you would deduct percentages of the cost over time.

The fees paid annually to state or local governments for obtaining those licenses can generally be deducted.

It’s wise to look further into the tax code to be sure you understand how to properly take these deductions.

12. Qualified Business Income

This is a newer self-employment deduction. If you earn $182,100 or less as a single filer (or $364,200 as a joint filer) in 2023, you may qualify for a 20% deduction on your taxable business income via the QBI, or qualified business income deduction.

13. Product Supplies and Storage Units

For freelancers who sell products, the supplies purchased in order to make those products can usually be a freelance tax deduction.

The costs of keeping business supplies and assets in a storage unit can generally also be deducted, since storage is an expense factored into the overall cost of the goods sold.

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No account or overdraft fees. No minimum balance.

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14. Business Loan Interest

If you’ve taken out a loan to help fund your business, you may be able to deduct the interest you incur from it as a business expense.

For this to be deductible, however, a freelancer must be legally liable for that debt. In addition, both the freelancer and the lender must intend that the debt be repaid and have a true debtor-creditor relationship.

15. Meals

Sorry, buying takeout and eating it at your desk isn’t tax-deductible. But if you are traveling for business, at a conference, or dining with a client, then you can deduct 50% of the cost if you have the receipt. If you don’t have the receipt, you can take off 50% of the standard meal allowance.

16. Transaction Fees

If part of your business involves processing credit card orders, you may have an additional freelancer deduction. The processing costs a freelancer may incur by accepting credit cards payments is usually deductible as a qualified business expense.

17. Attorney & Accountant Fees

The fees charged by attorneys and accountants that are related to operating your business are typically considered tax-deductible business expenses.

That includes tax preparation fees, as well as any additional tax resolution expenses that pertain to your business.

18. Education Costs

Freelancer deductions can include the cost of education that helps you maintain or improve skills needed in your present work. This tax deduction also typically includes costs for books, supplies and even transportation.

19. Industry Events

Fees for attending conferences or conventions that are business related can typically be deducted.

Not only are the admission or registration fees often deductible, but all reasonable travel expenses accrued in order to attend the event may be deductible as well.

20. Promotional Materials

Tools used for marketing, advertising, and the general promotion of a business are considered deductible expenses. That includes advertising your product or service on social media or elsewhere.

Any expenses incurred in order to influence legislation (such as lobbying), however, are not deductible.

21. Business Membership Fees

While you generally can’t deduct dues or fees paid for memberships in clubs organized for recreational or social purposes, dues paid to join organizations that align with your specific business industry are usually considered deductible.

This includes organizations, such as boards of trade, chambers of commerce, and professional organizations (like bar associations and medical associations).

22. Business Travel Expenses

Travel costs that are associated with conducting business are considered valid income tax deductions, as long as they are ordinary and necessary and last more than one workday.

This can include flights, hotel stays, meals, getting around locally via bus/train/ride sharing services, even dry cleaning or laundry expenses while you’re away from home.

You may want to keep in mind that lavish and extravagant travel conditions generally do not qualify for deduction.

Also, day-to-day commuter expenses between home and business are not typically deductible.

23. Business Gifts

If you give a gift to a client or vendor as a thank you for conducting business with you, the cost of the gift is generally deductible up to $25 per person per year.

Extra costs such as engraving, packing, or shipping aren’t included in the $25 limit if they don’t add significant value to the gift.

24. Health Insurance

Self-employed individuals with qualifying policies are typically allowed to deduct premiums for health, dental, and long-term care for themselves and their families.

25. Retirement Plan Contributions

Just because you don’t work for a large company doesn’t mean you can’t benefit from a tax-advantaged retirement plan. Indeed, freelancers often have even more options for saving this way.

Two self-employed retirement options you may want to consider: a traditional IRA (which allows you to contribute up to $6,500 per year in pre-tax dollars if you’re under 50, and up to $7,500 if you’re older) and a SEP IRA (which allows you to contribute up to 25% of your income for a maximum of $66,000 per year for tax year 2023).

Claiming Tax Deductions

Why is it important to claim tax deductions? They will help lower how much you pay in taxes and increase how much you keep to spend and save.

If, say, you earn $120,000 in a given year and can claim $25,000 in tax deductions, then you would only be paying taxes on $95,000. That can make a big difference in your daily financial life as well as your ability to build wealth and hit your financial goals.

Tips for Freelancer Tax Deductions

If you are a freelancer, there are a couple of smart guidelines to follow as you move through the tax year.

Keeping Records of Everything

As you earn, spend, and save as a freelancer, it’s important to make a budget and track where your money is going. Keeping records of how much you are paid from different clients or customers, what you are spending on your business, and when and where those expenses are incurred (and even how they are paid) can make a big difference when tax preparation time rolls around.

Also, if you ever need that information if audited, you will be glad you have those files.

Keeping Your Personal and Business Finances Separate

As you have learned, it’s important to keep your business and personal finances separate when you are self-employed. This means your workspace, your transportation and meal expenses, and the like.

This will have important implications at tax time. For instance, you may have to parse how much of your rent or mortgage and your utilities actually go towards your home-based business vs. personal use.

•   Opening a separate bank account for your business. It can be a smart move to keep your business finances separate from your personal to clarify your professional earning and spending. Many financial institutions offer business accounts to meet these needs. If you are just launching a side hustle or have a small, part-time gig, you might simply open up an additional checking and savings account to start.

Working With a Tax Professional

It’s not always easy to decipher the tax code as a freelancer or know which expenses qualify and to what expense.

Sometimes, working with a qualified tax professional can help. They are trained to know the ins and outs of the law and can guide you on correct tax filing.

The IRS offers guidelines for choosing a reputable tax professional that can be worth reading.

The Takeaway

As a freelancer, you can often lower your tax liability by deducting expenses that were incurred to operate your business.

There are a wide range of deductions you may be able to take, including some or all of your expenses for a home office, supplies for that home office, business events, advertising, self-employment taxes, and more.

In addition to managing your business income, you’ll also want to consider the full breadth of financial services you need, and compare which banking partner is best for your needs, whether personal or professional.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.


Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 4.00% APY on SoFi Checking and Savings.

FAQ

Do freelancers need to declare income?

Yes, if you are a freelancer, you need to declare your income and pay taxes on it. It is wise to pay quarterly estimated taxes to avoid a large tax bill and potential penalties at tax time.

How is income tax calculated for freelancers?

In addition to regular income tax, freelancers typically need to pay a self-employment tax of 15.3% to cover Social Security and Medicare taxes. Typically, employees and their employers split that bill. But self-employed people pay the whole thing.

What happens if you don’t file freelance taxes?

Not filing freelance taxes doesn’t mean you don’t owe them. Not paying taxes can mean you are still liable for the amount you owe, plus interest and penalties.

SoFi members with direct deposit activity can earn 4.00% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.00% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.00% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 12/3/24. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2024 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

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.

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

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

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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Health Savings Account (HSA) vs. Health Maintenance Organization (HMO): Key Differences

Health Savings Account (HSA) vs Health Maintenance Organization (HMO): Key Differences

By | Budgeting & Goals, Financial Independence, money | Comments Off on Health Savings Account (HSA) vs Health Maintenance Organization (HMO): Key Differences

A health savings account (HSA) and a Health Maintenance Organization (HMO) are both meant to help with medical costs, but there are vast differences between the two. An HSA acts as a personal saving account, where you can set aside tax-free dollars to be used toward out-of-pocket health care expenses. An HMO is typically a low-cost health insurance plan.

It’s tough to directly compare an HSA vs. HMO, as they serve different functions. But understanding how each works, and their pros and cons, can help lower medical costs and keep more money in your wallet. Here, you will learn:

•   How an HSA works

•   How to set up an HSA

•   The pros and cons of an HSA

•   How an HMO works

•   How to set up an HMO

•   The pros and cons of an HMO

•   The key differences of an HSA vs. HMO

•   How to fund healthcare costs.

What is a Health Savings Account (HSA)?

A health savings account (HSA) allows individuals to put away pre-tax dollars to be used for future medical purposes. These funds can be used for copays, dental and eye care, and a host of other expenses not covered by a healthcare plan.

Here’s the catch: You have to be enrolled in a high-deductible health plan (HDHP). An HDHP is geared to offer you lower monthly health-insurance payments. The downside, however, is that you could get hit with a lot of out-of-pocket expenses before meeting the plan’s high deductible.

That’s where a Health Savings Account (HSA) comes in. The money in your HSA can help bridge the gap between your high deductible and your pocketbook.

💡 Quick Tip: Help your money earn more money! Opening a bank account online often gets you higher-than-average rates.

How Does a Health Savings Account Work?

A Health Savings Account works similarly to other kinds of saving accounts. You can transfer funds and pay bills online. You are free to withdraw HSA funds at any time to pay for health costs not covered by your HDHP.

Employers can contribute to your HSA, with direct deposits made straight from payroll. HSA funds can be used for you or any family member covered by your HDHP.

The money in your HSA can remain in the account and roll over every year, accumulating tax-free interest. You can even use your HSA for retirement. After the age of 65, you can start withdrawing from your HSA with no penalty.

There are rules and limits to an HSA. For tax year 2024, the IRS limits contributions to no more than $4,150 for individuals and $8,300 for families with HDHP coverage. Those 55 and older can contribute an additional $1,000 as a catch-up contribution. For 2025, HSA contribution limits are $4,300 for individuals and $8,550 for families. Those 55 and older can contribute an additional $1,000 as a catch-up contribution.

How to Set Up an HSA

Setting up a tax-advantaged HSA is pretty straightforward. If you are self-employed, take the time to compare different HSAs online. Many of them have reasonable fees (or none) and minimal requirements.

If your HSA is offered directly through your employer, that makes the decision easy.

The steps to enroll in an HSA are not unlike opening a bank account. You’ll need proof of a government-issued ID, your Social Security number, and proof of your enrollment in a HDHP.

Once you have set up an HSA, you may be able to opt for regular, automatic deposits straight from your paycheck or your bank account, and start reaping the benefits of using a health savings plan.

Pros of an HSA

A health savings plan provides a range of advantages, including:

•   Covering out-of-pocket medical expenses, including dental costs, copays, new eye glasses, and hearing aids. The IRS has a lengthy list of all the goodies you can buy with your tax-free dollars.

•   Lowering taxable income. HSA contributions go into your account before taxes, so you could pay less taxes down the line.

•   Investing for the future. You can opt to have your HSA money invested in chosen mutual funds once you reach a minimum requirement balance.

•   Covering health expenses for your family. HSA benefits anyone who is currently covered by your high-deductible savings plan.

•   Rollover contributions. Unused contributions don’t vanish. They roll over into the next year, growing and accumulating tax-free interest.

•   Retirement savings. Any unused funds can be used to boost retirement savings. They can be withdrawn after the age of 65, and spent as you please. You can put the money toward a beach vacation or any other purpose.

•   Portability. If you move or change jobs, the money is still yours. You don’t have to surrender it.

Cons of an HSA

There are some potential disadvantages to having an HSA, including:

•   Penalties for non-qualified expenses. Before the age of 65, the IRS can impose a substantial 20% penalty on monetary amounts spent on unapproved purchases. This money will also be viewed as taxable income.

•   Monthly/annual fees. Some health savings accounts may charge a low monthly service fee. Service fees tend to be no more than $5 per month. Some HSAs allow you to invest in mutual funds after your balance reaches a certain amount. If you choose this option, you will probably be charged an annual account management fee.

•   Unable to contribute. Budgets can get tight. There are times when you might not be able to regularly contribute money to your HSA.

•   Tracking for your taxes. HSA expenditures and contributions must be reported on your tax return. Keeping tabs on those transactions can be tedious.

•   Monetary losses. As with an IRA or 401(k), if you choose to invest your HSA money in mutual funds, your balance can experience gains and losses as the market fluctuates. These investments are not FDIC-insured like bank accounts are.

💡 Quick Tip: Most savings accounts only earn a fraction of a percentage in interest. Not at SoFi. Our high-yield savings account can help you make meaningful progress towards your financial goals.

What is a Health Maintenance Organization (HMO)?

A Health Maintenance Organization (HMO) is a type of health insurance plan. An HMO tends to offer lower monthly or annual premiums and a specific pool of doctors. If you stay within their network of healthcare providers, you may have lower out-of-pocket costs and, unlike with a HDHP, a lower deductible or even no deductible at all.

How Does a Health Maintenance Organization Work?

A health maintenance organization (HMO) plan consists of a group of insurance providers who have contracted certain doctors and hospitals to work with them. These medical professionals and facilities agree on a payment rate for their services, which can translate into reduced costs for you.

As long as you use the doctors in the HMO network, you are eligible for medical services that cost less. HMOs typically require a referral from an in-network primary care physician in order to receive low-cost services from specialists, such as an oncologist or gynecologist.

Many health insurance companies offer HMO plans as a coverage option. An individual can choose the HMO plan and go through the steps of enrollment, either on paper or via an online form. The process includes selecting your primary care physician.

Pros of an HMO

The advantages of enrolling in an HMO plan can include:

•   Lower monthly premiums versus other insurance plans.

•   Lower out-of-pocket expenses when you see your GP or specialists, have tests done, and access other kinds of medical care.

•   Lower prescription costs for your medications.

•   Fewer medical claims, as the paperwork is filed in-network.

•   Appointing a primary care doctor, whose office may coordinate and advocate for your various medical services.

Cons of an HMO

There are disadvantages of having an HMO, including:

•   Limited access to doctors and facilities. You must stay within their network of providers or risk paying out-of-pocket, except in the case of certain emergencies.

•   A new primary care doctor. If your current doctor isn’t in the HMO’s network, you’ll have to find a new primary care physician. For some people, this may be a difficult switch to make.

•   Referral requirements. To see a specialist and have your HMO pay for those services, you’ll need referrals; you can’t just look up a specialist and see them.

•   Strict definitions. There are times when you must very specifically meet requirements to have medical services paid for. This can be important to know during emergencies and other medical situations.

Can You Have Both an HMO and HSA?

Yes. There is no real rivalry happening with HMOs vs. HSAs, as they are so different. But if you are wondering if you can have an HSA with an HMO, here’s what you need to know. You can use an HSA with an HMO, as long as the HMO qualifies as a high-deductible health plan (HDHP). Since HMOs are often low cost healthcare plans, an HMO may not qualify as an HDHP. Check with your particular plan to see.

Key Differences Between an HMO vs HSA

•   An HSA acts like a savings account, an HMO is a health plan offering savings through lower-cost healthcare options.

•   An HSA does not offer a network of doctors, but can offer investment opportunities and help you save for retirement.

Recommended: How to Save for Retirement

Ways to Fund Healthcare Costs

Besides enrolling in a low-cost HMO, or opening an HSA, there are other ways to save money and pay for medical expenses.

Flexible Spending Account

A flexible spending account (FSA) acts very much like an HSA. It is similar to a savings account, and can be used for medical expenses and saving for retirement.

An FSA, however, can only be obtained through an employer. Self-employed people cannot have an FSA.

Money Market Account

A money market account works like a traditional checking or savings account. You could use the money for healthcare costs, or any other purchases. Money market accounts can offer a higher interest rate than other saving accounts, but there may be a higher minimum account balance required and more costly fees.

Savings Account

A traditional savings account can be set up with a bank or a credit union. Funds in a savings account can be spent on anything. But savings accounts may offer lower interest rates than other types of saving options. However, high-yield savings accounts may help close that gap somewhat.

The Takeaway

Enrolling in a health savings plan (HSA) or a health maintenance organization plan (HMO) provides different advantages, with the same goal in mind: saving you money on healthcare costs. Enrolling in one (or both) can bring a sense of security for you and your family and help you hold onto more of your hard-earned cash.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 4.00% APY on SoFi Checking and Savings.

FAQ

Is an HSA better than an HMO?

An HSA isn’t better; it’s just different. An HSA is a kind of savings account for people enrolled in a high-deductible healthcare plan and is used to pay for medical costs. An HMO is a low-cost health insurance plan that gives you access to a specific network of healthcare professionals.

What happens to an HSA if you switch to an HMO?

You can keep and use an HSA with any type of health plan, as long as it qualifies as a high-deductible health plan (HDHP). If not, you can keep and access the money in the HSA, but you can no longer contribute to it.

What happens to my HSA if I cancel my insurance?

You can continue to use the money in the HSA account, but can no longer contribute to it until you’re enrolled in another HDHP.

SoFi members with direct deposit activity can earn 4.00% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.00% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.00% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 12/3/24. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2024 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

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.

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

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

Photo credit: iStock/Halfpoint
SOBK0324004

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2024
Guide to Employee Stock Ownership Plans

Guide To Employee Stock Ownership Plans

By | Growing Wealth, invest, Investing, Preparing for Retirement, Terminology | Comments Off on Guide To Employee Stock Ownership Plans

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.

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

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.

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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

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.

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

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

 2024

 2025
Limit for determining the lengthening of the five-year distribution period $275,000 $280,000
Limit for determining the maximum account balance subject to the five-year distribution period $1,380,000 $1,415,000

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.

Recommended: Should You Open an IRA If You Already Have a 401(k)?

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

There are different things to consider when starting a retirement fund but it’s important to remember that time is on your side. No matter what type of plan you choose, the sooner you begin setting money aside for retirement, the more room it may have to grow.

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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.

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