Financial Topics Archives | Page 246 of 808

May

2024

What Is a Guaranteed Minimum Income Benefit (GMIB)?

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

A guaranteed minimum income benefit (GMIB) is an optional rider that can be included in an annuity contract to provide a minimum income amount to the annuity holder. An annuity is an insurance product in which you pay a premium to the insurance company, then receive payments back at a later date. There are a number of different types of annuities, with different annuity rates.

A GMIB annuity can ensure that you receive a consistent stream of guaranteed income. If you’re considering buying an annuity for your retirement, it’s helpful to understand what guaranteed minimum income means, and how it works.

Key Points

• A Guaranteed Minimum Income Benefit (GMIB) is an optional rider in an annuity contract ensuring a minimum income.

• GMIBs protect annuity payments from market volatility, offering stable income in retirement.

• These benefits are available in variable or indexed annuities, which tie earnings to market performance.

• The cost of GMIBs can be high, as adding riders increases the overall expense of the annuity.

• Evaluating the financial stability of the annuity provider is crucial, as the company’s health impacts the security of the guaranteed income.

GMIBs, Defined

A guaranteed minimum income benefit (GMIB) is a rider that the annuity holder can purchase, at an additional cost, and add it onto their annuity. The goal of a GMIB is to ensure that the annuitant will continue to receive payments from the contract — that’s the “guaranteed minimum income” part — without those payments being affected by market volatility.

Annuities are one option you might consider when starting a retirement fund. But what are annuities and how do they work? It’s important to answer this question first when discussing guaranteed minimum income benefits.

As noted, an annuity is a type of insurance contract. You purchase the contract, typically with a lump sum, on the condition that the annuity company pays money back to you now or starting at a later date, e.g. in retirement.

Depending on how the annuity is structured, your money may be invested in underlying securities or not. Depending on the terms and the annuity rates involved, you may receive a lump sum or regular monthly payments. The amount of the payment is determined by the amount of your initial deposit or premium, and the terms of the annuity contract.

A GMIB annuity is most often a variable annuity or indexed annuity product (though annuities for retirement can come in many different types).

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How GMIBs Work

Let’s look at two different types of annuities for retirement: variable and indexed.

• Variable annuities can offer a range of investment types, often in the form of mutual funds that hold a combination of stocks, bonds, and money market instruments.

• Indexed annuities offer returns that are indexed to an underlying benchmark, such as the S&P 500 index, Nasdaq, or Russell 2000. This is similar to other types of indexed investments.

With either one, the value of the annuity contract is determined by the performance of the underlying investments you choose.

When the market is strong, variable annuities or indexed annuities can deliver higher returns. When market volatility increases, however, that can reduce the value of your annuity. A GMIB annuity builds in some protection against market risk by specifying a guaranteed minimum income payment you’ll receive from the annuity, independent of the annuity’s underlying market-based performance.

Of course, what you can draw from an annuity to begin with will depend on how much you invest in the contract, stated annuity rates, and to some degree your investment performance. But having a GMIB rider on this type of retirement plan can help you to lock in a predetermined amount of future income.

Recommended: Types of Retirement Accounts

Pros & Cons of GMIBs

Guaranteed minimum income benefit annuities can be appealing for investors who want to have a guaranteed income stream in retirement. Whether it makes sense to purchase one can depend on how much you have to invest, how much income you’re hoping to generate, your overall goals and risk tolerance.

Weighing the pros and cons can help you to decide if a GMIB annuity is a good fit for your retirement planning strategy.

Pros of GMIBs

The main benefit of a GMIB annuity is the ability to receive a guaranteed amount of income in retirement. This can make planning for retirement easier as you can estimate how much money you’re guaranteed to receive from the annuity, regardless of what happens in the market between now and the time you choose to retire.

If you’re concerned about your spouse or partner being on track for their own retirement, that income can also carry over to your spouse and help fund their retirement needs, if you should pass away first. You can structure the annuity to make payments to you beginning at a certain date, then continue those payments to your spouse for the remainder of their life. This can provide reassurance that your spouse won’t be left struggling financially after you’re gone.

Cons of GMIBs

A main disadvantage of guaranteed minimum income benefit annuities is the cost. The more riders you add on to an annuity contract, the more this can increase the cost. So that’s something to factor in if you have a limited amount of money to invest in a variable or indexed annuity with a GMIB rider. Annuities may also come with other types of investment fees, so you may want to consult with a professional who can help you decipher the fine print.

It’s also important to consider the quality of the annuity company. An annuity is only as good as the company that issues the contract. If the company were to go out of business, your guaranteed income stream could dry up. For that reason, it’s important to review annuity ratings to get a sense of how financially stable a particular company is.

Examples of GMIB Annuities

Variable or indexed annuities that include a guaranteed minimum income benefit can be structured in different ways. For example, you may be offered the opportunity to purchase a variable annuity for $250,000. The annuity contract includes a GMIB order that guarantees you the greater of:

• The annuity’s actual value

• 6% interest compounded annually

• The highest value reached in the account historically

The annuity has a 10-year accumulation period in which your investments can earn interest and grow in value. This is followed by the draw period, in which you can begin taking money from the annuity.

Now, assume that at the beginning of the draw period the annuity’s actual value is $300,000. But if you were to calculate the annuitized value based on the 6% interest compounded annually, the annuity would be worth closer to $450,000. Since you have this built into the contract, you can opt to receive the higher amount thanks to the guaranteed minimum income benefit.

This example also illustrates why it’s important to be selective when choosing annuity contracts with a guaranteed minimum income benefit. The higher the guaranteed compounding benefit the better, as this can return more interest to you even if the annuity loses value because of shifting market conditions.

It’s also important to consider how long the interest will compound. Again, the more years interest can compound the better, in terms of how that might translate to the size of your guaranteed income payout later.

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The Takeaway

As discussed, guaranteed minimum income benefits (GMIB) are optional riders that can be included in an annuity contract to provide a minimum income amount to the annuity holder. Annuities can help round out your financial strategy if you’re looking for ways to create guaranteed income in retirement.

Annuities may be a part of a larger investment and retirement planning strategy, along with other types of retirement accounts. To get a better sense of how they may fit in, if at all, it may be a good idea to speak with a financial professional.

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FAQ

What are guaranteed benefits?

When discussing annuities for retirement, guaranteed benefits are amounts that you are guaranteed to receive. Depending on how the annuity contract is structured, you may receive guaranteed benefits as a lump sum payment or annuitized payments.

What is the guaranteed minimum withdrawal benefit?

The guaranteed minimum withdrawal benefit is the amount you’re guaranteed to be able to withdraw from an annuity once the accumulation period ends. This can be the annuity’s actual value, an amount that reflects interest compounded annually or the annuity contract’s highest historical value.

What are the two types of guaranteed living benefits?

There are actually more than two types of guaranteed living benefits. For example, your annuity contract might include a guaranteed minimum income benefit, guaranteed minimum accumulation benefit or guaranteed lifetime withdrawal benefit.

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May

2024

Roth 401(k) vs Traditional 401(k): Which Is Best for You?

By AJ Smith | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

A traditional 401(k) and a Roth 401(k) are tax-advantaged retirement plans that can help you save for retirement. While both types of accounts follow similar rules — they have the same contribution limits, for example — the impact of a Roth 401(k) vs. traditional 401(k) on your tax situation, now and in the future, may be quite different.

In brief: The contributions you make to a traditional 401(k) are deducted from your gross income, and thus may help lower your tax bill. But you’ll owe taxes on the money you withdraw later for retirement.

Conversely, you contribute after-tax funds to a Roth 401(k) and can typically withdraw the money tax free in retirement — but you don’t get a tax break now.

To help choose between a Roth 401(k) vs. a traditional 401(k) — or whether it might make sense to invest in both, if your employer offers that option — it helps to know what these accounts are all about.

Key Points

• Traditional 401(k) contributions are made with pre-tax dollars, reducing taxable income for the year of contribution.

• Roth 401(k) contributions are made with after-tax dollars, offering tax-free withdrawals in retirement.

• Withdrawals from traditional 401(k)s are taxed as income, whereas Roth 401(k) withdrawals are tax-free if rules are followed.

• Early withdrawals from both accounts may incur taxes and penalties, though Roth contributions can be withdrawn tax-free.

• Starting January 2024, Roth 401(k)s are not subject to required minimum distributions, unlike traditional 401(k)s.

5 Key Differences Between Roth 401(k) vs Traditional 401(k)

Before deciding on a Roth 401(k) or traditional 401(k), it’s important to understand the differences between each account, and to consider the tax benefits of each in light of your own financial plan. The timing of the tax advantages of each type of account is also important to weigh.

1. How Each Account is Funded

• A traditional 401(k) allows individuals to make pre-tax contributions. These contributions are typically made through elective salary deferrals that come directly from an employee’s paycheck and are deducted from their gross income.

• Employees contribute to a Roth 401(k) also generally via elective salary deferrals, but they are using after-tax dollars. So the money the employee contributes to a Roth 401(k) cannot be deducted from their current income.

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2. Tax Treatment of Contributions

• The contributions to a traditional 401(k) are tax-deductible, which means they can reduce your taxable income now, and they grow tax-deferred (but you’ll owe taxes later).

• By contrast, since you’ve already paid taxes on the money you contribute to a Roth 401(k), the money you contribute isn’t deductible from your gross income, and withdrawals are generally tax free (some exceptions below).

3. Withdrawal Rules

• You can begin taking qualified withdrawals from a traditional 401(k) starting at age 59 ½, and the money you withdraw is taxed at ordinary income rates.

• To withdraw contributions + earnings tax free from a Roth 401(k) you must be 59 ½ and have held the account for at least five years (often called the 5-year rule). If you open a Roth 401(k) when you’re 57, you cannot take tax-free withdrawals at 59 ½, as you would with a traditional 401(k). You’d have to wait until five years had passed, and start tax-free withdrawals at age 62.

4. Early Withdrawal Rules

• Early withdrawals from a 401(k) before age 59 ½ are subject to tax and a 10% penalty in most cases, but there are some exceptions where early withdrawals are not penalized, including certain medical expenses; a down payment on a first home; qualified education expenses.

You may also be able to take a hardship withdrawal penalty-free, but you need to meet the criteria, and you would still owe taxes on the money you withdrew.

• Early withdrawals from a Roth 401(k) are more complicated. You can withdraw your contributions at any time, but you’ll owe tax proportional to your earnings, which are taxable when you withdraw before age 59 ½.

For example: If you have $100,000 in a Roth 401(k), including $90,000 in contributions and $10,000 in taxable gains, the gains represent a 10% of the account. Therefore, if you took a $20,000 early withdrawal, you’d owe taxes on 10% to account for the gains, or $2,000.

5. Required Minimum Distribution (RMD) Rules

With a traditional 401(k), individuals must take required minimum distributions starting at age 73, or face potential penalties. While Roth 401(k)s used to have RMDs, as of January 2024, they no longer do. That means you are not required to withdraw RMDs from a Roth 401(k) account.

For a quick side-by-side comparison, here are the key differences of a Roth 401(k) vs. traditional 401(k):

Traditional 401(k)	Roth 401(k)
Funded with pre-tax dollars.	Funded with after-tax dollars.
Contributions are deducted from gross income and may lower your tax bill.	Contributions are not deductible.
All withdrawals taxed as income.	Withdrawals of contributions + earnings are tax free after 59 ½, if you’ve had the account for at least 5 years. (However, matching contributions from an employer made with pre-tax dollars are subject to tax.)
Early withdrawals before age 59 ½ are taxed as income and are typically subject to a 10% penalty, with some exceptions.	Early withdrawals of contributions are not taxed, but earnings may be taxed and subject to a 10% penalty.
Account subject to RMD rules starting at age 73.	No longer subject to RMD rules as of January 2024.

Bear in mind that a traditional 401(k) and Roth 401(k) also share many features in common:

• The annual contribution limits are the same for a 401(k) and a Roth 401(k). For 2024, the total amount you can contribute to these employer-sponsored accounts is $23,000; if you’re 50 and older you can save an additional $7,500 for a total of $30,500. This is an increase over the 2023 limit, which was capped at $22,500 ($30,000 if you’re 50 and older).

• For both accounts, employers may contribute matching funds up to a certain percentage of an employee’s salary.

• In 2024, total contributions from employer and employee cannot exceed $69,000 ($76,500 for those 50 and up). In 2023, total contributions from employer and employee cannot exceed $66,000 ($73,500 for those 50 and up).

• Employees may take out a loan from either type of account, subject to IRS restrictions and plan rules.

Because there are certain overlaps between the two accounts, as well as many points of contrast, it’s wise to consult with a professional when making a tax-related plan.

How to Choose Between a Roth and a Traditional 401(k)

In some cases it might make sense to contribute to both types of accounts (more on that below), but in other cases you may want to choose either a traditional 401(k) or a Roth 401(k) to maximize the specific advantages of one account over another. Here are some considerations.

When to Pay Taxes

Traditional 401(k) withdrawals are taxed at an individual’s ordinary income tax rate, typically in retirement. As a result these plans can be most tax efficient for those who will have a lower marginal rate after they retire than they did while they were working.

In other words, a traditional 401(k) may help you save on taxes now, if you’re in a higher tax bracket — and then pay lower taxes in retirement, when you’re ideally in a lower tax bracket.

On the other hand, an investor might look into the Roth 401(k) option if they feel that they pay lower taxes now than they will in retirement. In that case, you’d potentially pay lower taxes on your contributions now, and none on your withdrawals in retirement.

Your Age

Often, younger taxpayers may be in a lower tax bracket. If that’s the case, contributing to a Roth 401(k) may make more sense for the same reason above: because you’ll pay a lower rate on your contributions now, but then they’re completely tax free in retirement.

If you’re older, perhaps mid-career, and in a higher tax bracket, a traditional 401(k) might help lower your tax burden now (and if your tax rate is lower when you retire, even better, as you’d pay taxes on withdrawals but at a lower rate).

Where You Live

The tax rates where you live, or where you plan to live when you retire, are also a big factor to consider. Of course your location some years from now, or decades from now, can be difficult to predict (to say the least). But if you expect that you might be living in an area with lower taxes than you are now, e.g. a state with no state taxes, it might make sense to contribute to a traditional 401(k) and take the tax break now, since your withdrawals may be taxed at a lower rate.

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The Benefits of Investing in Both a Roth 401(k) and Traditional 401(k)

If an employer offers both a traditional and Roth 401(k) options, employees might have the option of contributing to both, thus taking advantage of the pros of each type of account. In many respects, this could be a wise choice.

Divvying up contributions between both types of accounts allows for greater flexibility in tax planning down the road. Upon retirement, an individual can choose whether to withdraw money from their tax-free 401(k) account or the traditional, taxable 401(k) account each year, to help manage their taxable income.

It is important to note that the $23,000 contribution limit ($30,500 for those 50 and older) for 2024 is a total limit on both accounts.

So, for instance, you might choose to save $13,500 in a traditional 401(k) and $9,500 in a Roth 401(k) for the year. You are not permitted to save $23,000 in each account.

What’s the Best Split Between Roth and Traditional 401(k)?

The best split between a Roth 401(k) and a traditional 401(k) depends on your individual financial situation and what might work best for you from a tax perspective. You may want to do an even split of the $23,000 limit you can contribute in 2024. Or, if you’re in a higher tax bracket now than you expect to be in retirement, you might decide that it makes more sense for you to put more into your traditional 401(k) to help lower your taxable income now. But if you expect to be in a higher income tax bracket in retirement, you may want to put more into your Roth 401(k).

Consider all the possibilities and implications before you decide. You may also want to consult a tax professional.

The Takeaway

Employer-sponsored Roth and traditional 401(k) plans offer investors many options when it comes to their financial goals. Because a traditional 401(k) can help lower your tax bill now, and a Roth 401(k) generally offers a tax-free income stream later — it’s important for investors to consider the tax advantages of both, the timing of those tax benefits, and whether these accounts have to be mutually exclusive or if it might benefit you to have both.

When it comes to retirement plans, investors don’t necessarily have to decide between a Roth or traditional 401(k). Some might choose one of these investment accounts, while others might find a combination of plans suits their goals. After all, it can be difficult to predict your financial circumstances with complete accuracy — especially when it comes to tax planning — so you may decide to hedge your bets and contribute to both types of accounts, if your employer offers that option.

Another step to consider is a 401(k) rollover, where you move funds from an old 401(k) into an IRA. When you do a 401(k) rollover it can help you manage your retirement funds.

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FAQ

Is it better to contribute to 401(k) or Roth 401(k)?

Whether it’s better to contribute to a traditional 401(k) or Roth 401(k) depends on your particular financial situation. In general, if you expect to be in a lower tax bracket in retirement, a traditional 401(k) may make more sense for you since you’ll be able to deduct your contributions when you make them, which can lower your taxable income, and then pay taxes on the money in retirement, when you’re in a lower income tax bracket.

But if you’re in a lower tax bracket now than you think you will be later, a Roth 401(k) might be the preferred option for you because you’ll generally withdraw the money tax-free in retirement.

Can I max out both 401(k) and Roth 401(k)?

No, you cannot max out both accounts. Per IRS rules, the annual 401(k) limits apply across all your 401(k) accounts combined. So for 2024, you can contribute a combined amount up to $23,000 (or $30,500 if you’re 50 or older) to your Roth 401(k) and your traditional 401(k) accounts.

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

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

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May

2024

Callable Bonds (or Redeemable Bonds), Explained

By Paulina Likos | Growing Wealth, invest, Investing | Comments Off

Table of Contents

What Is a Callable Bond?
How Do Callable Bonds Work?
Types of Callable Bonds
Callable Bond Example
Interest and Callable Bonds
Pros and Cons of Callable Bonds

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

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

Key Points

• Callable bonds allow issuers the option to redeem the bond before its maturity date.

• These bonds can be advantageous for issuers during periods of falling interest rates, allowing them to refinance at lower rates.

• Investors receive higher interest rates on callable bonds to compensate for the risk of early redemption.

• The value of callable bonds is influenced by changes in interest rates, with their desirability decreasing as interest rates fall.

• There are various types of callable bonds, including optional redemption, sinking fund redemption, and extraordinary redemption bonds.

What Is a Callable Bond?

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

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

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How Do Callable Bonds Work?

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

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

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

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

Finding the Value of Callable Bonds

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

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

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

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Types of Callable Bonds

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

1. Optional Redemption Callable Bonds

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

2. Sinking Fund Redemption Callable Bonds

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

3. Extraordinary Redemption Callable Bonds

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

Callable Bond Example

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

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

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

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

• This calculation will yield 1.2155.

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

Interest and Callable Bonds

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

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

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Pros and Cons of Callable Bonds

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

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

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

The Takeaway

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

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

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FAQ

Are callable bonds a good investment?

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

What does it mean if a bond is callable?

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

What is the call rule on a callable bond?

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

What happens to callable bonds when interest rates rise?

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

Are callable bonds cheaper?

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

Do callable bonds have higher yields?

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

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SoFi Invest®

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

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

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

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

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

Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN0124036

May

2024

Should I Put My Bonus Into My 401(k)? Here’s What You Should Consider

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

If you received a bonus and you’re wondering what to do with the bonus money, you’re not alone. Investing your bonus money in a tax-advantaged retirement account like a 401(k) has some tangible advantages. Not only will the extra cash help your nest egg to grow, you could also see some potential tax benefits.

Of course, we live in a world of competing financial priorities. You could also pay down debt, spend the money on something you need, save for a near-term goal — or splurge! The array of choices can be exciting — but if a secure future is your top goal, it’s important to consider a 401(k) bonus deferral.

Here are a few strategies to think about before you make a move.

Key Points

• Investing a bonus in a 401(k) can significantly enhance retirement savings and offer potential tax benefits.

• Bonuses are subject to income tax withholding, which may reduce the expected amount.

• The 2024 contribution limit for a 401(k) is $23,000, with an additional $7,500 allowed for those 50 and older.

• If 401(k) contributions are maxed out, considering an IRA or a taxable brokerage account is beneficial.

• Allocating a bonus to a 401(k) or IRA can reduce taxable income for the year, potentially lowering the tax bill.

Receiving a Bonus Check

First, a practical reminder. When you get a bonus check, it may not be in the amount that you expected. This is because bonuses are subject to income tax withholding. Knowing how your bonus is taxed can help you understand how much you’ll end up with so you can determine what to do with the money that’s left, such as making a 401(k) bonus contribution. The IRS considers bonuses as supplemental wages rather than regular wages.

Ultimately, your employer decides how to treat tax withholding from your bonus. Employers may withhold 22% of your bonus to go toward federal income taxes. But some employers may add your whole bonus to your regular paycheck, and then tax the larger amount at normal income tax rates. If your bonus puts you in a higher tax bracket for that pay period, you may pay more than you expected in taxes.

Also, your bonus may come lumped in with your paycheck (not as a separate payout), which can be confusing.

Whatever the final amount is, or how it arrives, be sure to set aside the full amount while you weigh your options — otherwise you might be tempted to spend it.

💡 Quick Tip: Want to lower your taxable income? Start saving for retirement by opening an IRA account. The money you save each year in a traditional IRA is tax deductible (and you don’t owe any taxes until you withdraw the funds, usually in retirement).

What to Do With Bonus Money

There’s nothing wrong with spending some of your hard-earned bonus from your compensation. One rule of thumb is to set a percentage of every windfall (e.g. 10% or 20%) — whether a bonus or a birthday check — to spend, and save the rest.

To get the most out of a bonus, though, many people opt for a 401k bonus deferral and put some or all of it into their 401(k) account. The amount of your bonus you decide to put in depends on how much you’ve already contributed, and whether it makes sense from a tax perspective to make a 401(k) bonus contribution.

Contributing to a 401(k)

The contribution limit for 401(k) plans in 2024 is $23,000; for those 50 and older you can add another $7,500, for a total of $30,500. The contribution limit for 401(k) plans in 2023 is $22,500; for those 50 and older you can add another $7,500, for a total of $30,000. If you haven’t reached the limit yet, allocating some of your bonus into your retirement plan can be a great way to boost your retirement savings.

In the case where you’ve already maxed out your 401(k) contributions, your bonus can also allow you to invest in an IRA or a non-retirement (i.e. taxable) brokerage account.

Contributing to an IRA

If you’ve maxed out your 401k contributions for the year, you may still be able to open a traditional tax-deferred IRA or a Roth IRA. It depends on your income.

In 2024, the contribution limit for traditional IRAs and Roth IRAs is $7,000; with an additional $1,000 if you’re 50 or older. In 2023, the contribution limit for traditional IRAs and Roth IRAs is $6,500; with an additional $1,000 if you’re 50 or older. But if your income is over $161,000 (for single filers) or over $240,000 (for married filing jointly) in 2024, you aren’t eligible to contribute to a Roth. For 2023, you can’t contribute to a Roth if your income is over $153,000 (for single filers) or over $228,000 (for married filing jointly). And while a traditional IRA doesn’t have income limits, the picture changes if you’re covered by a workplace plan like a 401(k).

If you’re covered by a workplace retirement plan and your income is too high for a Roth, you likely wouldn’t be eligible to open a traditional, tax-deductible IRA either. You could however open a nondeductible IRA. To understand the difference, you may want to consult with a professional.

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.

Contributing to a Taxable Account

Of course, when you’re weighing what to do with bonus money, you don’t want to leave out this important option: Opening a taxable account.

While employer-sponsored retirement accounts typically have some restrictions on what you can invest in, taxable brokerage accounts allow you to invest in a wider range of investments.

So if your 401(k) is maxed out, and an IRA isn’t an option for you, you can use your bonus to invest in stocks, bonds, exchange-traded funds (ETFs), mutual funds, and more in a taxable account.

Deferred Compensation

You also may be able to save some of your bonus from taxes by deferring compensation. This is when an employee’s compensation is withheld for distribution at a later date in order to provide future tax benefits.

In this scenario, you could set aside some of your compensation or bonus to be paid in the future. When you defer income, you still need to pay taxes later, at the time you receive your deferred income.

💡 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.

Your Bonus and 401(k) Tax Breaks

Wondering what to do with a bonus? It’s a smart question to ask. In order to maximize the value of your bonus, you want to make sure you reduce your taxes where you can.

One method that’s frequently used to reduce income taxes on a bonus is adding some of it into a tax-deferred retirement account like a 401(k) or traditional IRA. The amount of money you put into these accounts typically reduces your taxable income in the year that you deposit it.

Here’s how it works. The amount you contribute to a 401(k) or traditional IRA is tax deductible, meaning you can deduct the amount you save from your taxable income, often lowering your tax bill. (The same is not true for a Roth IRA or a Roth 401(k), where you make contributions on an after-tax basis.)

The annual contribution limits for each of these retirement accounts noted above may vary from year to year. Depending on the size of your bonus and how much you’ve already contributed to your retirement account for a particular year, you may be able to either put some or all of your bonus in a tax-deferred retirement account.

It’s important to keep track of how much you have already contributed to your retirement accounts because you don’t want to put in too much of your bonus and exceed the contribution limit. In the case where you have reached the contribution limit, you can put some of your bonus into other tax deferred accounts including a traditional IRA or a Roth IRA.

How Investing Your Bonus Can Help Over Time

Investing your bonus may help increase its value over the long-run. As your money potentially grows in value over time, it can be used in many ways: You can stow part of it away for retirement, as an emergency fund, a down payment for a home, to pay outstanding debts, or another financial goal.

While it can be helpful to have some of your bonus in cash, your money is typically better in a savings or investment account where it has the potential to work for you. If you start investing your bonus each year in either a tax-deferred retirement account or non-retirement account, this could help you save for the future.

Investing for Retirement With SoFi

The yearly question of what to do with a bonus is a common one. Just having that windfall allows for many financial opportunities, such as saving for immediate needs — or purchasing things you need now. But it may be wisest to use your bonus to boost your retirement nest egg — for the simple reason that you may stand to gain more financially down the road, while also potentially enjoying tax benefits in the present.

The fact is, most people don’t max out their 401(k) contributions each year, so if you’re in that boat it might make sense to take some or all of your bonus and max it out. If you have maxed out your 401(k), you still have options to save for the future via traditional or Roth IRAs, deferred compensation, or investing in a taxable account.

Keeping in mind the tax implications of where you invest can also help you allocate this extra money where it fits best with your plan.

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 it good to put your bonus into a 401(k)?

The short answer is yes. It might be wise to put some or all of your bonus in your 401(k), depending on how much you’ve contributed to your workplace account already. You want to make sure you don’t exceed the 401(k) contribution limit.

How can I avoid paying tax on my bonus?

Your bonus will be taxed, but you can lower the amount of your taxable income by depositing some or all of it in a tax-deferred retirement account such as a 401(k) or IRA. However, this does not mean you will avoid paying taxes completely. Once you withdraw the money from these accounts in retirement, it will be subject to ordinary income tax.

Can I put all of my bonus into a 401(k)?

Possibly. You can put all of your bonus in your 401(k) if you haven’t reached the contribution limit for that particular year, and if you won’t surpass it by adding all of your bonus. For 2023, the contribution limit for a 401(k) is $22,500 if you’re younger than 50 years old; those 50 and over can contribute an additional $7,500 for a total of $30,000. In 2024, the contribution limit for a 401(k) is $23,000 if you’re under age 50, and those 50 and up can contribute an additional $7,500 for a total of $30,500.

You may also be interested in:

How Much Should I Contribute to My 401k?

Guide to Maxing Out Your 401(k)

The Average 401(k) Balance by Age

Photo credit: iStock/Tempura

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

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

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

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
SOIN0124066

May

2024

Investing in Options vs Stocks: Trading Differences to Know

Buying Options vs Stocks: Trading Differences to Know

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.

Stocks and options are two of the most popular investment types that investors might include in their portfolio. There are reasons to invest in each, and they both come with their own risks, timelines, pros, and cons.

When deciding whether to invest in stocks vs. options, or any type of security or asset, it’s important to consider your personal investing goals, experience, risk tolerance, and investing horizon.

Key Points

• Options are derivatives that provide the right, but not the obligation, to buy or sell a stock at a set price before a certain date.

• Stocks represent shares of ownership in a company, potentially offering dividends and voting rights.

• Options can offer high leverage, allowing significant exposure to stock price movements without full investment in the stock.

• The value of options can decrease rapidly over time due to time decay, especially as expiration approaches.

• Stocks can be held indefinitely, providing potential for long-term gains, whereas options have an expiration date limiting their lifespan.

What Are the Differences Between Options and Stocks?

	Stocks	Options
Common types of Investors	Beginners and long-term investors	Experienced and active traders
Potential Downsides	Risks, Taxes, Fees	Risks, Costs, Complexity
Type of Investment	Equity	Derivative

Options

Options, or stock options, are a type of derivative investment. Rather than buying shares of a company, options contracts give buyers the right, but not the obligation, to buy or sell shares at a specified price, (known as the strike price in options terminology,) at a specified time in the future.

A call option gives the buyer the right, but not the obligation, to buy a stock at a specified price, at a specified time in the future. The options investor does not have any ownership of the company’s shares unless they choose to exercise the option and buy the shares.

A put option gives the buyer the right, but not the obligation, to sell a stock at a specified price, at a specified time in the future.

Over the time period of the option, the contract gets exponentially less valuable. This is known as time decay.

Investors may exercise their right to buy or sell a stock, or sell their option position to make a potential profit. Options trading strategies can get complicated, involving buying and selling multiple options on the same underlying security.

Recommended: A Guide to Options Trading

Stocks

Stocks are portions of ownership in companies, also known as shares. Investors can buy shares in companies and become fractional owners of that company in proportion to the number of outstanding shares that company has. For instance, if a company has 100,000 shares and an investor buys 10,000, they own 10% of the company.

Investors who purchase stocks typically hope to buy them at a lower price then sell them later at a higher price to make a profit. There are also other ways investors can earn profits on stocks. For instance, some stocks pay out dividends to owners. Every month, quarter, or year, an investor can earn money based on the number of shares they own.

Recommended: How to Start Investing in Stocks

Finally, user-friendly options trading is here.*

Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.

*Check out the
OCC Options Disclosure Document.

5 Key Differences in Stocks vs Options

Both stocks and options are popular investments, and there can be a place for both of them in a diversified portfolio. Here’s a look at some of of the differences to keep in mind when it comes to trading options vs. stocks:

1. Risk

Both stocks and options have associated risks. For stocks, the risk is that the value of the security will fall lower than the investor expected. For options, there are additional risks, including the risk that they could exacerbate losses or could expire without being exercised.

2. Ownership

When an investor buys stock, they become partial owners of that company. When they buy options, they do not.

3. Quantities

When buying stock, the number of shares an investor buys is the total number they have, and they can purchase any number of shares, including fractional shares. When buying options, each contract represents 100 shares of stock.

4. Timeline

Options are contracts that are only valid for a certain period of time until the expiration date. They lose value over time until they are worthless when the contract expires. When an investor buys stock, they can hold it as long as they want.

5. Time Commitment

Investors can buy stock and hold onto it without doing much additional work, whereas options traders are often more hands-on and prefer an eye on the market for the duration of the contract.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

When to Consider Trading Stocks

There are several reasons to consider trading stocks, depending on your goals, timeline, and risk tolerance. Like any asset, stocks come with their share of risks and downsides. Some of the pros and cons of stocks include:

Pros

It can be relatively easy to start investing in stocks. There are several other benefits as well:

• Investors don’t have to sell their stocks on any particular date, so they can choose the best time to sell.

• Some stocks pay out dividends to investors.

• Stocks are easier to research than options since they have market history.

• Being an owner of a company may allow investors to vote on certain corporate issues that can affect their investment.

• Stocks typically have more liquidity than options, meaning it’s easier for traders to buy and sell them at any given time.

Cons

Like all securities, there are risks involved with investing in stocks. Those include:

• Whether you buy and sell stocks quickly as a day trading strategy, or hold onto them for years, you will need to pay short or long-term capital gains taxes if you sell for a profit.

• While trading stocks can be very profitable, it’s generally considered a long-term strategy.

• It can be emotionally challenging to watch the market, and one’s portfolio, go up and down in value over months or years.

• Making a big profit on stocks can require a large upfront investment.

• When investing in stocks, traders risk losing all the money they put in.

• Stocks of certain companies are very expensive, making it difficult for smaller traders to even buy one.

When to Consider Trading Options

Like stocks or any investment, options come with their share of risks and downsides. Some of the main pros and cons of trading options are:

Pros

Options trading can be complicated, but there can be significant upside potential. Benefits include:

• Options may be an inexpensive way to participate in the market.

• Options provide investors with leverage. Essentially the investor has some control and access to shares.

• Options can help hedge against market volatility.

Cons

Since fewer traders buy and sell options than stocks, there can be lower liquidity making it difficult to get out of an options contract. Other drawbacks include:

• If an investor buys a stock option, they must pay a premium to enter into the contract. If the stock doesn’t move the way they hope it will and they choose not to exercise the option, they lose that premium they had put in.

• Options lose value over time.

• Trading options may require more ongoing management than stocks.

💡 Quick Tip: In order to profit from purchasing a stock, the price has to rise. But an options trading account offers more flexibility, and an options trader might gain if the price rises or falls. This is a high-risk strategy, and investors can lose money if the trade moves in the wrong direction.

The Takeaway

Stocks and options are two popular types of investments traders use to earn profits and build a diversified portfolio. Depending on your investment strategy, you might invest in a combination of the two. Note that both have their own associated risks and potential benefits.

Options trading, however, is typically something that experienced investors delve into, and often requires traders to actively invest, rather than leave their portfolios idle. If you’re interested in options, it may be a good idea to speak with a financial professional for guidance.

Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.

Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

Photo credit: iStock/fizkes

SoFi Invest®

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

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

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

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN0324013

GMIBs, Defined

How GMIBs Work

Pros & Cons of GMIBs

Pros of GMIBs

Cons of GMIBs

Examples of GMIB Annuities

The Takeaway

FAQ

What are guaranteed benefits?

What is the guaranteed minimum withdrawal benefit?

What are the two types of guaranteed living benefits?

5 Key Differences Between Roth 401(k) vs Traditional 401(k)

1. How Each Account is Funded

2. Tax Treatment of Contributions

3. Withdrawal Rules

4. Early Withdrawal Rules

5. Required Minimum Distribution (RMD) Rules

How to Choose Between a Roth and a Traditional 401(k)

When to Pay Taxes

Your Age

Where You Live

The Benefits of Investing in Both a Roth 401(k) and Traditional 401(k)

What’s the Best Split Between Roth and Traditional 401(k)?

The Takeaway

FAQ

Is it better to contribute to 401(k) or Roth 401(k)?

Can I max out both 401(k) and Roth 401(k)?

What Is a Callable Bond?

How Do Callable Bonds Work?

Finding the Value of Callable Bonds

Alternative investments, now for the rest of us.

Start trading funds that include commodities, private credit, real estate, venture capital, and more.

Types of Callable Bonds

1. Optional Redemption Callable Bonds

2. Sinking Fund Redemption Callable Bonds

3. Extraordinary Redemption Callable Bonds

Callable Bond Example

Interest and Callable Bonds

Pros and Cons of Callable Bonds

The Takeaway

FAQ

Are callable bonds a good investment?

What does it mean if a bond is callable?

What is the call rule on a callable bond?

What happens to callable bonds when interest rates rise?

Are callable bonds cheaper?

Do callable bonds have higher yields?

Receiving a Bonus Check

What to Do With Bonus Money

Contributing to a 401(k)

Contributing to an IRA

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

Contributing to a Taxable Account

Deferred Compensation

Your Bonus and 401(k) Tax Breaks

How Investing Your Bonus Can Help Over Time

Investing for Retirement With SoFi

FAQ

Is it good to put your bonus into a 401(k)?

How can I avoid paying tax on my bonus?

Can I put all of my bonus into a 401(k)?

You may also be interested in:

What Are the Differences Between Options and Stocks?

Options

Stocks

Finally, user-friendly options trading is here.*

Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.

5 Key Differences in Stocks vs Options

1. Risk

2. Ownership

3. Quantities

4. Timeline

5. Time Commitment

When to Consider Trading Stocks

Pros

Cons

When to Consider Trading Options

Pros

Cons

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now for the rest of us.

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