Feb
27
2024
What Are the Different Types of Income?

What Are the Different Types of Income?

By | Financial Independence, Life & Career, money | Comments Off on What Are the Different Types of Income?

You may think of your income as being your paycheck or your freelance earnings, but there are actually many different types of income. If you have stocks that are generating dividends, that’s income, as is interest you earn on any savings accounts. Do you own a rental property that has rent payments flowing your way? That’s income, too.

Here, you’ll learn about seven common types of income and how they may affect your financial life.

Key Points

•   Income refers to money earned from labor, investments, or other sources, and can be categorized as earned, business, interest, dividend, rental, capital gains, or royalty income.

•   Earned income includes wages, salaries, tips, and bonuses, while business income is generated from products or services provided by a business.

•   Interest income is earned from interest-bearing financial vehicles like CDs or savings accounts, and dividend income comes from stock dividends.

•   Rental income is earned from property rentals, and capital gains are realized when selling assets for more than their purchase price.

•   Royalty income is earned from allowing others to use your property, such as patents or copyrighted work.

What Is Income?

Simply put, income is money that a person or business earns in return for labor, providing a product or service, or returns on investments. Individuals also often receive income from a pension, a government benefit, or a gift. Most income is taxable, but some is tax-exempt from federal or state taxes.

Another way to think about income types is whether it is active (or earned) or passive (or unearned).

•   Active or earned income is just what it sounds like: money that you work for, whether you are providing goods or a service.

•   Passive or unearned income is money you receive even though you are not actively doing anything to get it. For instance, if you have a certificate of deposit (CD) that earns you interest, that is passive income. Government benefits, capital gains, rental income, royalties, and more are also considered passive income. (We’ll go through these variations in more detail in a minute.)

People who are paid a salary may tend to think that their annual paycheck earnings are their income, but in truth, it’s common for many people to have multiple income streams. Granted, your salary may be by far the largest stream of income, but when considering your overall financial picture, don’t forget to think about the other ways that money comes to you.

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Different Types of Income

Now that you know the answer to “What is income?” question, here’s a look at the various kinds of Income. These are usually categorized as seven different types of income (though these may also be called income streams).

1. Earned Income

Earned income is the money you earn for work you do, either in a job or self-employed. Earned income includes wages, salaries, tips, and bonuses.

Earnings are taxed at varying rates by the federal and state governments. Taxes may be withheld by your employer. Self-employed workers often pay quarterly and annual taxes directly to the government. Low-income workers may be eligible for the earned income tax credit.

2. Business Income

Next up: What is business income? This is a term often used in tax reporting; you may sometimes also hear it referred to as profit income. It basically means income received for any products or services your business provides. It is usually considered ordinary income for tax purposes.

Expenses and losses associated with the business can be used to offset business income. Business income can be taxed under different rules, depending on what type of business structure is used, such as sole proprietorship, partnership, corporation, etc.

3. Interest Income

When you invest in various types of interest-bearing financial vehicles, the return is considered interest income. Retirees often rely on interest income to fund their retirement. You can earn interest from a variety of sources including:

•   Certificates of deposit (CDs)

•   Government bonds

•   Treasury bonds and notes

•   Treasury bills (T-bills)

•   Corporate bonds

•   Interest-bearing checking accounts

•   Savings accounts.

In most cases, interest income is taxed as ordinary income. Some types of interest are fully taxable, while other forms (such as interest from Treasury bonds) are sometimes partially taxable.

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4. Dividend Income

Some companies pay stockholders dividends as a way of sharing profits. These are usually regular cash payments that investors can take as income or reinvest in the stock. Dividend income is one of the most common ways investors can make money from stocks. (Worth noting: Money-market funds distributions may seem like interest, but they are usually considered dividends.)

Dividends from stocks held in a taxable brokerage account are considered taxable income. These funds will be taxed at your regular income-tax rate or as a long-term capital gain. By contrast, dividends that are paid from a stock held inside a tax-advantaged savings account such as an IRA or 401(k) are not taxed.

5. Rental Income

Just as it sounds, rental income is income earned from rental payments on property you own. This could be as straightforward as renting a room in your house or as complicated as owning a multi-unit building with several tenants.

Rental income can provide a steady stream of passive vs. active income. It may enhance your livelihood or even be your main income. When your rental property increases in value, you may also gain from that appreciation and increase in equity. In addition, rental income qualifies for several tax advantages, including taking depreciation and some expense write-offs.

But there are downsides. Owning a rental property isn’t for the faint of heart. Unreliable tenants, decreasing property values, the cost of maintaining and repairing properties, as well as fees for rental property managers can all take a bite out of your rental income stream.

6. Capital Gains

Another important income stream can come from capital gains. You incur a capital gain when you sell an asset for more than what you originally paid for it. For the purposes of capital gains, an asset usually means an investment security such as a stock or bond. But it can also encompass possessions such as real estate, vehicles, or boats. You calculate a capital gain by subtracting the price you paid from the sale price.

There is another key point to know on this topic: Two types of capital gains are possible — short-term and long-term.

•   Short-term capital gains are realized on assets you’ve held for one year or less.

•   Long-term capital gains are earned on assets held for more than a year.

The tax consequences are different for each type of capital gain. Short-term gains are taxed as ordinary income, while long-term capital gains are taxed at a lower rate depending on income. Taxpayers could typically pay 0%, 15%, or 20% on long-term capital gains, depending on their income.

Keep in mind, however, that capital losses can happen too. That’s when a capital asset is sold for less than the purchase price. While it’s never pleasant to experience losses, there can be a small silver lining in this case. Many times capital losses can be taken as a tax deduction against current and/or future capital gains.

7. Royalty Income

Royalty income comes from an agreement allowing someone to use your property. These payments can come from the use of patents, copyrighted work, franchises, and more. An example or two:

Inventors who sell their creations to a third party may receive royalties on the revenue their inventions generate. Celebrities often allow their name to be used to promote a product for royalty payments. Oil and gas companies pay landowners royalties to extract natural resources from their property. The market for music royalties has been particularly lucrative in recent years with the proliferation of music streaming services.
Royalty payments are often a percentage of the revenues earned from the other party using the property. Many things impact how much royalty is paid, including exclusivity, the competition, and market demand. How royalty payments are taxed can also vary, depending on the type of agreement.

Now that you’ve reviewed the seven different types of income, you may be wondering, “What about residual income?” That’s a term that doesn’t actually describe money that’s heading your way. Instead, think of that as the amount of your income left over after you’ve paid your financial obligations. It’s similar to discretionary income. Unfortunately, it’s not another way to enrich your bank account.

Recommended: 10 Personal Finance Basics

The Takeaway

Understanding the seven general income streams (such as earned, dividend, and rental income) can help you make the most of your financial planning. Earning income from any of these sources can add stability and help achieve long-term goals, such as saving for retirement. Because some types of income have unique tax implications, it can be important to check with your tax advisor about any tax consequences that may exist.

Aside from earned income, it’s likely that interest is the kind of income most people receive. And seeking out the best possible interest rate can be a solid way to enhance your money; looking for a high-yield bank account may be a good place to start.

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SoFi members with direct deposit activity can earn 4.20% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.20% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

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

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

Interest rates are variable and subject to change at any time. These rates are current as of 10/31/2024. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

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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Feb
27
2024
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Safe Harbor 401(k) Plan: What Is It? Is It for You?

By | Growing Wealth, Investing, Preparing for Retirement | Comments Off on Safe Harbor 401(k) Plan: What Is It? Is It for You?

Safe harbor 401(k) plans enable companies to avoid the annual IRS testing that comes with traditional 401(k) plans. With a safe harbor 401(k), an employer makes mandatory contributions to all employees’ retirement accounts, and those funds vest immediately.

Often a perk used to attract top talent, safe harbor 401(k) plans are a way for highly compensated employees, like company executives and owners, to save more than a traditional 401(k) plan would normally allow.

Keep reading to learn more about safe harbor rules, why companies use these plans, along with the benefits, drawbacks, and relevant deadlines.

Key Points

•   Like a traditional 401(k), a safe harbor 401(k) lets employees deposit tax-deferred funds from their paychecks into a retirement savings account.

•   Employers are required to contribute to employees’ safe harbor 401(k) accounts.

•   Employer contributions in a safe harbor 401(k) vest immediately. There is no waiting period.

•   Highly-paid employees can contribute more to a safe harbor 401(k) than a traditional 40(k).

•   Safe harbor 401(k) plans allow companies to skip the annual nondiscrimination regulatory testing required by the IRS for traditional 401(k)s.

What Is a Safe Harbor 401(k) Plan?

A 401(k) safe harbor plan is similar to a traditional 401(k) plan — but with a twist. In both cases, eligible employees can use the plan to contribute pre-tax funds to a retirement account and employers may contribute matching funds.

But with a traditional 401(k) retirement plan, companies must submit to annual nondiscrimination regulatory testing by the IRS to ensure that the company plan doesn’t treat highly compensated employees (HCEs) — generally defined as earning at least $150,000 in the 2023 tax year and $155,000 in the 2024 tax year and being in the company’s top 20% in pay, or owning more than 5% of the business — more favorably than others. The testing process is complex and can be a burden for some companies.

An alternative is to set up a safe harbor 401(k) plan with a safe harbor match. This allows a company to skip the annual IRS testing — and avoid imposing restrictions on employee saving — by providing the same 401(k) contributions to all employees, regardless of title, salary, or even years spent at the company. And those funds must vest immediately.

This is an important benefit, because in many cases, employer contributions to traditional 401(k) plans vest over time, requiring employees to stay with the company for some years in order to get the full value of the employer match. Often, if you leave before the employer contributions or match have vested, you may forfeit them.

For smaller companies, it may be worth making the extra safe harbor match contributions in order to avoid the time and expense of the IRS’s annual nondiscrimination testing. For larger companies, giving all employees the same percentage contribution could be expensive. But the upside is that highly paid employees can then make much larger 401(k) contributions without running afoul of IRS rules, a real perk for company leaders. In addition, 401(k) safe harbor plans are typically less expensive to set up than traditional plans.

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Traditional 401(k) vs Safe Harbor 401(k) Plans

While safe harbor 401(k)s and traditional 401(k) plans are similar in many ways, there are some important differences that employers should be aware of.

For instance, with traditional 401(k) plans, contributions from highly compensated employees can’t comprise more than 2% of the average of all other employee contributions, in addition to other restrictions. However, with safe harbor 401(k) plans, those limits don’t apply.

Comparing Plan Features and Benefits

Here is a side-by-side comparison of a safe harbor 401(k) vs. a traditional 401(k)

Safe Harbor 401(k) Traditional 401(k)
Employer contributions are required. Employer contributions are optional.
Employer contributions are vested immediately. Employer contributions may vest over time.
Highly-paid employees can contribute up to the $22,500 maximum in tax year 2023 and up to $23,000 in 2024. Highly-paid employees can be limited in how much they can contribute.
Companies do not have to do annual nondiscrimination testing. Companies must do annual nondiscrimination testing.

Choosing the Right Plan for Your Business

A safe harbor plan may be beneficial for some smaller companies that can’t afford the expense of nondiscrimination testing. In addition, the plan is simpler with less administrative tasks.

A company might also choose a safe harbor 401(k) if it has some key high-earning employees that make up a large share of the workforce.

However, if your company is able to easily manage the nondiscrimination testing process, you may want to opt for a traditional 401(k). A traditional 401(k) could also be a good option for business owners who want to try to retain employees over the long-term. They could set up a vesting schedule for employer contributions that requires employees to be with the company for three years before becoming fully vested, for instance.

Setting Up a Safe Harbor 401(k) Plan

For employers interested in using a safe harbor 401(k), there are some general rules and guidelines they will need to follow.

Requirements, Contribution Formulas, and Deadlines

To fulfill the safe harbor 401(k) requirements, the employer must make qualifying 401(k) contributions (a.k.a. the safe harbor match) that vest immediately. The company contributes to employees’ retirement accounts in one of three ways:

•   Non-elective: The company contributes the equivalent of 3% of each employee’s annual salary to a company 401(k) plan, regardless of whether the employee contributes.

•   Basic: The company offers 100% matching for the first 3% of an employee’s 401(k) plan contributions, plus a 50% match for up to 5% of an employee’s contributions.

•   Enhanced: The company offers a 100% company match for all employee 401(k) contributions, up to 4% of a staffer’s annual salary.

Companies that opt for a safe harbor 401(k) plan have to adhere to strict compliance filing deadlines. These are the dates worth knowing.

October 1: That’s the deadline for filing for a safe harbor 401(k) for the current calendar year. This deadline meets the government criteria of a company needing to have a safe harbor 401(k) in operation for at least three months in a 12 month period, for the first year operating a safe harbor plan.

December 1: By this date, all companies — whether they’re rolling out a brand new safe harbor plan or are administering an existing one — must issue a formal notice to employees that a safe harbor 401(k) will be offered to company staffers.

January 1: The date that all safe harbor 401(k) plans are activated. For companies that currently have no 401(k) plan at all, they can roll out either a traditional 401(k) plan or a safe harbor 401(k) plan at any point in the year, for that calendar year.

Advantages of Implementing a Safe Harbor 401(k) Plan

Safe harbor 401(k)s offer some distinct upsides for business owners and employees alike.

Benefits for Employers and Employees

By creating a safe harbor 401(k) plan, a business owner can potentially attract and maintain highly skilled employees. Employees are attracted to higher retirement plan contributions and the ability to optimize retirement plan contribution amounts, ensuring more money for long-term retirement savings.

Plus, a safe harbor 401(k) plan can also help business owners save money on the compliance end of the spectrum. For example, companies save on regulatory costs by avoiding the costs of preparing for a nondiscrimination test (and the staff hours and training that goes with it).

There are some additional upsides to offering a safe harbor 401(k) retirement plan, for higher paid employees and regular staff too.

•   Playing catch up. If a company owner, or high-level managers, historically haven’t stowed enough money away in a company retirement plan, a safe harbor 401(k) plan can help them catch up. The same may be true, although to a lesser degree, for regular employees.

•   The spread of profit. Suppose a company has a steady and robust revenue stream and is managed efficiently. In that case, company owners may feel comfortable “spreading the wealth” with not only high-profile talent but rank-and-file employees, too.

•   Encourage retirement savings. If a company is seeing weak contribution activity from its rank-and-file employees, it may feel more comfortable going the safe harbor route and at least guaranteeing minimum 401(k) contributions to employees while rewarding higher-value employees with more lucrative 401(k) plan contributions.

Disadvantages of Safe Harbor Plans

Safe harbor 401(k) plans have their downsides, too. Here are some drawbacks to consider.

Financial Implications for Employers

The matching contribution requirements for safe harbor 401(k)s can add up to a hefty expense, depending on employee salaries. And because employees are vested immediately, there’s no incentive to stay with the company for a certain period.

In addition, if a company introduces a safe harbor 401(k) plan, it must commit to it for one calendar year, no matter how the plan is performing internally. Even after a year, 401(k) plan providers (which administer and manage the retirement plans) may charge a termination fee if a company decides to pull the plug on its safe harbor plan after one year.

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Safe Harbor 401(k) Contribution Limits and Match Types

There are some different rules for employer contribution limits and matching with a safe harbor 401(k) vs. a traditional 401(k).

Understanding Contribution Limits

Just like traditional 401(k) plans, the maximum employee contribution limit for a safe harbor plan is $22,500 in 2023 and $23,000 in 2024. If you are over 50, you would be eligible for an additional $7,500 catch-up contribution, if your plan allows it.

But in a safe harbor plan, a company owner can reserve the maximum $22,500 (in 2023) and $23,000 in 2024 for their plan contribution and also boost contribution payments to valued team members up to an individual profit-sharing maximum amount of 100% of their compensation, or $66,000 in 2023 ($73,500 for those over age 50) — whichever is less. In 2024, that number is $69,000 (76,500 for those over age 50).

Regular employees are allowed the standard maximum contribution limit of $22,500 in 2023 and $23,000 in 2024, plus anyone over age 50 can contribute an extra “catch-up” amount of $7,500. Those are the same maximum contribution ceilings as regular 401(k) plans.

Different Types of Employer Matching Contributions

As mentioned earlier, with a safe harbor 401(k), an employer must make qualifying 401(k) contributions that vest immediately in one of these ways:

•   Non-elective: The company contributes the equivalent of 3% of each employee’s annual salary to a company 401(k) plan.

•   Basic: The company matches 100% for the first 3% of an employee’s 401(k) plan contributions, plus a 50% match for the following 2% of their contributions.

•   Enhanced: The company provides a 100% company match for all employee 401(k) contributions, up to 4% of a staffer’s annual salary.

IRS Compliance Testing and Safe Harbor Provisions

To help understand the benefit of safe harbor plans, it helps to see what employers with traditional 401(k) plans face in terms of following IRS rules and submitting to the annual nondiscrimination tests.

Navigating Non-Discrimination Testing

Each year, a company must conduct Actual Deferral Percentage (ADP), Actual Contribution Percentage (ACP), and Top Heavy tests to confirm there is no compensation discrimination.

If the company fails one of the tests, it could mean considerable administrative hassle, plus the expense of making corrections, and potentially even refunding 401(k) contributions.

Before explaining the details of each test, here’s a refresher on how the IRS defines highly compensated employees (HCEs) and non-highly compensated employees (NHCEs).

To be a HCE:

•   The employee must own more than 5% of the company at any time during the current or preceding year (directly or through family attribution).

•   The employee is paid over $150,000 in compensation from the employer for 2023 and $155,000 in 2024. The plan can limit these employees to the top 20% of employees who make the most money.

Employees who don’t fit these criteria are considered non-highly compensated. The nondiscrimination tests are designed to assess whether top employees are saving substantially more than the rank-and-file staffers.

•   The Actual Deferral Percentage (ADP) test measures how much income highly paid employees contribute to their 401(k), versus staff employees.

•   The Actual Contribution Percentage (ACP) test compares employer retirement contributions to HCEs versus the contributions to everyone else.

According to the IRS, the terms of the ADP test — which compares the amounts different employees are saving in their 401(k)s — are met if the ADP for highly compensated employees (HCE) doesn’t exceed the greater of:

•   125% of the deferral percentage for ordinary, i.e., non-highly compensated employees (NHCEs)

Or the lesser of:

•   200% of the deferral percentage for the NHCEs

•   or the deferral percentage for the NHCEs plus 2%.

The ACP test is met if the deferral percentage for highly compensated employees doesn’t exceed the greater of:

•   125% of the deferral percentage for the NHCEs,

Or the lesser of:

•   200% of the deferral percentage for the group of NHCEs

•   or the deferral percentage for the NHCEs plus 2%.

Last, the top-heavy test measures the value of the assets in all company 401(k) accounts, total. If the 401(k) balances of “key employees” account for more than 60% of total plan assets, the 401(k) would fail the top heavy test. The IRS defines key employees somewhat differently than highly compensated employees, although both groups are similar in that they earn more than ordinary staff.

As you can see, maintaining a traditional 401(k) plan, and meeting these requirements each year, can be a burden for some companies. Fortunately, by setting up a safe harbor 401(k) plan, a company can avoid the annual nondiscrimination tests and still provide a 401(k) savings plan for employees.

The Takeaway

Companies that don’t want the regulatory obligations of a traditional 401(k) plan, and would like to prioritize talent acquisition and employee retention may want to consider safe harbor 401(k) plans.

However, a business owner needs to weigh the pros and cons of a safe harbor 401(k) plan because, in some cases, it can be expensive for a company to maintain.

But no matter what type of 401(k) an employer decides to go with, having a retirement plan in place, with different savings and investment options, can help employees — and business owners themselves — save for the future.

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FAQ

Is a safe harbor 401(k) worth it?

Whether a safe harbor 401(k) is worth it depends on the goals of the business owner. A safe harbor 401(k) allows a company to skip the expense of nondiscrimination testing. And by creating a safe harbor 401(k) plan, a business owner may be able to attract and maintain highly skilled employees because of the higher contributions. However, the matching employer contribution requirements can add up to a high expense. A business owner needs to weigh the pros and cons of these plans.

Can I cash out my safe harbor 401(k)?

You can withdraw safe harbor 401(k) funds without penalty at age 59 ½ or if you leave your job. However, hardship withdrawals for immediate and heavy financial need may be allowed in certain circumstances. You can learn more at irs.gov.

Why would a company use a safe harbor 401(k)?

A company might use a safe harbor 401(k) to avoid the expense of nondiscrimination testing and to simplify the administration of a 401(k) plan. They might also use a safe harbor 401(k) to help attract and keep highly skilled employees.

What is an example of a safe harbor 401(k) match?

If an employer with a safe harbor 401(k) chooses to offer non-elective matching contributions, that means they contribute at least 3% of each employee’s annual salary. So if an employee makes $70,000 a year, for example, the employer would contribute $2,100 to their safe harbor 401(k) account.

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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.

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.

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

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

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Feb
27
2024
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12 Things To Consider When Choosing A Bank

By | Budgeting & Goals, money | No Comments

When it’s time to choose a bank, you’ll have loads of options and offers to consider. But making a smart choice depends upon several factors and, of course, your unique needs.

Finding the right match is an important step in securing your financial future, so read on to learn a dozen critical factors to consider when looking for a bank. Whether you’re more comfortable with a small local financial institution or a major national business, this list will guide you toward a good answer to the “How do I choose a bank?” question.

Key Points

•   When choosing a bank, consider factors like security, bank fees, interest rates, location, ease of deposit, and digital banking capabilities.

•   Other important considerations include minimum requirements, availability of funds, customer service, investment account options, and perks offered by the bank.

•   Security is crucial, so ensure the bank is insured by the FDIC or NCUA.

•   Bank fees can eat into your savings, so be aware of ATM charges, maintenance fees, and overdraft protection fees.

•   Interest rates vary, so compare rates and consider online banks that offer higher rates on savings and checking accounts.

Importance of Finding a Good Bank

It can be valuable (literally and figuratively) to find the right banking partner for a few good reasons:

•   It provides a home base for the money you earn.

•   It can provide security, knowing that your cash is safe and you have a team of professionals to assist you with your money management.

•   It can pay you interest on your funds so your cash grows.

•   It can help you build your financial security and literacy.

•   It may be flexible enough to grow and change with you as you move through the stages and phases of your life. (If not, you can always switch as your needs evolve.)

•   It can offer you additional benefits, like a cash back debit card or a lower mortgage rate.

What to Look for in a Bank

There are thousands of options in terms of banking in the United States. So how do you narrow the choices down to the one bank that’s right for you? There’s no right or wrong answer; it’s all about finding what works best for you.

Consider the following twelve factors that can help you find the right fit for your current needs. You might create a comparison chart (Excel can be your friend here) so you can tick off the most important factors to you as you delve into this topic.

A good first step is to make yourself a comparison chart.

Then use the process of elimination to find your perfect financial institution match.

Sure, it can be smart to take friends’ suggestions into consideration, but the final choice should be the one that is all about you and your needs… not just what has a good marketing gimmick. Here’s what you need to consider when choosing a bank.

1. Security

Whether you choose to put your money in an online bank vs. a traditional bank vs. a credit union, it’s vital to make sure your funds are safe. You will likely want to make sure your account is either at a bank that’s insured by the Federal Deposit Insurance Corporation (FDIC) or a credit union that is insured by the National Credit Union Administration (NCUA).

In the very rare event of a bank or credit union closure, either FDIC or NCUA would be a safety net. You would be covered for $250,000 per depositor, per insured bank, for each account ownership category by FDIC and $250,000 per share owner, per insured credit union, for each account ownership category by NCUA.

2. Bank Fees

This is an important factor. Fees can eat away at the money you have on deposit and the savings you are trying to build up. Some banks charge minimal or no account fees, but in other cases, you may be faced with a deluge. A few of the obvious fees are ATM charges, maintenance fees, and overdraft protection, and they can add up quickly.

What are ATM fees? They can run a few dollars per out-of-network withdrawal and sometimes even more. And how about overdraft? The average overdraft fee is currently around $35, and while they’re a good way to avoid negative balances, they can cost you hundreds of dollars if you fall behind.

Returned deposits, foreign transactions, low balances, lost cards, and sometimes even interacting with a human can also incur fees. If you want to avoid monthly maintenance fees and more, be sure to read through the terms and conditions carefully so you aren’t unpleasantly surprised. You may just want to choose an account that’s fee-free instead.

3. Interest Rates

While some lenders might still offer the traditional — and very low — 0.01% interest rates on savings accounts, it doesn’t mean you’re stuck with that.

Especially with online-only banking where overhead is much less than traditional brick-and-mortar banks, customers are able to enjoy upwards of 3% annual percentage yields (APYs) on not only savings accounts. Many also offer some interest on checking balances, too.

Get up to $300 when you bank with SoFi.

No account or overdraft fees. No minimum balance.

Up to 4.20% APY on savings balances.

Up to 2-day-early paycheck.

Up to $2M of additional
FDIC insurance.


4. Location

Consider whether you’re the kind of person who likes to visit brick-and-mortar branches or use ATMs often. If you do, you may want to bank with a financial institution that has physical locations close to your home, your workplace, or both.

You might also want to check out if your bank has ATMs or a partner network of no-fee machines near you and the neighborhoods where you typically spend time. This can be important for avoiding ATM fees, such as non-network fees and ATM operator fees. These can add a few or several dollars to every transaction.

5. Ease of Deposit

Along the same lines, you may want to consider how easy it is to deposit funds in a particular financial institution. Many banks offer the benefit of mobile deposit, or the ability to add a check to your account by snapping a photo with your cell phone and uploading it. Check to see what’s available.

Also, if you are looking at online banks, suss out how you might deposit cash, if that’s something you frequently do, and make sure it’s a convenient process for you.

6. Digital Banking

Building on the topic of mobile deposits, it’s likely worth your while to check out a potential bank’s app and online services. Are they easy to navigate? Do they offer the features you’re most likely to use? Comparing a couple of financial institutions’ user experiences can reveal important nuances.

See if you can download a demo or find one on YouTube. Ratings and reviews can also be a great way to find out other customers’ experiences — the good, the bad and the ugly — as opposed to trusting a commercial to be honest with you.

Linking to an outside bank account can help you lower overdraft fees.

For instance: Can you activate push alerts for low balances, or can you link your account to another financial institution? (Life hack: Linking to an outside bank account can help you lower overdraft fees — you’ll still get charged if your bank has to pull from the external account, but it’s typically less than if you didn’t have any other account to pull from at all.)

7. Minimum Requirements

Explore whether your potential bank has a minimum deposit and minimum account balance requirement. If so, that means you must initially put in a certain amount of cash to open your account or to start it and earn a certain APY. Then, with minimum balance requirements, if you dip below a given level, you’ll likely pay a monthly account charge. For traditional banks, there is often a $100 or more minimum balance requirement.

With online banks, you may not have a minimum opening deposit or balance requirement; however, you may not earn the top APY unless you maintain a certain level of funds in the account. Read the details when considering a bank.

8. Availability of Funds

Few people like waiting for funds to clear. When evaluating prospective financial institutions, find out how quickly funds clear. Some banks may offer early paycheck access, for instance, for qualifying accounts.

9. Customer Service

Here’s another dimension to consider when choosing a bank: What kind of customer service do they offer and when? If you are the type of person who likes to interact in-person, you may prefer a traditional bank with branches.

But even if that isn’t a big plus for you, also consider the availability of support by phone and chat during non-business hours. What if you have a pressing financial problem at 9 AM on a Sunday? Would help be there for you?

10. Investment Account Options

If you’re looking for more than just checking and savings, consider a bank that also has investment account options. Having everything you need within the same financial system can make deposits, withdrawals, transfers, and automatic saving a breeze.

11. Perks

Some banks may offer perks that appeal to you, so see what’s out there. For instance, some financial institutions may offer a cash bonus when you open an account; others may have cash back options that suit your spending style. Still others may offer educational events to boost financial literacy; others have special passes that allow clients to visit local cultural institutions for free.

12. Your Banking History

One last factor to consider when choosing a bank: If you have some less than perfect aspects of your financial life, see if you will be penalized for that. For instance, some banks may scrutinize your banking history. If you have enough overdrafts in your history or other issues, they may not approve your account application. Or you might need to open what’s known as a second chance checking account until you prove that you’re a reliable client. It’s wise to consider this as you go bank shopping.

Banking with SoFi

If you’re in the market for a banking partner, come take a look at all that SoFi offers. We think you can bank smarter when you open an online bank account with us. Our Checking and Savings account lets you spend and save in one simple spot; you’ll earn a competitive APY, and you won’t pay any account fees. That means managing your money may be simpler and your cash can grow faster. What’s more, qualifying accounts with direct deposit may get paycheck access up to two days early.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 4.20% APY on SoFi Checking and Savings.

FAQ

What should I do if a bank does not have what I am looking for?

If a bank doesn’t have the features you are looking for, it’s wise to shop around. There are thousands of banks and credit unions in America, and one or more are likely to suit your needs.

What are some banking red flags?

Banking red flags will vary depending on what your needs are. For instance, is that enticing APY offered just a promotional rate that will drop considerably lower in a short period of time? Do you notice that your bank’s ATM network is getting smaller? Focus on the most important features you’re looking for and read the fine print to prevent disappointment and dissatisfaction.

What is the most important thing to look for in a bank?

Depending on your particular financial style and goals, the most important things when choosing a bank may be interest rates and fees; convenience; and additional features it may offer (such as budgeting tools, cash back, competitive mortgage rates, and the like).

SoFi members with direct deposit activity can earn 4.20% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.20% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

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

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

Interest rates are variable and subject to change at any time. These rates are current as of 10/31/2024. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

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

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.

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.

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Feb
27
2024
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What Is Disposable Income?

By | Budgeting & Goals, Terminology | No Comments

Here’s the definition of disposable income: It’s the amount of money you have available to spend or save after your income taxes have been deducted.

You may also hear this sum of money called disposable earnings or disposable personal income (or DPI). Another interesting fact: Disposable income is carefully watched by economists because it is a valuable indicator of the economy’s health.

What’s more, as you may realize, disposable income is the basis of your own personal budget. It’s an indicator of your financial status as well as the foundation for deciding how to spend and save your cash.

Key Points

•   Disposable income refers to the money available for spending or saving after income taxes have been deducted.

•   It is an important indicator of an individual’s financial status and is used to determine how to allocate funds.

•   Disposable income is different from discretionary income, which takes into account essential expenses.

•   Calculating disposable income involves subtracting taxes and other mandatory deductions from gross earnings.

•   Budgeting disposable income involves tracking spending, setting goals, and allocating funds for basic living expenses, discretionary spending, and saving/investing.

What Is Disposable Income?

Simply put, the disposable income definition is money you have left over from your earnings after taxes and any other mandatory charges are deducted.

This money (which may also be referred to as expendable income) can then be spent or saved as you see fit. You will likely use it for your basic living expenses, or the needs in your daily life, such as housing, utilities, food, transportation, healthcare, and minimum debt payments.

You may also spend that money on the wants in life, such as dining out, entertainment, travel, and non-vital purchases, such as a cool new watch or mountain bike.

Your disposable income can also be allocated towards your goals, such as saving for your child’s college education, the down payment on a house, and/or retirement.

💡 Quick Tip: Typically, checking accounts don’t earn interest. However, some accounts do, and online banks are more likely than brick-and-mortar banks to offer you the best rates.

Why Disposable Income Is Important

There are different types of income, and disposable income is usually defined as the amount of money you keep after federal, state, and local taxes and other mandatory deductions are subtracted from gross earnings. Consider these details:

•  Mandatory deductions include Social Security, state income tax, federal income tax, and state disability insurance.

•  Voluntary deductions, such as health benefit deductions, 401(k) contributions, deductions for other employer-sponsored benefits, as well as any assignments of support (such as child support) are excluded from the calculation. These costs are considered part of your disposable earnings.

•  Disposable income is an important number not just for consumers, but also the nation as a whole. The average disposable income of the country is used by analysts to measure consumer spending, payment ability, probable future savings, and the overall health of a nation’s economy.

•  International economists use national measures of disposable income to compare economies of different countries.

On an individual level, your disposable income is also a key economic indicator because this is the actual amount of money you have to spend or save.

For example, if your salary is $60,000, you don’t actually have $60,000 to spend over the course of the year. Federal, state, and possibly other local taxes will be deducted, as will Social Security and Medicare taxes.

What is left over is what you would have to spend on everything else in your life, such as housing, transportation, food, health insurance and other necessities.

Of course, that doesn’t mean you should spend all of your disposable income. Another thing to consider is disposable vs. discretionary income. This will tell you actually how much money you have to play with.

Recommended: What’s the Difference Between Income and Net Worth?

Disposable Income vs. Discretionary Income

Although they’re often confused with one another, disposable income is completely different from discretionary income.

While disposable income is your income minus only taxes, discretionary income takes into account the costs of both taxes and other essential expenses. Essential expenses include rent or mortgage payments, utilities, groceries, insurance, clothing, and more.

Discretionary income is what you can have leftover after the essentials are subtracted. This is what you can spend on nonessential or discretionary items.

Some costs that fall under the discretionary category are dining out, vacations, recreation, and luxury items, like jewelry. Although internet service and your cell phone may seem like necessities, these expenses are considered discretionary expenses.

Similarities

Both disposable and discretionary income are a way of looking at income after taxes.

However, discretionary income goes a step further and deducts essential expenses, such as housing and healthcare.

Differences

As you might expect, discretionary income is always less than disposable income. When you subtract discretionary income from disposable income, the amount that remains is how much you can put towards wants (fun spending) and savings.

Get up to $300 when you bank with SoFi.

No account or overdraft fees. No minimum balance.

Up to 4.20% APY on savings balances.

Up to 2-day-early paycheck.

Up to $2M of additional
FDIC insurance.


Calculating Disposable Income

Disposable income refers to the amount of earnings left over after mandatory federal, state and local deductions. But disposable income is not necessarily the same as your take-home pay.

Deductions from your paycheck may include additional items such as health insurance, retirement plan contributions, and health savings accounts. These deductions are voluntary, not mandatory.

To calculate your disposable earnings, you can simply subtract federal, state and local taxes, Medicare, and Social Security from your gross earnings. Be sure to include any passive income streams, such as rental income, or side hustle earnings (more on that in a moment), when doing the math for your gross income. The resulting amount is your disposable income.

How to calculate disposable income

Some of the finer points to note:

•  You may want to keep in mind, however, that taxes deducted from your paycheck are an estimate. If you have a history of getting a large refund or having a large amount of taxes due, it may be worth reviewing your withholdings through your employer.

This could help you adjust the withholdings so it is closer to the actual expected tax that will be calculated when you file. You can then plan accordingly.

•  Even if you’re a contractor or freelancer, or if you made additional income from side gigs along with your salary, you can still calculate your disposable income.

This requires subtracting your quarterly tax payments and any additional taxes you will owe from your overall income. You can then determine your monthly after-tax income.

Setting aside money to pay taxes can also help you budget with your disposable income.

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

Disposable Income Budgeting

Calculating your disposable income is a key first step in preparing a budget. You need to know how much you have to spend in order to plan your monthly spending and saving.

A personal budget puts you in control of your disposable income and helps you make financial decisions. It forces you to take a closer look at how you’re spending your money.

Here are a few ideas that could be helpful when developing a budget based on disposable income.

Tracking Spending

Disposable income is what’s coming into your account every month. It’s a good idea to also determine what is going out each month.

To do this, you can gather up bank and credit card statements, as well as receipts, from the past three months or so, and then list all of your monthly spending (both essential and discretionary/nonessential).

To make this list more accurate, you may want to actually track your spending for a month. You can do this with a phone app (your bank’s app may include this function), by carrying a small notebook and jotting down everything you buy, or by saving all of your receipts and logging it later.

This can be an eye-opening exercise. Many of us have no idea how much we’re spending on the little things, like morning coffees, and how much they can add up to at the end of the month.

Once you see your spending laid out in black and white, you may find some easy ways to cut back, such as getting rid of subscriptions and streaming services that you rarely use, brewing coffee at home, cooking more and getting less take-out, or getting rid of a pricy gym membership and working out at home.

Setting Goals And Spending Targets

Tracking income and spending can provide a great starting point for setting financial goals and spending targets.

•  Goals are things that a person aims for in the short- or long-term — like paying off student loans or buying a new car.

•  Spending targets are how much you want to spend each month in general categories in order to have money left over to put towards your savings goals.

Since essential spending often can’t be adjusted, spending targets are typically for discretionary income.

One option for budgeting disposable income is the 50/30/20 plan. This suggests spending about 50% on necessities, 30% on discretionary items, and then putting aside 20% for savings and other long-term goals.

Use the 50/30/20 budget calculator below to see how your budget would fall into those three categories.


These percentages are general guidelines, however, and can be adjusted as needed based on individual circumstances. For example, if you live in a competitive housing area, rent may take up a larger portion of your expenses, and you may have to bump up necessity spending to 60% and decrease fun money to 20% instead.

Or, if you are saving for something in the near term, like a car or a wedding, you may want to temporarily bump up the savings category, and pull back unnecessary spending for a few months.

3 Uses for Your Disposable Income

Once you have calculated your disposable income, you can consider the ways you might divide it up:

Basic Living Expenses

Some of your disposable income will go towards necessities, such as:

•  Housing

•  Utilities

•  Food

•  Healthcare

•  Transportation

•  Insurance

•  Minimum debt payments.

Discretionary Spending

Next, there are the wants in life. These are things that are not vital for survival but can certainly make things more enjoyable:

•  Eating out

•  Entertainment, such as streaming platforms, movies, concerts, and books

•  Clothing that isn’t essential (like winter boots)

•  Electronics, like the latest mobile phone

•  Travel

•  Gifts.

Saving and Investing

In addition to the spending outlined above, you will likely want to save money or invest it for your short-term and/or long-term goals. These may include:

•  Your emergency fund

•  The down payment for a house

•  A college fund for children

•  Money to start your own business

•  A new car

•  Retirement.

Recommended: Get a personalized estimate for your emergency fund by using our emergency fund calculator.

Opening a Savings Account With SoFi

Disposable income is a key concept in budgeting, as it refers to the income that’s left over after you pay taxes. Knowing how much disposable income you have is the foundation for putting together a simple budget that allows for necessary expenses, having fun, while also saving for the future. Finding the right banking partner is another important element of planning for tomorrow.

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 4.20% APY on SoFi Checking and Savings.

FAQ

What does disposable income mean?

Disposable income (or what may be known as disposable earnings) is the money you have left after taxes and other mandatory deductions are taken out of your income.

What is an example of disposable income?

An example of disposable income would be a $100,000 gross salary, minus $30,000 in taxes and $15,300 in Social Security and Medicare deductions. The remaining $54,700 is disposable income.

What is the difference between disposable income and discretionary income?

Disposable income refers to earnings minus taxes and mandatory deductions, such as Social Security and Medicare. Discretionary income is a subset of disposable income. It is the money left once you have paid for essentials, such as housing, utilities, food, and healthcare. The money that is left can be used for non-essential spending and for saving.


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

SoFi members with direct deposit activity can earn 4.20% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.20% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

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

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

Interest rates are variable and subject to change at any time. These rates are current as of 10/31/2024. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

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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Feb
27
2024
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APY vs Interest Rate

By | Budgeting & Goals, money, Terminology | Comments Off on APY vs Interest Rate

Interest rates and APY, or annual percentage yield, are likely words that you’ll hear throughout your financial life. If you are opening an interest-earning bank account, you’ll likely want to earn the highest return on your money that you can find. Conversely, if you are borrowing money (say, taking out a home loan), you’ll probably want to snag the lowest rate on your mortgage.

While you may see the terms interest and APY used interchangeably, they are not identical. APY expresses how much you will earn on your cash over the course of a year. Interest rate, however, is the interest percentage that you’ll earn or that a lender will change you.

Ready to learn more about APY vs. interest rate and how each impacts your finances

Key Points

•   APY (Annual Percentage Yield) and interest rate are two different concepts that are often used interchangeably but have distinct meanings.

•   APY represents the amount of money you will earn on your deposits over the course of a year, taking into account compound interest.

•   Interest rate, on the other hand, is the percentage at which your money will accrue interest, without considering compounding.

•   APY is higher than the interest rate because it includes the effect of compounding, which allows your money to grow faster.

•   Understanding the difference between APY and interest rate is important when opening a bank account or taking out a loan.

APY and Interest Rate Defined

If you deposit money into an interest-bearing account, you will earn an annual percentage yield (APY) on that money. The APY is a useful number because it tells you how much you’ll earn on your deposits over the course of a year, expressed as a percentage. The APY calculation takes into account the interest rate being offered, then factors in whether or not the financial institution offers compounded interest.

Compound interest is the interest you earn on the interest you’ve already earned. Depending on the bank or credit union, interest may compound daily, monthly, quarterly, or annually. The more frequently interest compounds, the faster your money grows.

💡 Quick Tip: An online bank account with SoFi can help your money earn more — up to 4.20% APY, with no minimum balance required.

What Is APY?

APY expresses how much money your cash will earn over the course of a year when it’s in an interest-bearing account.

APY is often confused with APR, which stands for annual percentage rate and comes into play when you take out a loan. A loan’s APR factors in the loan’s interest rate, as well as any additional fees and costs. It tells you how much you will pay for the loan over one year.

What Is an Interest Rate?

An interest rate is typically either the money you earn for keeping your cash at a financial institution or the cost that lenders charge you when they extend credit.

For example, if you put your money in a high-interest savings account, you might earn 4.50% for keeping your funds there. But if you take out a mortgage, you might be charged 7.00% interest for the privilege of borrowing that money to buy a house and paying it back over time.

Incidentally, the difference between the interest rates that banks pay depositors and charge borrowers is one of the ways these financial institutions earn money.

Earn up to 4.20% APY with a high-yield savings account from SoFi.

No account or monthly fees. No minimum balance.

9x the national average savings account rate.

Up to $2M of additional FDIC insurance.

Sort savings into Vaults, auto save with Roundups.


APY vs. Interest Rate Explained

So what is the difference between APY and interest rate? And why does interest rate vs. APY matter anyway? When you are opening a bank account, it can make a difference as one can give you a better picture of how your money will grow while on deposit.

The interest rate tells you the basic rate at which your money will accrue interest. The APY, however, gives you great insight to what you will have earned at the end of a year because it factors in the boost that compound interest can deliver.

Recommended: Different Ways to Earn Interest

The APY Formula

For those who want to delve in a bit deeper, the actual formula for APY calculation is as follows: (1 + r/n)ⁿ – 1.

•   The “r” stands for the interest rate being paid.

•   The “n” represents the number of compounding periods within a year.

If, for example, the interest rate is 3.50%, then that’s what you’d use for the “r.” If interest is compounded quarterly, then “n” would equal four.

Compounding frequency can cause two different savings accounts with the same interest rates to have different APYs. For example, if two different banks offer a certificate of deposit (CD) with the same interest rate and one of them compounds annually, that institution would have a lower APY than the institution that compounds quarterly or daily.

Fortunately, if you want to compare savings rates from one bank or credit union to another, you don’t need to perform these in-depth calculations.

Financial institutions are required to provide information on APY as part of the Truth in Savings Act. And, here’s the heart of it all: The higher the APY, then the more quickly the money you deposit can grow.

Recommended: Use the APY calculator below to see how much interest you can earn on your investments.


Calculating APR

The APR vs. interest rate of a loan tells you how much the loan will cost you over one year, including both the loan’s interest rate and fees, and is expressed as a percentage. A loan’s APR gives you a better sense of the true cost of the loan than the loan’s interest rate, since it includes fees. The higher the APR, the more you’ll pay over the life of the loan.

Thanks to the federal Truth in Lending Act, lenders must provide the APR of a loan. This allows you to compare loans apples to apples. A loan with a low interest rate but high fees may not be a good deal. In fact, you may be better off with a loan that charges a higher interest rate but no or lower fees. APR allows you to be a savvy consumer.

APR can be calculated with this formula: APR = ((Interest + Fees / Principal or Loan amount) / N or Number of days in loan term)) x 365 x 100. Lender’s will tell you the APR of a loan and you won’t need to perform any complicated calculations.

How Simple and Compound Interest Differ

Another dimension of interest rate vs. APY is seen when you consider how simple and compound interest differ. With simple interest, no compounding is involved. If you were to deposit $10,000 in an account earning 4.00% simple interest, at the end of three years, your money would earn $1,200 for a total of $11,200.

If, however, the interest were compounded daily, you would earn $408 the first year. The second year, interest would accrue on the principal and the interest ($10,408), and you would earn $425 the next year (for $10,833), and then $442 the year after that, for a total of $11,275.

While the dollar amount may not seem earth-shattering in this example of a few years, when you are talking about your decades-long financial life, it can really add up. Your money will grow faster with compound interest, helping you reach your financial goals.

Types of High-Interest Accounts for Savings

If you’re looking to earn a competitive rate on your savings, you’ll want to compare accounts by looking at APYs, as well as account fees and minimums. Generally, you can find competitive rates by looking at high-yield savings accounts, money market accounts, and CDs.

•   High-yield savings accounts, typically offered by credit unions and online banks, are accounts that typically pay a substantially higher APY than the national average of traditional savings accounts. They generally also have low or no fees.

•   Money market accounts are savings accounts that offer some of the features of a checking account, such as checks or a debit card. They often come with a higher APY than a traditional savings account, but typically require a higher balance, such as $1,000 or more, to avoid monthly fees.

•   Certificates of deposits (CDs) also tend to pay a higher APY than a regular savings account but require you to leave your money untouched for a certain period of time, called a term. If you take money out before then, you’ll likely pay an early withdrawal penalty. CD terms typically range from three months to five years. Generally, the longer the term, the higher the APY.

Recommended: How Does a High-Yield Savings Account Work?

High-Interest Checking Accounts

Checking accounts work well for everyday spending but typically offer no interest or very little. A high-yield checking account is a special type of account offered by some financial institutions (such as traditional and online banks, and credit unions) that offers a higher-than-average APY. These are accounts designed to give you the flexibility of a traditional checking account (with checks and/or a debit card) but with higher-interest returns.

A few points to note:

•   Often, to qualify for the highest rate the checking account has to offer, you need to meet certain criteria. This might be making a certain number of debit card transactions in a month, having at least one direct deposit or automated clearing house (ACH) payment each month, or choosing to receive paperless statements.

•   Some high-interest checking accounts will offer different APY tiers, with higher account balances earning a higher APY than lower account balances.

Creating a SoFi Savings Account

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 4.20% APY on SoFi Checking and Savings.

FAQ

Why is APY higher than the interest rate?

There is a difference between APY and interest rate: The APY is higher than the interest rate because it reflects the effect of compounding, in which your money earns interest on its interest.

What does it mean to earn 5.00% APY?

If an account says it earns 5.00% APY, that means at the end of the year, your money on deposit will earn 5.00% (say, $500 on $10,000 on deposit). The interest rate may be lower, because the APY reflects the impact of compounding interest.

Why do banks use APY instead of APR?

When a bank tells you its APY, or annual percentage yield, it’s sharing how much your money can grow when on deposit for a year. On the other hand, APR stands for annual percentage rate, which is the amount charged if you borrow money. If you are interested in taking out a loan from the bank, you would be told the APR.

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

SoFi members with direct deposit activity can earn 4.20% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.20% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

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

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

Interest rates are variable and subject to change at any time. These rates are current as of 10/31/2024. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

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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