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May

2024

Should I Use a Dividend Reinvestment Plan?

Dividend Reinvestment Plans: How DRIP Investing Works

By Laurel Tincher | Growing Wealth, Investing | No Comments

A dividend reinvestment plan, or DRIP, allows investors to reinvest the cash dividends they receive from their stocks into more shares of that stock. Hundreds of companies, funds, and brokerages offer DRIPs to shareholders. Reinvesting dividends through a DRIP may come with a discount on share prices or no commissions.

Of course, it’s possible to simply keep the cash dividends to spend or save, or use them to buy shares of a different stock. If you’re wondering, should I reinvest dividends?, it helps to know the pros and cons of dividend reinvestment programs and how they work.

Key Points

• Dividend reinvestment plans (DRIPs) allow investors to reinvest cash dividends into more shares of the same stock.

• DRIPs can be offered by companies or through brokerages, with potential discounts on share prices or no commissions.

• There are two types of DRIPs: company-operated DRIPs and DRIPs through brokerages.

• Reinvesting dividends through a DRIP may lead to greater long-term returns due to compounding.

• However, DRIPs have limitations, such as tying up cash, risk exposure, and limited flexibility in choosing where to reinvest funds.

What Is Dividend Reinvestment?

Dividend reinvestment typically means using the dividends you receive to purchase additional shares of stock in the same company rather than taking the dividend as a payout.

When you initially buy a share of dividend-paying stock, you typically have the option of choosing whether you’ll want to reinvest your dividends automatically.

Need a refresher on dividends? Check out what a dividend is and how they work.

What Is a Dividend Reinvestment Plan?

Depending on which stocks you invest in, you may have the option to enroll in a Dividend Reinvestment Plan or DRIP. This type of plan, offered by about 650 companies and 500 closed-end funds, allows you to automatically reinvest dividends as they’re paid out into additional shares of stock.

💡 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.

Types of Dividend Reinvestment Plans

There are two main types of dividend reinvestment plans. They are:

Company DRIPs

With this type of plan, the company operates its own DRIP as a program that’s offered to shareholders. Investors who choose to participate simply purchase the shares directly from the company, and DRIP shares are often offered to them at a discounted price. Some companies allow investors to do full or partial reinvestment, or to purchase fractional shares.

DRIPs through a brokerage

Many brokerages also provide dividend reinvestment as well. Investors can set up their brokerage account to automatically reinvest in shares they own that pay dividends.

DRIP Example

Here’s a dividend reinvestment example that illustrates how a company-operated DRIP works. If you own 20 shares of a stock that has a current trading value of $100 per share, and the company announces that it will pay $10 in dividends per share of stock, then the company would pay you $200 in dividends that year.

If you choose to reinvest the dividends, you would own 22 shares of that stock ($200 in dividends/$100 of current trading value = 2 new shares of stock added to your original 20). If the stock price was $200, you’d be able to purchase a single share; if it was $50, you could theoretically reinvest and own an additional four shares.

If, instead, you want cash, then you’d receive $200 to spend or save, and you’d still have the initial 20 shares of the stock.

Pros and Cons of DRIPs

If you’re wondering, should I reinvest dividends?, it’s a good idea to weigh the advantages and disadvantages of DRIPs. But note, too, that some of the pros and cons may be specific to one of the two types of DRIPs: Those offered through a company, and those through a brokerage.

Pros of Dividend Reinvestment Plans

On the “pros” side, one reason to reinvest your dividends is that it may help to position you for potentially greater long-term returns, thanks to the power of compounding returns, which may hold true whether investing through a company-operated DRIP, or one through a brokerage.

Generally, if a company pays out the same level of dividends each year — whether that’s 2%, 3%, or another amount — and you take your dividends in cash, then you’ll keep getting the same amount in dividends each year (assuming you don’t buy any additional shares).

But if you take your dividends and reinvest them through a DRIP, then you’ll have more shares of stock next year, and then more the year after that — which means, ideally, that the dollar amount of the dividends (at least in our example where the payout percentage is the same each year) will keep rising. Over a period of time, the amount you would receive during subsequent payouts could increase.

An important caveat, however: Real-life situations aren’t often as straightforward as this example, of course. For one thing, stock prices aren’t likely to stay exactly the same for an extended period of time.

Plus, there’s no guarantee that dividends will be paid out each period; and even if they are, there is no way to know for sure how much they’ll be. The performance of the company and the general economy can have a significant impact on company profitability and, therefore, typically affect dividends given to shareholders.

There are more benefits associated with DRIPs:

• You may get a discount: Discounts on DRIP shares can be anywhere from 1% to 10%, depending on the type of DRIP (company-operated) and the specific company.

• Zero commission: Most company-operated DRIP programs may allow you to buy new shares without paying commission fees. However, many brokerages offer zero-commission trading outside of DRIPs these days, too.

• Fractional shares: DRIPs may allow you to reinvest into fractional shares, rather than whole shares that may be at a pricier level than you wish to purchase. This may be an option with either a company-operated or brokerage-operated DRIP.

• Dollar-cost averaging: This is a common strategy investors use to manage price volatility. You invest the same amount of money on a regular basis (every week, month, quarter) no matter what the price of the asset is.

Cons of Dividend Reinvestment Plans

Dividend reinvestment plans also come with some potential negatives.

• The cash is tied up. First, reinvesting dividends obviously puts that money out of reach if you need it, which may be particularly true for company-operated DRIP plans. That can be a downside if you want or need the money for, say, home improvements, a tuition bill, or an upcoming vacation.

• Risk exposure. You should also keep potential risk factors in mind. For example, you may have concerns about the stock market in general, or about the particular company where you’re a shareholder, and reinvesting your cash into more equities may seem unwise.

Or you may need to rebalance your portfolio. If you’ve been reinvesting your dividends, and the stock portion of your portfolio has grown, using a DRIP could inadvertently put your allocation further out of whack.

• Flexibility concerns. Another possible drawback to consider is that when your dividends are automatically reinvested through a DRIP, they will go right back into the company that issued the dividend. Though some company-operated DRIPs do give investors options (such as full or partial reinvestment), some investors may find that those DRIPs offer limited options as to where to reinvest their funds.

Perhaps you’d simply rather buy stock from another company – an option which may be available through a brokerage-operated DRIP. Note, though, that even brokerage-operated DRIPs may reinvest dividends as soon as they’re paid, so investors may not have a chance to redirect the investment.

• Less liquidity. Also, when you use a company-operated DRIP, and later wish to sell those shares, you must sell them back to the company in many cases. DRIP shares cannot be sold on exchanges. Again, this will depend on the specific company and DRIP, but is something investors should keep in mind.

💡 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.

Cash vs Reinvested Dividends

Should I reinvest dividends or take cash instead? How you approach this question can depend on several things, including:

• Your short-term financial goals

• Long-term financial goals

• Income needs

Accepting the cash value of your dividends can provide you with ongoing income. That may be important to you if you’re looking for a way to supplement your paychecks during your working years, or for other income sources if you’re already retired.

As mentioned earlier, you could use that cash income to further a number of financial goals. For instance, you might use cash dividend payouts to pay off debt, fund home improvements or put your kids through college. Or you may use it to help pay for long-term care during your later years.

You might consider a cash option for dividends rather than reinvesting dividends if you’re already building sufficient wealth for retirement in your portfolio. That way, you can free up the cash now to enjoy it or address other current priorities.

Cash may also be more attractive if you’re comfortable with your current portfolio configuration and don’t want to purchase additional shares of the dividend stocks you already own.

On the other hand, reinvesting dividends automatically through a DRIP could help you to increase your savings for retirement. This assumes, of course, that your investments perform well and that the stocks you own don’t decrease or eliminate their dividend payout over time.

Tax Consequences of Dividends

For those wondering, do you have to pay taxes on reinvested dividends?, one thing to keep in mind is that dividends — whether you cash them out or reinvest them — are not free money. There may be tax consequences when you receive dividends because if the amount is significant enough, you might need to pay income taxes on what you’ve earned.

Each year, you’ll receive a tax form called a 1099-DIV for each investment that paid you dividends, and these forms will help you to determine how much you owe in taxes on those earnings.

Dividends are considered taxable whether you take them in cash or reinvest them — even though when you reinvest, the money isn’t currently available for you to spend.

The exception to that rule is for funds invested in retirement accounts, such as an online IRA, as the money invested in these accounts is tax-deferred. If you have received or believe you may receive dividends this year, it can make sense to get professional tax advice to see how you can minimize your tax liability.

Should You Reinvest Dividends?

Reinvesting dividends through a dividend reinvestment plan is partly a short-term decision, and mostly a long-term one.

If you need the cash from the dividend payouts in the near term, or have doubts about the market or the company you’d be reinvesting in (or you’d rather purchase another stock), you may not want to use a DRIP.

If on the other hand you don’t have an immediate need for the cash, and you can see the value of compounding the growth of your shares in the company over the long haul, reinvesting dividends could make sense.

The Takeaway

Reinvesting dividends and using a dividend reinvestment plan (DRIP) is an automatic feature investors can use to take their dividend payouts and use them to purchase more shares of the company’s stock. However, it’s important to consider all the scenarios before you decide to surrender your cash dividends to an automatic reinvestment plan.

While there is the potential for compound growth, and using a DRIP may allow you to purchase shares at a discount and with no transaction fees, these dividend reinvestment plans are limiting. You are locked into that company’s stock during a certain market period, and even if you decided to sell, you wouldn’t be able to sell DRIP shares on any exchange but back to the company. Whether you use a DRIP or not, you may want to consider having some dividend-paying stocks as part of a balanced portfolio in your investment account.

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 do you set up a dividend reinvestment plan?

There are two ways to set up a dividend reinvestment plan. First, you can set up an automatic dividend reinvestment plan with the company whose stock you own. Or you can set up automatic dividend reinvestment through a brokerage. Either way, all dividends paid for the stock will automatically be reinvested into more shares of stock.

Can you calculate dividend reinvestment rates?

There is a very complicated formula you can use to calculate dividend reinvestment rates, but it’s typically much easier to use an online dividend reinvestment calculator instead.

What is the difference between a stock dividend and a dividend reinvestment plan?

A stock dividend is a payment made from a company to its shareholders (people who own shares of their company’s stock). A dividend reinvestment plan allows investors to reinvest the cash dividends they receive from their stocks into more shares of that stock.

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

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

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

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May

2024

TFSA vs RRSP: What’s the Difference?

By Jacqueline DeMarco | Investing, money, Preparing for Retirement, Terminology | Comments Off

Both TFSAs and RRSPs are accounts that provide Canadian consumers with a chance to save while enjoying investment earnings and unique tax benefits. While a TFSA acts as a more general savings account, an RRSP is used for retirement savings.

Saving is never a bad idea, so here you can learn the difference between these accounts and how they can play a role in securing your financial future.

Keep reading for a more detailed breakdown of a TFSA vs. RRSP so you can make the right financial move for your needs.

🛈 Currently, SoFi does not provide RRSP and TFSA accounts.

What Is the TFSA?

A Tax-Free Savings Account (TFSA) is a type of registered tax-advantaged savings account to help Canadians earn money on their savings — tax-free. TFSA accounts were created in 2009 by the Canadian government to encourage eligible citizens to contribute to this type of savings account.

Essentially, a TFSA holds qualified investments that can generate capital gains, interest, and dividends, and they’re tax-free. These accounts can be used to build an emergency fund, to save for a down payment on a home, or even to finance a dream vacation.

A TFSA can contain the following types of investments:

• Cash

• Stocks

• Bonds

• Mutual funds

It’s possible to withdraw the contributions and earnings generated from dividends, interest, and capital gains without having to pay any taxes. Accountholders don’t even have to report withdrawals as income when it’s time to file taxes.

There is a limit to how much someone can contribute to a TFSA on an annual basis. This limit is referred to as a contribution limit, and every year the Canadian government determines what the contribution limit for that year is. If someone doesn’t meet the contribution limit one year, their remaining allowed contributions can be made up for in following years.

To contribute to a TFSA, an individual must be at least 18 years of age and be a Canadian resident with a valid Social Insurance Number (SIN).

What Is the RRSP?

A Registered Retirement Savings Plan (RRSP) is, as the name indicates, a type of savings plan specifically designed to help boost retirement savings. To obtain one, a Canadian citizen must register with the Canadian federal government for this financial product and can then start saving.

When someone contributes to an RRSP, their contributions are considered to be tax-advantaged. What this means: The funds they contribute to their RRSP are exempt from being taxed the year they make the contribution (which can reduce the total amount of taxes they need to pay for that year). On top of that, the investment income these contributions generate will grow tax-deferred. This means the account holder won’t pay any taxes on the earnings until they withdraw them.

Unlike a TFSA, there isn’t a minimum age requirement to open and contribute to an RRSP. That being said, certain financial institutions may require their customers to be the age of majority in order to contribute. It’s possible to contribute to an RRSP until the year the account holder turns 71 as long as they are a Canadian resident, earned an income, and filed a tax return.

Keep reading for a TFSA vs. RRSP comparison.

Similarities Between a TFSA and an RRSP

How does a TFSA vs. RRSP compare? There are a few similarities between TFSAs and RRSPs that are worth highlighting. Here are the main ways in which they are the same:

• Only Canadians citizens can contribute

• Contributions can help reach savings goals

• Investments can be held in each account type

• Both accounts offer tax advantages.

Differences Between a TFSA and RRSP

Next, let’s answer this question: What is the difference between an RRSP and a TFSA? Despite the fact that both an RRSP and a TFSA share similar goals (saving money and earning interest on it) and advantages (tax benefits), they have some key differences to be aware of.

• Intended use. RRSPs are for retirement savings whereas TFSAs can be used to save for any purpose.

• Age eligibility. To contribute to a TFSA one must be 18 years old, but there isn’t an age requirement to open an RRSP.

• Contribution limit. The limits are usually set annually and are different for TFSAs and RRSPs. For 2024, the contribution limit for an RRSP is the lesser of either 18% of earned income reported on an individual’s tax return for the previous year or the contribution limit, which is currently $31,560 in US dollars. The limit for a TFSA, which also can vary annually, was most recently $7,000.

• Taxation on withdrawals. While RRSP withdrawals are taxable (but subject to certain exceptions), TFSA withdrawals can be made at any time tax-free.

• Taxation on contributions. Contributions made to a TFSA aren’t tax-deductible, but RRSP contributions are.

• Plan maturity. An RRSP matures at the end of the calendar year that the account holder turns 71. TFSAs don’t have age limits for account maturity.

• Spousal contributions. There is no form of spousal TFSA available, but someone can contribute to a spousal RRSP.

How Do I Choose Between a TFSA and RRSP?

Choosing between a TFSA and an RRSP depends on someone’s unique savings goals and tax preferences. That being said, if someone’s main goal is saving for retirement, they’ll likely find that an RRSP is the right fit for them. When someone contributes to an RRSP, they can defer paying taxes during their peak earning years. Once they retire and make withdrawals (which they will need to pay taxes on), they will ideally have a lower income (and be in a lower tax bracket) and smaller tax liabilities at that point in their life.

If someone wants to be able to use their savings for a variety of different purposes (perhaps including a medium-term goal like the amount needed for a down payment on a home), they may find that a TFSA offers them more flexibility.
That said, there’s no reason TFSA savings can’t be used for retirement later on. Contributing to a TFSA is a great option for someone who has already maxed out their RRSP contributions for the year, but who wants to continue saving and enjoying tax benefits.

Recommended: What Tax Bracket Do I Fall Under?

Can I Have Both a TFSA and RRSP?

It is indeed possible to have both an RRSP and TFSA and to contribute to them at the same time. Putting money into both of these financial vehicles can be a great way to save. There are no downsides associated with contributing to both an RRSP and TFSA at the same time if a person can afford to do so.

Can I Have Multiple RRSP and TFSA Accounts?

Yes, it’s possible to have more than one TFSA and RRSP open at the same time, but there’s no real benefit here. The same contribution limits apply.

That means that opening more than one version of the same account or plan only leads to having more accounts to manage and incurring more administration and management fees. Just as you don’t want to pay fees on your checking account and other bank accounts, you probably don’t want to burn through cash on fees here.

Should I Prioritize One Over the Other?

Which type of account someone should prioritize depends on their savings goals. Their preferences regarding the unique tax advantages of each account may also come into play. That being said, if someone is focused on saving for retirement, they’ll likely want to make sure they max out their RRSP contributions first.

The Takeaway

Both RRSP and TFSA accounts are great ways for Canadian citizens to save for financial goals like retiring or financing a wedding. Each account has unique advantages and contribution limits. While an RRSP account is designed to help with stashing away cash for retirement, a TFSA account can be used to save for any type of financial need. Whether you choose one or both of these products, you’ll be on a path towards saving and helping to secure your financial future.

FAQ

Is it better to invest in TFSA or RRSP?

When it comes to TFSA vs. RRSP, there’s no right answer to whether investing in one is better than the other. Someone focused on saving for retirement may want to prioritize an RRSP, while someone who wants to save for other expenses (like a home or wedding) may find a TFSA more appealing.

Should I max out RRSP or TFSA first?

If someone is focused on saving for retirement, they may want to max out their RRSP first. That being said, this is a personal decision that depends on unique financial goals and tax preferences.

When should you contribute to RRSP vs TFSA?

Typically, the contribution deadline for RRSPs is around March 1st. A Canadian citizen can put funds in a TFSA at any point in a calendar year, and if they don’t max out their account, they will usually be able to contribute the remaining amount in the future.

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May

2024

Direct Listings vs. IPOs: How Are They Different?

By Laurel Tincher | invest, Investing | Comments Off

Table of Contents

What Is the Difference Between Direct Listings and IPOs?
Comparing the Direct Listing and IPO Process
Pros and Cons of Direct Listings
FAQ

When you hear of a company “going public,” one route is via an initial public offering, or IPO — but a company can also go public through a direct listing, where no new shares are created and underwriters are not required.

Direct listings, also known as the direct listing process (DLP), direct placement, or direct public offering (DPO), are a way for companies to raise capital by selling existing shares without the complexity of engaging investment banks and other intermediaries.

While a direct listing is typically less expensive than an IPO, and typically there’s no lock-up period, there is a risk in direct listing shares without the support of underwriters.

Key Points

• Direct listings allow companies to go public by selling existing shares without underwriters.

• Initial Public Offerings (IPOs) involve issuing new shares and usually require underwriters.

• Direct listings can be less costly and avoid lock-up periods unlike IPOs.

• IPOs provide companies with support from underwriters, which can help stabilize share prices.

• Direct listings offer immediate liquidity for existing shareholders, allowing them to sell shares directly to the public.

What Is the Difference Between Direct Listings and IPOs?

A direct listing is one method by which a company can list shares of stock on a public exchange such as the New York Stock Exchange (NYSE) or Nasdaq directly, without using underwriters to create new shares, as you might with an IPO.

While some listing choices involve selling shares of stock to investors, IPOs and direct listings have many differences. The main difference between the two is that with an IPO a company issues and sells new shares of stock, while with a direct listing shareholders sell existing shares.

Comparing the Direct Listing and IPO Process

The differences between using a direct listing vs. an IPO to take a company public are pretty straightforward.

How a Direct Listing Works

If a private company is interested in going public, but doesn’t want the hassle of working with underwriters, they may choose to do a direct listing. With a direct listing, anyone who owns shares in the company can sell them directly to the public once the new company is listed on a public exchange. Shareholders may include investors, promoters, and employees.

By choosing a direct listing over an IPO, a company can avoid using an underwriter, which potentially saves money and time. Underwriters fulfill multiple roles in the IPO process, including working with the fledgling company to meet regulatory standards and set the initial price per share. These are important steps, but not necessary if a new company is only selling existing shares.

Further, because no new shares are created with a direct listing, existing shares won’t get diluted.

💡 Quick Tip: Access to IPO shares before they trade on public exchanges has usually been available only to large institutional investors. That’s changing now, and some brokerages offer pre-listing IPO investing to qualified investors.

How an Initial Public Offering Works

When a company offers shares of stock to the general public for the first time, it’s known as an initial public offering (IPO).

Before an IPO, a company is considered private, which means that shares of stock are not available for sale to the general public. Also, a private company is not generally required to disclose financial information to the public.

To have an IPO, a company must file a prospectus with the Securities and Exchange Commission (SEC). The company will use the prospectus to solicit investors, and it includes key information like the terms of the securities offered and the business’s overall financials.

Initial public offerings are a popular choice for companies looking to raise capital. The company works with an underwriter (typically part of an investment bank), who helps navigate regulations and figure out the initial price of the shares. They may also purchase shares from the company and sell them to investors (such as mutual funds, insurance companies, investment banks, and broker-dealers) who will in turn sell them to the public.

One benefit of working with an underwriter is the greenshoe option. This is an agreement that a company can enter into with the underwriter in which the underwriter has the right to sell a greater number of shares during the sale than they originally intended to, if there is a lot of market demand. This can help the company gain additional investment.

Working with an underwriter creates some security for the company, which is one reason so many companies go the route of the IPO.

Pros and Cons of Direct Listings

There are advantages and disadvantages for companies and investors when it comes to direct listings vs. IPOs.

Pros of a Direct Listing

Less expensive than an IPO for the company

Unlike IPOs, direct listings do not require underwriters, since no new shares are being created. Typically, an underwriter charges a fee between 3% and 7% per share. Depending on the scope of the IPO, these fees can add up to hundreds of millions of dollars.

In addition, underwriters often purchase shares below their agreed-upon market value, so companies don’t receive as much investment as they may have had they sold those shares directly to retail investors.

No lock-up periods for shares

If a company goes through an IPO, existing shareholders are generally not allowed to sell their shares to the public during the sale and for a period of time following the sale. These lock-up periods are required in order to prevent stock prices from decreasing due to an oversupply.

The direct listing model is essentially the opposite, in which existing shareholders sell their stock to the public and no new shares are sold.

Provides liquidity for existing shareholders

Anyone who owns stock in the company can sell their shares during a direct listing.

💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

Cons of a Direct Listing

There are also some potential drawbacks when it comes to direct listings.

Risk that shares won’t sell

With a direct listing, the amount of shares sold is based solely on market demand. Because of this, it’s important for a company to evaluate the market demand for its stock before deciding to go the route of a direct listing.

Companies best suited to direct listings are those that sell directly to consumers and have both a strong, recognizable brand and a business model that the public can easily understand and evaluate.

No help from underwriters with marketing and sales

Underwriters provide guarantees, promotion, and support during the listing process. Without an underwriter involved, the company may find that shares are difficult to sell, there may be legal issues during the sale, and the share price may see extreme swings.

No guarantee of stock price

Just as there is no guarantee that shares will sell, there is also no guarantee of stock price. In contrast, having an underwriter can help manage potentially extreme price swings.

This chart outlines the main points covered above.

Pros of Direct Listings	Cons of Direct Listings
Less expensive than an IPO	Potential for initial volatility
No lock-up periods	Risk that shares won’t sell
Liquidity for existing shareholders	No help from underwriters
	No stock price guarantee

The Takeaway

Direct listings are an appealing alternative to IPOs for private companies who want to go public, thanks in part to lower costs and reduced regulations. A direct listing may also be appealing to retail investors who want to purchase shares from companies that are going public.

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

FAQ

Why would a company do a direct listing?

A direct listing offers a more direct path to going public on a stock exchange. The company doesn’t have to issue new shares, as only existing shares get sold in a direct listing. This eliminates the need for intermediaries like underwriters.

Can anyone buy a direct listing stock?

Yes, investors can buy a direct stock listing as they would any other stock listed on an exchange.

Is a direct offering good for a stock?

Since direct listings bypass the middleman and eliminate the need for underwriters, they can be less expensive for a company vs. IPOs, but the lack of marketing support could hurt the stock price and initial sales.

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.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

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.

SOIN0124047

May

2024

Guide to Deposit Interest Rates

By Austin Kilham | Budgeting & Goals, Growing Wealth, money | Comments Off

A deposit account — such as a savings account or interest-bearing checking account — can be an attractive place to park your cash. It’s safe, allows relatively quick access, and even helps you earn a little bit of money, thanks to what’s known as the deposit interest rate.

The deposit interest rate is the amount of interest that a bank or other financial institution will pay you when you make a deposit. (You may also hear it referred to by such terms as simply the interest rate or the APY, for annual percentage yield.) Understanding deposit interest rates can help you choose among banking products and find the one that best suits your needs. Learn more here.

What Is a Deposit Interest Rate?

When you put money into a deposit account, your bank or financial institution will pay you interest. Why? Banks make money by using a portion of the money that’s deposited with them to make loans to other customers, perhaps as a mortgage, business loan, or personal loan.

The bank pays you interest for the privilege of lending out your money. They will then charge a higher interest rate on the loans they make, which is how the bank turns a profit.

Incidentally, just because a bank is loaning out your money doesn’t mean your cash won’t be there when you need it. Banks typically carry a cash reserve to cover withdrawals their customers need to make.

How Does a Deposit Interest Rate Work?

Deposit interest rates in banking are expressed as percentages. The amount of interest you earn will be based on how much cash you’ve deposited in your account, also known as your principal.

The interest rate you’re offered will vary by account. For example, a simple savings account may offer a relatively low interest rate, while a high-yield savings account or a money market account may offer a higher rate.

Your interest rate will also be determined in part by the federal funds rate. That rate is the amount the Federal Reserve suggests banks charge to lend each other money overnight.

How Is Deposit Interest Rate Calculated?

Wondering how interest rates are calculated? It usually is done in one of two ways: as simple interest or compounding interest.

Simple interest is a matter of multiplying the principal by the interest rate. As the name suggests, it is easier to calculate. However, most banks will use compounding to calculate interest rates. Compounding interest essentially allows you to earn a return on your returns, which can help your money grow exponentially. So your principal earns interest, and that amount of interest is added to the principal. Then the interest rate gets calculated again at a certain interval based on that pumped-up principal. This keeps happening, helping your savings grow. Interest can compound at various rates, such as continuously, monthly, or annually, depending on the product and financial institution.

Ways Deposit Interest Rates Are Applied by Institutions

Financial institutions can apply interest rates in a variety of ways. First, they can be fixed or variable. A fixed interest rate guarantees that you will receive an interest payment equal to a certain percentage of your principal. This percentage won’t change over the life of the account. So if your interest rate on your money is set at, say, 2%, that is what you will get, period.

A variable interest rate, on the other hand, may change according to shifts in a benchmark interest rate, such as the federal funds rate. As the benchmark rises, so too will the interest rate. What if the benchmark drops? That means you’re paid less interest.

Additionally, some deposit accounts will offer higher interest rates for larger balances. A certificate of deposit, or CD, may offer you better interest rates if you agree to park your cash in the account for a longer term.

Here’s how to do the math on a couple of examples of deposit interest rates. If you’re a bank customer with $10,000 to deposit, here are two scenarios:

• Bank 1 is a bricks-and-mortar bank offering 0.01% interest. (Remember, one percentage point is one-hundredth of a whole.) If you deposit your $10,000 for one year, you’ll earn: 10,000 x 0.0001 = 1. At the end of 365 days, you will have the principal plus the interest, or $10,001.

• Bank 2 is an online bank offering 1.0% interest. If you deposit the same $10,000 for a year, you’ll earn: 10,000 x 0.01 = 100. You’ll have $10,100 at year’s end.

Types of Deposit Interest Rate Accounts

There are a variety of different deposit account types that you might encounter. Here are four of which you should be aware. We’ll explain how each one works.

1. Savings Accounts

Savings accounts are designed specifically as a place for you to put cash you might need in the short-term. For example, you might keep your emergency fund in a savings account, since you’d need quick access to cash if your car’s transmission failed or you had to cover an unexpected medical bill.

Not only does your savings account allow you to earn interest, it is also one of the safest places you can put your money. That’s because the Federal Deposit Insurance Corporation (FDIC) guarantees your money, up to $250,000, per depositor, per account category, per insured institution, as it does with the deposit accounts below. That means in the rare case that your bank fails, you will still have access to your money.

You can deposit cash at an ATM, in person, or through mobile deposits. You can deposit checks or cash into the account, too. When you make a deposit, your funds may not be immediately available for use. Check with your bank to understand their rules around fund availability.

2. Interest-Bearing Checking Accounts

Many checking accounts have very low fees and don’t pay interest. As a result, it doesn’t make sense to keep a lot of money in this type of account. In fact, you may want to keep just enough to pay your bills.

Interest-bearing checking accounts are an exception. They allow you to collect interest on your account, which could be a nice perk. After all, you may well have your paycheck deposited there by setting up direct deposit, which can make your funds available quickly. Whatever remains in your account after paying your bills could be earning you some interest.

However, these accounts may be more complicated and expensive, with higher fees and minimum balance requirements. It’s important to make sure that the expense of holding the account doesn’t outweigh the interest paid.

💡 Quick Tip: If your checking account doesn’t offer decent rates, why not apply for an online checking account with SoFi to earn 0.50% APY. That’s 7x the national checking account average.

3. Certificates of Deposit

A certificate of deposit, or CD, is a product offered by financial institutions that offers a higher interest rate if you agree to keep your funds in place for a period of time. Typically, the length of time is from six months to a few years, but it could be anywhere from one month to 20 years. The longer the period, the higher the interest rate you will probably be offered.

Here’s the rub: If you find that you need the money in the CD before the account matures (meaning the agreed-to time period passes), you’ll likely have to pay early withdrawal penalties. That said, it is possible to get CD’s with no-penalties, but you may have to compromise, such as by accepting lower interest rates.

4. Money Market Accounts

Money market accounts, on the other hand, pay interest and allow for withdrawals. They often pay higher interest rates than traditional savings accounts. However, in return, these accounts may require you to make higher initial deposits and they may have minimum balances, which could be $10,000 or more.

Like checking accounts, money market accounts can offer checks and debit cards, though they may limit the number of transactions you may make per month.

The Takeaway

There are a number of different deposit accounts that offer a deposit interest rate, ranging from checking and savings accounts to CDs and money market accounts. The interest rates will likely vary. For example, with CDs, the rates may depend on factors such as account minimums or term of deposit. Understanding these kinds of “fine print” differences will help you find the right match for your needs, whether your goal is the highest possible interest or having enhanced access to your funds.

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 you get interest when you deposit money?

When you deposit money in an interest-bearing deposit account, you will start to earn interest. In other words, your money makes money.

Which deposits pay more interest?

The amount of interest you earn will depend on your interest rate and the amount of money in the account. The more money you deposit and the higher the interest rate, the more interest you will earn. Also, online banks typically pay interest rates than bricks-and-mortar banks.

Do all banks have deposit interest rates?

Banks that offer interest-bearing deposit accounts will always offer a deposit interest rate.

Photo credit: iStock/AsiaVision

SOBK-Q224-1890392-V1

May

2024

Backdoor Roth IRAs

By Pam O’Brien | Growing Wealth, invest, Investing, Preparing for Retirement, Terminology | No Comments

Want to contribute to a Roth IRA, but have an income that exceeds the limits? There’s another option. It’s called a backdoor Roth IRA, and it’s a way of converting funds from a traditional IRA to a Roth.

A Roth IRA is an individual retirement account that may provide investors with a tax-free income once they reach retirement. With a Roth IRA, investors save after-tax dollars, and their money generally grows tax-free. Roth IRAs also provide additional flexibility for withdrawals — once the account has been open for five years, contributions can generally be withdrawn without penalty.

But there’s a catch: Investors can only contribute to a Roth IRA if their income falls below a specific limit. If your income is too high for a Roth, you may want to consider a backdoor Roth IRA.

Key Points

• A backdoor Roth IRA allows high earners to contribute to a Roth IRA by converting funds from a traditional IRA.

• This strategy involves paying income taxes on pre-tax contributions and earnings at conversion.

• There are no income limits or caps on the amount that can be converted to a Roth IRA.

• The process includes opening a traditional IRA, making non-deductible contributions, and then converting these to a Roth IRA.

• Potential tax implications include moving into a higher tax bracket and owing taxes on pre-tax contributions and earnings.

What Is a Backdoor Roth IRA?

If you aren’t eligible to contribute to a Roth IRA outright because you make too much, you can do so through a technique called a “backdoor Roth IRA.” This strategy involves contributing money to a traditional IRA and then converting it to a Roth IRA.

The government allows individuals to do this as long as, when they convert the account, they pay income tax on any contributions they previously deducted and any profits made. Unlike a standard Roth IRA, there is no income limit for doing the Roth conversion, nor is there a ceiling to how much can be converted.

💡 Quick Tip: How much does it cost to open an IRA account? Often there are no fees to open an IRA, but you typically pay investment costs for the securities in your portfolio.

How Does a Backdoor IRA Work?

This is how a backdoor IRA typically works: An individual opens a traditional IRA and makes non-deductible contributions. They then convert the account into a Roth IRA. The strategy is generally most helpful to those who earn a higher salary and are otherwise ineligible to contribute to a Roth IRA.

Example Scenario

For instance, let’s say a 34-year-old individual whose tax filing status is single and who makes $150,000 a year wants to open a Roth IRA. Their income is too high for them to be eligible for a Roth directly (more on this below), but they can use the “backdoor IRA” strategy. In order to do this, the individual would open a traditional IRA and contribute non-deductible funds to it. They then convert that money to a Roth IRA.

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.

Income and Contribution Limits

In general, Roth IRAs have income limits. In 2024, a single person whose modified adjusted gross income (MAGI) is more than $161,000, or a married couple filing jointly with a MAGI more than $240,000, cannot contribute to a Roth IRA. For tax year 2023, a single filer whose MAGI is more than $153,000, or a married couple filing jointly with a MAGI over $228,000, cannot contribute to a Roth IRA.

There are also annual contribution limits for Roth IRAs. In 2024, an individual can contribute up to $7,000 in a Roth IRA (or up to $8,000 if they are 50 or older). For tax year 2023, an individual can contribute up to $6,500 in a Roth IRA (or up to $7,500 if they are 50 or older). Traditional IRAs have the same contribution limits as Roth IRAs.

How to Set Up and Execute a Backdoor Roth

Here’s how to initiate and complete a backdoor Roth IRA.

• Open a Traditional IRA. You could do this with SoFi Invest^®, for instance.

• Make a non-deductible contribution to the Traditional IRA.

• Open a Roth IRA, complete any paperwork that may be required for the conversion, and transfer the money into the Roth IRA.

Tax Impact of a Backdoor Roth

If you made non-deductible contributions to a traditional IRA that you then converted to a Roth IRA, you won’t owe taxes on the money because you’ve already paid taxes on it. However, if you made deductible contributions, you will need to pay taxes on the funds.

In addition, if some time elapsed between contributing to the traditional IRA and converting the money to a Roth IRA, and the contribution earned a profit, you will owe taxes on those earnings.

You might also owe state taxes on a Roth IRA conversion. Be sure to check the tax rules in your area.

Another thing to be aware of: A conversion can also move people into a higher tax bracket, so individuals may consider waiting to do a conversion when their income is lower than usual.

And finally, if an investor already has traditional IRAs, it may create a situation where the tax consequences outweigh the benefits. If an individual has money deducted in any IRA account, including SEP or SIMPLE IRAs, the government will assume a Roth conversion represents a portion or ratio of all the balances. For example, say the individual contributed $5,000 to an IRA that didn’t deduct and another $5,000 to an account that did deduct. If they converted $5,000 to a Roth IRA, the government would consider half of that conversion, or $2,500, taxable.

The tax rules involved with converting an IRA can be complicated. You may want to consult a tax professional.

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

Is a Backdoor Roth Right for Me?

It depends on your situation. Below are some of the benefits and downsides to a backdoor Roth IRA to help you determine if this strategy might be a good option for you.

Benefits

High earners who don’t qualify to contribute under current Roth IRA rules may opt for a backdoor Roth IRA.

As with a typical Roth IRA, a backdoor Roth may also be a good option when an investor expects their taxes to be lower now than in retirement. Investors who hope to avoid required minimum distributions (RMDs) when they reach age 73 might also consider doing a backdoor Roth.

Downsides

If an individual is eligible to contribute to a Roth IRA, it won’t make sense for them to do a backdoor conversion.

And because a conversion can also move people into a higher tax bracket, you may consider waiting to do a conversion in a year when your income is lower than usual.

For those individuals who already have traditional IRAs, the tax consequences of a backdoor Roth IRA might outweigh the benefits.

Finally, if you plan to use the converted funds within five years, a backdoor Roth may not be the best option. That’s because withdrawals before five years are subject to income tax and a 10% penalty.

Is a Backdoor Roth Still Allowed for 2023? For 2024?

Backdoor IRAs are still allowed for tax year 2023. And at this point, they are still allowed for 2024 as well.

There had been some discussion in previous years of possibly eliminating the backdoor Roth IRA, but as of yet, this has not happened.

The Takeaway

A backdoor Roth IRA may be worth considering if tax-free income during retirement is part of an investor’s financial plan, and the individual earns too much to contribute directly to a Roth.

In general, Roth IRAs may be a good option for younger investors who have low tax rates and people with a high income looking to reduce tax bills in retirement.

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

What are the rules of a backdoor Roth IRA?

The rules of a backdoor Roth IRA include paying taxes on any deductible contributions you make; paying any other taxes you may owe for the conversion, such as state taxes; and waiting five years before withdrawing any earnings from the Roth IRA to avoid paying a penalty.

Is it worth it to do a backdoor Roth IRA?

It depends on your specific situation. A backdoor Roth IRA may be beneficial if you earn too much to contribute to a Roth IRA. It may also be advantageous for those who expect to be in a higher tax bracket in retirement.

What is the 5-year rule for backdoor Roth IRA?

According to the 5-year rule, if you withdraw money from a Roth IRA before the account has been open for at least five years, you are typically subject to a 10% tax on those funds. The five year period begins in the tax year in which you made the backdoor Roth conversion. There are some possible exceptions to this rule, however, including being 59 ½ or older or disabled.

Do you get taxed twice on backdoor Roth?

No. You pay taxes once on a backdoor IRA — when you convert a traditional IRA with deductible contributions and any earnings to a Roth. When you withdraw money from your Roth in retirement, the withdrawals are tax-free because you’ve already paid the taxes.

Can you avoid taxes on a Roth backdoor?

There is no way to avoid paying taxes on a Roth backdoor. However, you may be able to reduce the amount of tax you owe by doing the conversion in a year in which your income is lower.

Can you convert more than $6,000 in a backdoor Roth?

There is no limit to the amount you can convert in a backdoor Roth IRA. The annual contribution limits for IRAs does not apply to conversions. But you may want to split your conversions over several years to help reduce your tax liability.

What time of year should you do a backdoor Roth?

There is no time limit on when you can do a backdoor Roth IRA. However, if you do a backdoor Roth earlier in the year, it could give you more time to come up with any money you need to pay in taxes.

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

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

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

SoFi Invest®

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

Dividend Reinvestment Plans: How DRIP Investing Works

What Is Dividend Reinvestment?

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

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

What Is a Dividend Reinvestment Plan?

Types of Dividend Reinvestment Plans

Company DRIPs

DRIPs through a brokerage

DRIP Example

Pros and Cons of DRIPs

Pros of Dividend Reinvestment Plans

Cons of Dividend Reinvestment Plans

Cash vs Reinvested Dividends

Tax Consequences of Dividends

Should You Reinvest Dividends?

The Takeaway

FAQ

How do you set up a dividend reinvestment plan?

Can you calculate dividend reinvestment rates?

What is the difference between a stock dividend and a dividend reinvestment plan?

TFSA vs RRSP: What’s the Difference?

What Is the TFSA?

What Is the RRSP?

Similarities Between a TFSA and an RRSP

Differences Between a TFSA and RRSP

How Do I Choose Between a TFSA and RRSP?

Can I Have Both a TFSA and RRSP?

Can I Have Multiple RRSP and TFSA Accounts?

Get up to $300 when you bank with SoFi.

Should I Prioritize One Over the Other?

The Takeaway

FAQ

Is it better to invest in TFSA or RRSP?

Should I max out RRSP or TFSA first?

When should you contribute to RRSP vs TFSA?

Direct Listings vs. IPOs: How Are They Different?

What Is the Difference Between Direct Listings and IPOs?

Comparing the Direct Listing and IPO Process

How a Direct Listing Works

How an Initial Public Offering Works

Pros and Cons of Direct Listings

Pros of a Direct Listing

Cons of a Direct Listing

The Takeaway

FAQ

Why would a company do a direct listing?

Can anyone buy a direct listing stock?

Is a direct offering good for a stock?

Guide to Deposit Interest Rates

What Is a Deposit Interest Rate?

Earn up to 4.00% APY with a high-yield savings account from SoFi.

How Does a Deposit Interest Rate Work?

How Is Deposit Interest Rate Calculated?

Ways Deposit Interest Rates Are Applied by Institutions

Types of Deposit Interest Rate Accounts

1. Savings Accounts

2. Interest-Bearing Checking Accounts

3. Certificates of Deposit

4. Money Market Accounts

The Takeaway

FAQ

Do you get interest when you deposit money?

Which deposits pay more interest?

Do all banks have deposit interest rates?

Backdoor Roth IRAs

What Is a Backdoor Roth IRA?

How Does a Backdoor IRA Work?

Example Scenario

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

Income and Contribution Limits

How to Set Up and Execute a Backdoor Roth

Tax Impact of a Backdoor Roth

Is a Backdoor Roth Right for Me?

Benefits

Downsides

Is a Backdoor Roth Still Allowed for 2023? For 2024?

The Takeaway

FAQ

What are the rules of a backdoor Roth IRA?

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

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