Jan
30
2024
Can You Have Multiple IRAs?

Can You Have Multiple IRAs?

By | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off on Can You Have Multiple IRAs?

In theory, there’s no limit to how many individual retirement accounts (IRAs) one person can have. A retirement saver could potentially maintain more than one traditional IRA, Roth IRA, rollover IRA, or simplified employee pension (SEP) IRA in order to gain certain tax advantages now, and potentially down the road.

That said, the rules governing these different IRA accounts vary considerably, and combining many IRAs — without running afoul of contribution limits or creating tax issues — can be difficult.

How Many Roth and Traditional IRAs Can You Have?

As mentioned above, you may open any number of individual retirement accounts (IRAs). The Internal Revenue Service (IRS) does not limit the number of IRAs you can have and will not penalize you for having multiple IRAs in your name, as long as you follow the rules and contribution limits for each account.

One or more IRAs could work in tandem with a 401(k) workplace retirement plan. For instance, you might put part of each paycheck into a 401(k) plan at work while also maxing out your traditional IRA contributions every year. There might be restrictions, though, about the amount you can deduct.

An individual’s annual contribution limit — for traditional and Roth IRAs combined — is $7,000 for the 2024 tax year and $6,500 for the 2023 tax year. The limit is $7,500 for savers age 50 or older.

Recommended: What is an IRA?

Types of IRA

The two main account types are the traditional IRA and the Roth IRA. Again, your traditional IRA withdrawals are taxed at your ordinary income tax rate in retirement while Roth IRA money can be withdrawn tax-free.

With a traditional IRA, contributions can provide tax deductions when the money is deposited. Qualified distributions are taxed as ordinary income in retirement. Funds distributed before the account holder reaches age 59 ½ are usually subject to an added 10% tax.

Roth IRA contributions do not qualify for a deduction when deposited. However, when the account holder reaches age 59 ½, the money may be withdrawn tax-free. As with traditional IRAs, you can have multiple Roth IRAs.

There is a third type of IRA, the SEP IRA. These IRAs have higher contribution limits: up to $69,000 for tax year 2024 and $66,000 for tax year 2023, or 25% of compensation, whichever is less. But because these are employer-funded plans, they follow a different set of rules.

If you are self-employed and contributing to a SEP IRA on your own behalf, or if you work for a company with a SEP plan, you may or may not have the option of making traditional IRA contributions — but you could likely contribute to a Roth in addition to the SEP.

You may want to consult with a professional so you don’t over-contribute — or contribute less than you could have — or miss out on any of the potential tax benefits.

Advantages and Disadvantages of Multiple IRAs

Whether it makes sense for you to have multiple IRAs can depend on many factors, including your investment goals, financial situation, marital status, and career plans.

Advantages

Here are some of the chief advantages of maintaining more than one IRA:

•   Tax management. Traditional IRAs and Roth IRAs are taxed differently, as mentioned above. Also, traditional IRAs are subject to required minimum distributions (RMDs), which can increase your taxable income in retirement, while Roth IRAs are not. Having money in both types of IRA could make your retirement investing more tax-efficient.

•   Diversification. Diversification can help manage investment risk. Holding money in multiple IRAs, each with a different investment strategy, could help you create a diversified portfolio.

   Diversification may also benefit you from a tax perspective if you keep less tax-efficient investments in a traditional IRA and more tax-efficient ones in a Roth IRA.

•   Access. Traditional IRAs do not permit early withdrawals before age 59 ½ without triggering a tax penalty. You can, however, withdraw your original contributions from a Roth IRA at any time without owing income tax or penalties on those distributions. Having one IRA of each type could make it less expensive for you to withdraw money early if needed. This is possible whether investing online or not.

•   Avoiding RMDs. Traditional IRAs are subject to RMD rules, which dictate that you must begin taking minimum IRA distributions at age 72. If you don’t, the IRS can levy a steep tax penalty. Roth IRAs aren’t subject to RMD rules, so they could help you hang on to more assets as you age.

Disadvantages

Opening and funding multiple IRAs isn’t always an optimal strategy. Here are some disadvantages that may make you reconsider having several IRAs:

•   Contribution limits. The IRS caps the amount you can contribute in a given year. For 2024, your total contributions to all your IRAs cannot exceed $7,000 (or $8,000 if you’re 50 or older). For 2023, your total contributions to all your IRAs cannot exceed $6,500 (or $7,500 if you’re 50 or older). So having multiple IRAs doesn’t give you an edge in saving up for retirement.

•   Overweighting. When a significant share of your asset allocation is dedicated to a single stock, security, or sector, your portfolio is overweight. This overexposure can heighten your risk profile, such that a downturn in that investment could drag down your entire portfolio. Having multiple IRAs may put you at risk of being overweight if you’re not careful about reviewing the holdings in each account.

•   Fees. Brokerages often charge various fees to maintain IRAs. Plus, within each IRA, you may have to pay additional fees for specific investments. For example, a mutual fund has an annual ownership cost signified by its expense ratio. If you’re not paying attention to each IRA’s fees, it’s possible that you could overpay and shrink your investment returns.

•   Organization. Having multiple IRAs could present an organizational burden in the form of additional paperwork or, if you manage your IRAs online, logging in to multiple brokerages or robo-advisor platforms. You may also worry about increased risk for cybercrime.

Reasons You Might Want More Than One IRA

Evaluating your investment goals can help you decide if having more than one IRA makes sense for you. But you may need extra accounts if you’re:

•   Rolling over a 401(k). When separating from your employer, you could leave your 401(k) money where it is or roll it into a traditional IRA instead. If you open a rollover IRA and already have a Roth account too, you may end up with multiple IRAs.

•   Planning a backdoor Roth. Roth IRAs offer tax-free distributions but there’s a catch: To fund one, you have to meet eligibility requirements pertaining to your income and filing status. People who are over the income limit sometimes work around it by setting up a traditional IRA and later transferring some of that money to a Roth IRA. Taxes are levied on the transferred amount. This arrangement is known as a Roth conversion or backdoor Roth.

•   Married and the sole income-earner. The IRS allows married couples who file a joint tax return to each contribute to IRAs, even when one spouse does not have taxable compensation. So if you’re the breadwinner in your relationship, you could set up an IRA for yourself and open a spousal IRA to make contributions on behalf of your spouse.

•   Self-employed or plan to be. People who are self-employed can use traditional, Roth, or SEP IRAs to save for retirement. You might end up with multiple IRAs if you were an employee who had a traditional or Roth IRA, then later went out on your own as an entrepreneur. You could then open a SEP IRA, which allows for tax-deductible contributions and a higher annual contribution limit ($69,000 in 2024, and $66,000 in 2023).

Reasons You Might Want Your IRAs With Different Companies

Whether you’re planning to open your first IRA or your fifth, it’s important to choose the right place to keep your retirement savings. You can open an IRA with a traditional broker, an online brokerage, or sometimes at your bank or credit union.

So why would you want to have your IRAs in different places? Two big reasons for that center on investment options and insurance.

Setting up IRAs at different brokerages could offer you greater exposure to a wider variety of investments. Every brokerage has its own policies on IRA assets. One brokerage might lean almost exclusively toward investing in exchange-traded funds (ETFs) or index funds, for example, while another might allow you to purchase individual stocks or bonds through your IRA.

You can also benefit from increased insurance coverage. The Securities Investor Protection Corporation (SIPC) insures Roth IRAs and other eligible investment accounts up to $500,000 per person. Under those rules, you could have a traditional IRA at one brokerage and a Roth IRA at another and they’d both be covered up to $500,000.

Note: SIPC coverage only protects you against the possibility of your brokerage failing, not against any financial losses associated with changes in the value of your investments.

How to Transfer an IRA to Another Investment Company

It’s fairly straightforward to move an IRA from one brokerage to another. First you need to set up an IRA at the new brokerage. Then you’d contact your current brokerage to initiate the transfer of some or all of your IRA funds.

You can request a trustee-to-trustee transfer, which allows your current IRA company to move the money to the new IRA on your behalf. No taxes are withheld on the transfer amount and you also avoid the risk of triggering a tax penalty.

The IRS also allows 60-day rollovers, in which you get a distribution from your existing IRA then redeposit it into your new retirement account. Taxes are withheld, so you’ll have to make that amount up when you deposit the money to your new IRA. If you fail to complete the rollover within 60 days, the IRS treats the deal as a taxable distribution.

The Takeaway

Investing in multiple IRAs is perfectly legal and, in theory, you can have an unlimited number of them. The IRS’s annual limits on contributions apply across all your accounts, however. Traditional and Roth IRAs have different tax rules and can sometimes be useful to offset each other. SEP IRAs offer the potential to save more, thanks to their higher contribution limits. Wage earners can often contribute to separate accounts for their non-working spouses, potentially doubling the amount of allowable contributions.

If you have yet to set up an IRA, getting started is easier than you might think. With SoFi Invest, you can open a traditional or Roth IRA. And you may want to consider doing a rollover IRA, where you roll over old 401(k) funds so that you can better manage all your retirement money.

SoFi makes the rollover process seamless and simple, so you don’t have to worry about transferring funds yourself, or potentially incurring a penalty. There are no rollover fees, and you can complete your 401(k) rollover without a lot of time or hassle.

Help grow your nest egg with a SoFi IRA.

FAQ

Does it make sense to have multiple IRAs?

Having more than one IRA could make sense for some people, depending on their investment strategies. When maintaining multiple IRAs, the most important thing to keep in mind are the limits on annual contributions. It’s also helpful to weigh the investment options offered and the fees you might pay to own multiple IRAs.

Can I have both a traditional and a Roth IRA?

Yes, you can have both a traditional IRA and a Roth IRA. However, your total contribution to all your IRAs cannot exceed the annual limits allowed by the IRS.

How many Roth IRAs can I have?

A person can have any number of Roth IRAs. The IRS does, however, set guidelines on who can contribute to a Roth IRA and the maximum amount you can contribute each year.

Photo credit: iStock/Prostock-Studio

SoFi Invest®

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

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


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

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Jan
30
2024
child with magnifying glass

Custodial Roth IRA: How to Open a Roth IRA For Kids

By | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off on Custodial Roth IRA: How to Open a Roth IRA For Kids

A Roth IRA can be a retirement savings tool for children as well as adults. Funded with after-tax dollars, a Roth IRA grows tax-free, so account holders won’t need to pay taxes when they withdraw money in retirement as long as the account has been open for at least five years. Plus, the money in a Roth IRA will have many decades to grow if you open it when your child is young.

And while a Roth IRA has an early distribution penalty, that penalty is generally waived for certain expenses, such as paying for qualified college expenses, if your child needs to access those funds. That flexibility can make a Roth IRA appealing.

Can you open a Roth IRA for a child? Yes! A Roth IRA for kids, called a Custodial Roth IRA, can be opened by a parent, grandparent, or other adult for a child of any age, as long as the child earns income (more on that later).

Here’s everything you need to know about a Roth IRA for kids.

🛈 Currently, SoFi does not offer custodial banking or investment products.

What Is a Roth IRA for Kids?

A Roth IRA for kids, also known as a custodial Roth IRA, is an IRA opened by an adult (usually a parent), who manages the account until the child gets full control of it, which is at age 18 or 21 in most states.

A custodial Roth IRA for kids generally operates in the same way a Roth IRA for adults does. The account holder contributes after-tax dollars toward their retirement savings and the money grows tax-free in the account.

In order to open and contribute to a Roth IRA, your child must have earned income.

Who’s Eligible for a Roth IRA for Kids?

A child of any age can have a Roth IRA for kids. However, to be eligible, a child must have an earned income. Earned income can include the compensation earned from jobs like babysitting, dog walking, or working for an employer.

Custodial Roth IRA Rules

In addition to the standard rules for a Roth IRA, there are specific rules for custodial Roth IRAs. These rules include:

No Minimum Age Limit

A child of any age can have a custodial Roth IRA as long as he or she has earned income.

A Child Must Have Earned Income

In order to open a custodial Roth IRA, a child must have earned income. The IRS generally defines earned income as taxable income, wages, and tips. This can also include self-employment, such as yard work or babysitting. Cash gifts given to a child do not count as earned income.

There Are Contribution Limits

The contribution limit for a Roth IRA is $7,000 for 2024 ($8,000 for those 50 and older), or the total of the individual’s earned income for the year, whichever is less.

In addition, a child (or an adult on behalf of a child) cannot contribute an amount greater than the child’s earned income. So if a child earned $2,000 as a lifeguard at the local swimming pool, for example, the most that can be contributed to the child’s custodial IRA that year, including contributions from parents, is $2,000.

Certain Early Withdrawals Are Allowed

In general, you can withdraw contributions from a Roth IRA at any time without penalty. Earnings typically can’t be withdrawn before age 59 ½ without penalty except in certain circumstances. Allowable exceptions include withdrawals up to certain limits to pay for qualified college expenses, cover certain medical bills, and to buy a first home.

Eventual Conversion to a Regular Roth IRA

When the child reaches the legal age in their state (typically 18 or 21, depending on the state), the custodial Roth IRA will need to be converted to a regular Roth IRA in the child’s name.

How to Open a Custodial Roth IRA for a Kid

A Roth IRA for kids can be opened by any adult, such as a parent or grandparent, for instance. While the child is a minor, the adult will have sole access to the account; once the child comes of age (the timing of which varies by state), the account will transfer over to the child.

As with any Roth IRA, investment options within the account can include stocks, bonds, and mutual funds.

A Roth IRA can be opened through a financial institution or brokerage firm. You can typically open the account online by providing some basic information about yourself and your child. Choosing the right institution and Roth IRA offering depends on the investor and their preferences, so be sure to do some research.

Benefits of Starting a Roth IRA for a Child

Flexibility in how to use the funds can be one benefit of opening a custodial Roth IRA as part of an investment plan for your child. A Roth IRA can provide flexibility not only for potential expenses in early adulthood — such as college expenses or buying a home — but can be an investment vehicle throughout your child’s lifetime.

Another benefit is that a Roth IRA typically gives you more control over investments than an education-focused 529 college savings plan, and it may allow you to create a diversified portfolio of different asset classes.

A Roth IRA is a gift that can keep growing, since investors can potentially maximize compounding returns to get the most out of their investment. Here’s how a Roth IRA may unlock the power of compounding: As an example, let’s say you open a custodial Roth IRA when the child is 10 years old, and contribute $2,000 annually. At a certain point, your child might take over contributing $2,000 annually.

Assuming a 7% rate of return, the account will be worth $928,000 by the time your child is 60 years old — even though the amount you and your child contributed would be $100,000 in total. In comparison, if that same money was put in a taxable savings account over the same time period, the total of the account would be approximately $515,764.

And unlike a traditional IRA, there is no required minimum distribution (RMD) on a Roth IRA once the account owner reaches retirement age. A Roth IRA also allows people to continue contributing throughout their lifetime, as long as they’re earning income.

Alternatives to a Roth IRA for a Kid

If you’re looking for other possible investments for your child, some options to consider include the following.

•   Savings account: A parent can open a savings account for a child, as long as the parent is a joint account holder. Savings accounts typically have low interest rates (as of January 2024, the average interest rate for a savings account was 0.47%), so you might want to look for a high-yield savings account instead. These accounts have average interest rates of more than 4% as of early 2024.

•   Savings bonds: If your child doesn’t have earned income, you may want to consider savings bonds. However, savings bonds don’t offer the same potential tax advantages a Roth IRA does since you have to pay federal income tax on the bonds when they mature or you cash them. You won’t pay income taxes on Roth IRA earnings unless you take a non-qualified distribution.

•   529 plans: These plans can help you save for your child’s education. You can typically invest the money you contribute to a 529 plan and choose from a wide range of investment options. While these plans aren’t tax deductible at the federal level, your state may offer tax breaks for contributions made to them. And funds can be withdrawn tax-free for qualified education expenses. As of 2024, money left in a 529 may be rolled over to a Roth IRA for your child, although certain conditions and limits may apply.

•   UGMA/UTMA accounts: A Uniform Gifts to Minors Act (UGMA) account and a Uniform Transfers to Minors Act (UTMA) account are custodial accounts in which an adult can invest on behalf of a child. These accounts are typically used to invest in stocks, bonds, mutual funds, and so on. There are no contribution or income limits, and gifts below the annual gift threshold do not need to be reported. However, there are no tax benefits when contributions are made, and earnings are made to these accounts, and earnings are subject to taxes. When the child reaches legal age, they take over control of the account.

The Takeaway

For a child with earned income, a custodial Roth IRA may be a good way to help them prepare for their future and get started on the path to investing. A child does need to have an earned income to open a custodial Roth IRA, and contributions cannot exceed their income. If your child qualifies, a Roth IRA for kids could potentially give them years of tax-free growth on their money.

FAQ

Can you open a Roth IRA for a child if they don’t earn income?

No. A child must have earned income — which the IRS defines as wages, salaries, tips and other taxable employee compensation, as well as net earnings from self-employment — in order to open a custodial Roth IRA.

Can you open a Roth IRA for a baby?

It’s possible to open an IRA for a baby. As long as a baby earns an income — modeling baby clothes, for instance — you can open a custodial Roth IRA for them. There is no minimum age to open a custodial Roth IRA, but the child must have earned income.

Is it a good idea to open a Roth IRA for a child?

It may be a good idea to open a Roth IRA for a child for several reasons. A Roth IRA can help a child save up for and cover certain expenses in early adulthood, such as qualified college expenses. Also, a Roth IRA typically has higher returns than a savings account. And because kids have a low tax rate now, when contributions are made, it makes sense to open a Roth IRA, which is taxed upfront. At retirement, as long as they are at least age 59 ½, they can withdraw the money tax-free.

Can I give my child money for a Roth IRA?

Yes, you can contribute to your child’s IRA. However, annual contributions to the account cannot exceed the child’s annual earned income. Also, per IRS rules, the overall amount you can contribute to a Roth IRA is to $7,000 in 2024 for individuals under age 50, or the total annual earned income, whichever is less.

What is the disadvantage of a Roth IRA for kids?

One potential disadvantage of an IRA for kids is that your child must earn an income in order to open and contribute to an account. In addition, you can only contribute the amount the child earns. So if the child makes $500 for the year babysitting, that is the most you can contribute to their custodial Roth IRA.

Can I open a Roth IRA for my 2 year old?

As long as your 2-year-old earns an income, you can open a custodial Roth IRA for them. There is no minimum age requirement for a Roth IRA for kids.

How do I prove my child’s income for a Roth IRA?

If your child receives a W-2 or 1099 form for work they did for an employer, you can use those documents to prove your child’s income. However, if they are self-employed and do work like babysitting, dog walking or yard work to earn money, you should keep receipts or records of the type of work they did, the amount they earned, when the work was done, and who it was for, as proof of their income.

What happens to a custodial Roth IRA when the child turns 18?

Once a child is of legal age, which is typically 18 or 21, depending on your state, the IRA must be converted to a regular Roth IRA in the child’s name that they then own and manage.

Do children need to file a tax return to fund their Roth IRA?

As long as their income is below the threshold that requires them to file a tax return, children are typically not required to file a tax return just because they have a custodial IRA. However, you may want to consult with a tax professional about your specific situation.

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.

SoFi Invest®

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

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

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2024
401a vs 401k: What's the Difference?

401(a) vs 401(k) Compared

By | Budgeting & Goals, Growing Wealth, invest, Preparing for Retirement, Terminology | No Comments

A 401(k) plan and a 401(a) plan may sound confusingly similar, but there are some differences between the two retirement accounts.

The biggest differences between 401(k) vs 401(a) plans are in the types of companies that offer them and their contribution requirements. While most private sector companies are eligible to offer 401(k) plans, only certain government and public organizations can offer their employees a 401(a) plan. Employers must contribute to 401(a) plans and can make it mandatory for employees to contribute a pre-set amount as well. By contrast, employers do not have to contribute to 401(k) plans and employees are free to choose whether they want to contribute.

Key Points

•   A 401(a) plan is an employer-sponsored retirement account typically available to government workers and employees at educational institutions and nonprofits. Employer contributions are mandatory, while employee contributions may be voluntary.

•   A 401(k) plan is offered by for-profit employers as part of the employee’s compensation package. Employers are permitted but not required to contribute to a 401(k) plan.

•   For 2023, the total contribution limit — from both employer and employee — is $66,000 for 401(a) and 401(k) plans, with an additional $7,500 catchup contribution allowed for employees age 50 or older.

•   Employee contributions to 401(a) or 401(k) plans in 2023 can amount to $22,500, or for people 50 or older the cap is $30,000. However, employee contributions cannot exceed their salary.

•   You can borrow from either a 401(a) or a 401(k) plan with restrictions. Withdrawals before age 59 1⁄2 may incur penalties. Employees can begin to withdraw money without penalty when they turn 59 1⁄2.

What Is a 401(a) Plan?

A 401(a) plan is an employer-sponsored type of retirement account that typically covers government workers and employees from specific education institutions and nonprofits. It is different from an IRA in that the employer sponsors the plan, determines the investment options that the employees can choose from, and sets the vesting schedule (the amount of time an employee will have had to have worked with the organization before all employer contributions become fully theirs, even if they leave the company).

With IRAs, the individual investor decides how much to contribute and if/when they want to make withdrawals from the account. With a 401(a) plan, employer contributions are mandatory; employee contributions are not. All contributions made to the plan accrue on a tax-deferred basis.

Recommended: IRAs vs 401(k) plans

However, withdrawing from either type of plan may incur penalties for withdrawing money before age 59 ½.

What Is a 401(k) Plan?

A 401(k) plan is a benefit offered by for-profit employers as part of the employee’s compensation package. The employer establishes the plan, along with the investment options the employee can choose from and the vesting schedule. As with 401(a) plans, funds contributed are tax-deferred and help employees save for retirement.

Some employers choose to offer a match program in which the company matches employee contributions up to a specific limit.

401(k) plans are also accessible to entrepreneurs and self-employed business owners.

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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.

Who Contributes to Each Plan?

Under a 401(a) plan, employer contributions are mandatory, though the employer can decide whether they’ll contribute a percentage of the employees’ income or a specific dollar amount. Employers can establish multiple 401(a) accounts for their employees with different eligibility requirements, vesting schedules, and contribution amounts.

Employee participation is voluntary, with contributions capped at 25% of their pre-tax income.

Under a 401(k) plan, employees can voluntarily choose to contribute a percentage of their pre-tax salary. Employees are not required to participate in a 401(k) plan.

Employers are permitted but not required to contribute to a 401(k) plan, and many will match up to a certain amount — say, 3% — of employees’s salaries.

401(a) vs 401(k) Contribution Limits

For 2023, the total 401(a) contribution limit — from both employer and employee — is $66,000. However, employees with 401(a) plans can also contribute to a 403(b) plan and a 457 plan simultaneously (more on those plans in the 401(a) vs Other Retirement Plan Options section).

Employee contributions for 401(k) plans have a $23,000 limit in 2024 and a $22,500 limit in 2023. Employees who are 50 or older may contribute up to an additional $7,500 for a total of $30,500 in 2024 and a total of $30,000 in 2023. An employee with a 401(k) plan can also have a Roth or traditional IRA. However, there are limits on how much they can contribute to an IRA account — $7,000 for a traditional IRA for 2024 and $6,500 for a traditional IRA for 2023, with an extra $1,000 for people over age 50.

401(a) vs 401(k) Investment Options

401(a) vs 401(k) plans often offer various investment options, which may include more conservative investments such as stable value funds to more aggressive investments such as stock funds. Some 401(a) plans may allow employees to simplify diversified portfolios or seek investment advice through the plan’s advisor.

Most 401(k) plans also offer various investment choices ranging from low-risk investments like annuities and municipal bonds to equity funds that invest in stocks and reap higher returns.


💡 Quick Tip: All investments come with some degree of risk — and some are riskier than others. Before investing online, decide on your investment goals and how much risk you want to take.

401(a) vs 401(k) Tax Rules

The tax rules in a 401(a) plan may be one difference between a 401(k) and 401(a).

With a 401(a), employees make pre-tax or after-tax contributions, depending on how their employer decides to structure the plan. Pre-tax means contributions are not taxed at the time of investment, but later upon withdrawal. After-tax means contributions are taxed before being deposited into the account

A 401(k), on the other hand, is a tax-deferred retirement plan, meaning all contributions are pre-tax. The wages employees choose to contribute to their plan are untaxed upon initial investment. Income taxes only kick in when the employee decides to withdraw funds from their account.

Can You Borrow from Each Plan?

You can borrow from either a 401(a) or a 401(k) plan if you have an immediate financial need, but there are some restrictions and it is possible to incur early withdrawal penalties.

An employer can limit the amount borrowed from a 401(a) plan — and may choose not to allow employees to borrow funds. If the employer does allow loans, the maximum amount an employee can borrow is the lesser of:

•   $10,000 or half of the vested account balance, whichever is greater OR

•   $50,000

Because the employee is borrowing money from their account, when the employee pays back the loan’s interest, they are paying it to themselves. However, the IRS requires employees to pay back the entire loan within five years . If they don’t pay the loan back, the IRS will consider the loan balance to be a withdrawal and will require taxation on the remaining loan amount as well as a 10% penalty if the employee is under age 59 ½.

Borrowing from a 401(k) plan is similar. Employees are limited to borrowing $50,000 or half of the vested balance — whichever is less. One big difference between borrowing from a 401(a) vs. a 401(k) plan is employees lose out on a tax break if they borrow from their 401(k) because they are repaying it with after-tax dollars. Because the money is taxed again when withdrawn during retirement, an investor is essentially being taxed twice on that money.

Can You Borrow Money from a 401(a) or 401(k) to Buy a Home?

You may be able to use the funds from a 401(a) or 401(k) account to purchase a home. Remember, with 401(a) plans, the employer ultimately decides if loans are permitted from the 401(k).

If you borrow money from your 401(a) or 401(k) to fund the purchase of a home, you have at least five years to repay what you’ve taken out.

The maximum amount you’re allowed to borrow follows the rules stated above:

•   $50,000 OR

•   The greater between $10,000 or half of what’s vested in your account,

Whichever is less.

When Can You Withdraw From Your Retirement Plan?

Employees can begin to withdraw money from their 401(a) plan without penalty when they turn 59 ½. If they make any withdrawals before 59 ½, they will need to pay a 10% early withdrawal penalty. Once they reach 70 ½, they’re required to make withdrawals if they haven’t already started to.

With a 401(k) plan, if an employee retires at age 55, they can start withdrawing money without penalty. However, to take advantage of this early-access provision, they need to have kept the money in the 401(k) plan and not have rolled it into a Roth IRA.

Employees also need to have ended their employment no earlier than the year in which they turn 55.

Otherwise, the restrictions are the same as with a 401(a) plan, and they can begin to withdraw money penalty-free once they turn 59 ½.

401(a) vs 401(k) Rollover Rules

Generally, 401(a) and 401(k) accounts have similar rollover rules. When an employee chooses to leave their job, they have the option to roll over funds. The employee can choose to roll the account into another retirement plan or take a lump-sum distribution. Generally, if the employee decides to roll over their plan to another plan, they have to do so within 60 days of moving the funds.

The rules for a 401(a) rollover dictate that funds can be transferred to another qualified plan like a 401(k) or an individual retirement account (IRA). The rules for 401(k)s are the same.

If the employee decides to take a lump-sum distribution from the account, they will have to pay income taxes on the full amount. If they are under 59 ½, they will also have to pay the 10% penalty.

Recommended: How To Roll Over a 401(k)

What Happens to Your 401(a) or 401(k) If You Quit Your Job?

If you quit your job, you can leave the money in your former employer’s plan, roll it into the plan of your new employer, transfer it to a Rollover IRA, or cash it out. If you are under age 59 ½ and cash out the plan, you will likely need to pay taxes and a 10% penalty.

However, if you quit your job before you are fully invested in the plan, you will not get your employer’s contributions. You will only get what you contributed to the plan.

What Is a 401(a) Profit Sharing Plan?

A 401(a) profit sharing plan is a tax-advantaged account used to save for retirement. Employees and employers contribute to the account based on a set formula determined by the employer. Unlike 401(a) plans, the employer’s contributions are discretionary, and they may not contribute to the plan every year.

All contributions from employees are fully vested. The ownership of the employer contributions may vary depending on the vesting schedule they create.

Like 401(a) plans, 401(a) profit sharing plans allow employees to select their investments and roll over the account to a new plan if the employee leaves the company. If an employee wants to take a distribution before reaching age 59 ½, they are subject to income taxation and a 10% penalty.

Summarizing the Differences Between 401(k) and 401(a) Plans

The main differences between a 401(k) and 401(a) are:

•   401(a) plans are typically offered by the government and nonprofit organizations, while 401(k) plans are offered by private employers.

•   Employees don’t have to participate in a 401(K), but they often must participate in a 401(a).

•   An employer decides how much employees contribute to a 401(a), while 401(k) participants can contribute what they like.

•   With a 401(a), employees make pre-tax or after-tax contributions, depending on how their employer decides to structure the plan. With a 401(k), all contributions are pre-tax.

Summarizing the Similarities Between 401(a) vs 401(k) Plans

A 401(k) vs. a 401(a) has similarities as well. These include:

•   Both types of plans are employer-sponsored retirement accounts.

•   Employees can borrow money from each plan, though certain restrictions apply.

•   There may be a 10% penalty for withdrawing funds before age 59 ½ for both plans.

401(a) vs Other Retirement Plan Options

401(a) vs 403b

A 403b is a tax-advantaged retirement plan offered by specific schools and nonprofits. Like 401(a) and 401(k) plans, employees can contribute with pre-tax dollars. Employers can choose to match contributions up to a certain amount. Unlike the 401(a) plan, employers don’t have mandatory contributions.

For 2024, the employee contributions limit is $23,000. For 2023, the employee contributions limit is $22,500. If the plan allows, 50 or older employees may contribute a catch-up amount of $6,500.

Generally, 403b plans are either invested in annuities through an insurance company, a custodian account invested in mutual funds, or a retirement income account for church employees.

Additionally, 403b plans allow for rollovers and distributions without a 10% penalty after age 59 ½. Like similar plans, employees may have to pay a 10% penalty if they take a distribution before reaching age 59 ½ unless the distribution meets other qualifying criteria.

401(a) vs 457

457 plans are retirement plans offered by certain employers such as public education institutions, colleges, universities, and some nonprofit organizations. 457 plans share similar features with 401(a) plans, including pre-tax contributions, tax-deferred investment growth, and a choice of investments that employees can select.

Employees can also roll over funds to a new plan or take a lump-sum distribution if they leave their job. However, unlike a 401(a) or 401(k) plan, the withdrawal is not subject to a 10% IRS penalty.

Another option offered through 457 plans is for employees to contribute to their account on either a pre-tax or post-tax basis.

401(a) vs Pension

A 401(a) is a defined contribution plan, where a pension is a defined benefit plan. With a pension, employees receive the benefit of a fixed monthly income in retirement; their employer pays them a fixed amount each month for the rest of their life. The monthly payment can be based on factors like salary and years of employment.

With a 401(a), employees have access to what they and their employer contributed to their 401(a) account. In contrast to a pension plan, retirees aren’t guaranteed a fixed amount and their contributions may not last through the end of their life.

Pros and Cons of 401(k) vs 401(a) Plans

Both 401(k) and 401(a) plans have pros and cons.

Pros of a 401(k):

•   Employers may match a portion of the employee’s contributions.

•   The plan is fairly easy to set up.

•   Employees generally have a wide range of investment options.

Pros of a 401(a):

•   Lower fees

•   Contributions are tax-deferred.

•   Both the employer and employee make monthly contributions.

Cons of a 401(k):

•   Fees may be high.

•   Need to wait until fully vested to keep employer matching contributions.

•   Penalty for withdrawing funds early.

Cons of a 401(a):

•   Investment choices may be limited.

•   Participation may be mandatory.

•   Penalty for withdrawing funds early.

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

Other Retirement Account Options

Roth IRAs

Roth IRAs are funded with after-tax contributions, which means they aren’t tax deductible. However, the withdrawals you take in retirement are tax-free.

You can withdraw the amount you contributed to an IRA at any time, without penalty.

The Roth IRA contribution limit for 2024 is $7,000 ($8,000 if you’re 50 or older) and for 2023 is $6,500 ($7,500 if you’re 50 or older).

Traditional IRAs

A traditional IRA is similar to a 401(k): both plans offer tax-deferred contributions that may lower your taxable income. However, in retirement, you will owe taxes on the money you withdraw from both accounts.

Unlike a 401(k), a traditional IRA is not an employer-sponsored plan. Anyone can set up an IRA to save money for retirement. And if you have a 401 k), you can also have a traditional IRA.

The IRA contribution limit for 2024 is $7,000 ($8,000 if you’re 50 or older) and for 2023 is $6,500 ($7,500 if you’re 50 or older).

HSAs

An HSA, or Health Savings Account, allows you to cover healthcare costs using pre-tax dollars. But you can also use an HSA as a retirement account. At age 65, you can withdraw the money in your HSA and use it for any purpose. However, you will pay taxes on anything you withdraw that’s not used for medical expenses.

In 2024, you can contribute up to $4,150 in an HSA as an individual, or $8,300 for a family. In 2023, you can contribute up to $3,850 in an HSA as an individual, or $7,750 for a family.

Investing In Your Retirement

The largest difference between 401(a) and 401(k) plans is the type of employers offering the plans. Whereas 401(a) plans typically cover government workers and employees from specific education institutions and nonprofits, 401(k) plans are offered by for-profit organizations. Thus, a typical employee won’t get to choose which plan to invest in — the decision will be made based on what organization they work for.

Both 401(a) plans and 401(k) plans do have restrictions that might bother some investors. For example, an employee will be at the mercy of their employer’s choice when it comes to investing options.

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

Easily manage your retirement savings with a SoFi IRA.

FAQ

Is a 401(a) better than a 401(k)?

It’s not necessarily a matter of which plan is “better.” 401(k) plans are offered by private employers, while the government and nonprofits offer 401(a) plans. Both plans allow you to save for retirement in a tax-deferred way.

How are 401(a)s different from 401(k)s?

There are some differences between 401(k) and 401(a) plans. For instance, 401(a) plans are typically offered by the government and nonprofit organizations, while 401(k) plans are offered by private employers. In addition, employees don’t have to participate in a 401(k), but they often must participate in a 401(a). An employer decides how much employees contribute to a 401(a), while 401(k) participants can contribute what they like. And finally, those who have a 401(k) may have more investment options than those who have a 401(a).

Can you roll a 401(a) into a 401(k)?

Yes, you can roll a 401(a) into a 401(k) if you leave your job and then get a new job with a private company that offers a 401(k). You can also roll over a 401(a) into a traditional IRA.

Photo credit: iStock/solidcolours

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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Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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31 Facts About FAFSA

31 Facts About FAFSA for Parents

By | Going to College, Student Loans, student_loan | Comments Off on 31 Facts About FAFSA for Parents
Editor’s Note: The new, simplified FAFSA form for the 2024-2025 academic year is available, although applicants are reporting a number of glitches. Try not to worry, take your time, and aim to submit your application as soon as possible.

Applying for federal aid is a crucial step most high school students take while transitioning to college life. Parents going through the college admissions process for the first time, though, may not realize that they also play a huge role in helping their children apply for grants and scholarships through the Free Application for Federal Student Aid or FAFSA®.

Applications for the 2023-2024 round of FAFSA opened on Oct. 1 and will remain open until June 30, 2024. If you’re looking for facts about FAFSA that will help your child apply for college aid during the 2023-2024 academic year, we’ve compiled some of the most important information on how you can help your child during the FAFSA process.

Recommended: FAFSA Guide

FAFSA Facts and Tips

Filling out FAFSA for the first time? These facts and FAFSA tips can help you prepare for the application process and offer suggestions for getting the most aid.

1. FAFSA Is Required to Receive Government Student Loans

For those who may be new to the financial aid process, FAFSA is the form students fill out to apply for federal financial aid. Just over 18 million students fill out the FAFSA each year. Your child won’t be eligible for government-funded college aid, such as federal loans or grants if they don’t apply.

Recommended: 12 Steps to Filling Out the FAFSA Form for School Year 2023-2024

2. Your Child Could Qualify for Grants by Filling Out FAFSA

While you can get subsidized or unsubsidized loans through FAFSA, your child may also be eligible for grants. One common federal grant is the Pell grant, which is awarded to first-time undergraduate students who show exceptional financial need, such as coming from a low-income family.

Recommended: Types of Federal Student Loans

3. It Determines Work-Study Eligibility

Federal work-study is a way for students to earn income at a part-time job while in college. These jobs can be on or off-campus and vary by school, although not all schools participate in the program. You have to fill out FAFSA to determine if you’re eligible for work-study programs.

4. Some Schools Use FAFSA to Determine What Aid They Offer

If the schools your child applies to offer their own aid, such as need-based scholarships, they may use FAFSA to determine eligibility. You may want to check with the schools your child is applying to and ask if they have a separate application for internal scholarships and grants.

5. Most Applicants Under Age 22 Are Considered Dependents

Most students under the age of 22 who are neither married nor parents themselves won’t be able to apply as an independent student . As a result, for most incoming freshmen, their parents’ income is counted in the determination of financial need.

Recommended: Independent vs Dependent Student: Which One Are You?

6. Your Child Needs Your Information to Apply

If your child is filing as a dependent, then they’ll need some basic information about your finances, such as your income and paid taxes. You may also elect to apply for a Parent PLUS loan, which can help cover your child’s educational expenses if they don’t receive enough in loans and grants to cover costs. Note that you may need additional information to apply for a Parent Plus loan.

7. High-Income Families May Want to Still Apply

If your family is middle- or upper-class, you may wonder if your child will receive any FAFSA aid. However, applying is free, and family income is just one of many factors considered during the application process. Additionally, your child’s school still may require FAFSA to be eligible for institutional aid, so it may be worth applying for even if you don’t think your child will need or receive aid.

8. Grades Don’t Affect FAFSA Eligibility

FAFSA does not have a GPA requirement to apply. However, your child may want to keep in mind that they could lose any aid given to them through FAFSA if they have poor grades for multiple semesters after they receive the aid.

9. Deadlines May Differ by State and School

While the FAFSA doesn’t close until June 30, 2024 for the 2023-24 academic year, FAFSA application deadlines may vary by state and school. State and school deadlines may close prior to the federal deadlines. If you’re not sure what deadlines apply to your student, consider checking with the financial aid office of each school your child applies to and ask what their FAFSA deadlines are.

10. Having Multiple Kids in College No Longer Affects Financial Aid Awards

Since 2021, the number of children in a family who are in college or applying to college no longer affects aid eligibility. Before, families with multiple children in college may have qualified to receive more aid. This is one of many changes throughout the FAFSA Simplification Act, which aims to simplify the FAFSA form and therefore hopefully encourage more families to fill out FAFSA.

11. Expected Family Contribution Is Also Changing

Expected family contribution (EFC) is an estimate of how much FAFSA believes families can contribute to the cost of a student’s education. However, as part of the FAFSA Simplification Act, EFC will be replaced with the Student Aid Index, or SAI, starting on July 1, 2024 (for the 2024-2025 academic year). While that may sound far off, a freshman during the 2023-2024 academic year will be a sophomore when SAI is put into effect.

12. FAFSA Is Changing the Process for Children of Divorce

Before the new simplified FAFSA, in the case when a child’s parents are separated, the custodial parent’s information was included on the form. However, with the new changes, the parent who provides the most financial support to the student is responsible for filling out the FAFSA.

Recommended: How much FAFSA Money Can I Expect?

13. Your Child Will Need Their Social Security or Alien Registration Number

As your child prepares to fill out the FAFSA, they’ll need their Social Security or Alien Registration number.

14. Have Nontaxable Income at the Ready

One question that may trip up parents is what FAFSA considers nontaxable income. For FAFSA, that generally includes (but is not limited to):

•   Workers compensation

•   Disability benefits

•   Welfare benefits

•   Social Security income

•   Veteran’s benefits

•   Military or clergy allowances (if applicable)

•   Foreign income not taxed by any government

15. Your Child May Need to Report Grants and Scholarships

Most first-time college students won’t need to report any grants or scholarships they received. However, they may if they had to report them on their taxes, such as:

•   AmeriCorps benefits, such as living allowances or awards

•   Taxable work-studies, assistantships or fellowships

•   Combat pay, special combat pay, or cooperative education program earnings

•   Other grants or scholarships reported to the IRS

If you have any doubts about what types of grants may be taxable, consider consulting a tax professional.

16. Have Bank Statements Available

To fill out FAFSA, you’ll need bank statements for both you and your child. This information helps determine how much aid your child will be eligible for.

17. You Don’t Have to Have a Social Security Number to Sign the Form

If you’re filing for FAFSA online, you can create a federal student aid (FSA) ID . This is simply your login and password. Your child can create one here . But if you don’t have a Social Security number, you can print out the signature page of the form, sign it, and mail it in.

18. You Don’t Need to File Taxes Before Submitting FAFSA

If you filed for an extension for your tax return, you can use your W-2 or 1099 statements. But you will need to update FAFSA once you file. This is because which tax bracket you’re in can impact how much aid your child is eligible for.

Recommended: What Tax Bracket Am I In?

19. You’ll Need to Have a List of Assets Ready

FAFSA uses parental assets to help determine aid eligibility. You’ll need to know how much in assets you have, which include (but are not limited to):

•   Money in cash, savings, and checking accounts

•   Non-retirement investments (such as stocks and mutual funds)

•   Businesses that have more than 100 full-time equivalent employees and you and your family have minority stakes in

•   Investment farms (in other words, you don’t live on and operate the farm)

•   Other investments, such as real estate and stock options

20. 529 Plans Are Also Considered Assets

When filling out information about assets, you’ll also need to provide the value of all 529 College Savings Plans you own — including the accounts for siblings. Also, if your child owns a 529 plan (often called an UGMA or UTMA 529 plan), you will need to report it as a parental asset – and not as the student’s asset. (Please note, however, that if your child owns a UGMA or UTMA account that is not a 529 plan, you don’t list it as an asset — your child does as their asset.)

21. Your Primary Home Doesn’t Need to Be Listed as an Asset

One common FAFSA mistake is listing your primary home as an asset. However, FAFSA does not require you to do so. In fact, listing it as an asset can decrease the amount of aid your child receives.

22. You Don’t Need Your Retirement or Insurance Information

FAFSA also doesn’t count retirement or insurance accounts as assets. Again, including them can inflate the number of assets you have and therefore may decrease the amount of aid your child is offered.

23. You’ll Need to Include Each School Your Child Is Applying To

When you and your child fill out the FAFSA, you’ll want to have a list of all the schools your child may be interested in applying to. You’ll need each school’s federal school code to add them to the list of schools you want your FAFSA information sent to, although you can also search for this information on the form itself if you can’t find it on the school’s website. It may be wise to include schools your child isn’t sure they want to apply to yet since it’s easier to simply add the school to the list now than having to send the school your FAFSA information later.

24. Schools, Not the Government, Will Give You Financial Aid Updates

Part of the reason you’ll need to send your FAFSA to schools your child is considering applying to is because schools, not the government, send out financial aid packages. As such, each school your child applies to may offer a different financial aid package.

25. Skipping Information Can Be Costly

Before hitting submit, you might want to double check that every section of the FAFSA is filled out (and accurate). Skipping FAFSA sections may result in delays in your application being processed, errors that prevent you from submitting, or even a decrease in the amount of aid offered.

26. Your Child Will Need to Take Student Loan Exit Counseling

While filing FAFSA or talking to your school’s financial aid office, you may hear about something called student loan exit counseling. This is mandatory for anyone who gets federal student loan aid. Counseling is simply an online module that will help your child navigate how the student loan repayment process works. A reminder will be sent to your child’s email in their last year of school about when this exit counseling is due. However, you and your child may want to consider reviewing student loan exit repayment options before the counseling is due to ensure they pick the best option based on their financial situation.

27. File Early to Get the Most Aid

While it may seem like you have a ton of time to fill out the FAFSA, it may be best to complete it sooner rather than later. Delaying can mean financial aid for your state or school dries up before your child can even be considered for it. Additionally, knowing how much aid each school is offering your child may help them when deciding on which school to attend.

28. You Could Be Selected for FAFSA Verification

After your child receives their student aid report, they may get a message saying they were selected for verification. FAFSA verification is used by some schools to simply verify that students’ FAFSA information is accurate. Some schools randomly select people to be verified, some verify all students, and some may elect not to verify any students.

Recommended: 14 Must-Know College Financial Aid Terms for Parents

29. You Can Appeal Your Aid Package

Once your child has their financial aid packages, they may find that they were offered less than they expected or hoped for. If your child’s dream college didn’t offer enough aid (or perhaps even didn’t offer them any aid), they may be able to appeal for more financial aid. This process may be especially important if your financial situation has changed since you and your child first applied for FAFSA. While schools may deny the request, it doesn’t cost you or your child anything but time to ask for more aid.

30. You Can List Unusual Circumstances That Affect Your Finances

Another way to try and increase your financial aid package is by listing unusual financial circumstances both on your FAFSA and in an appeal letter to schools you’re applying to. Some common unusual circumstances include (but are not limited to):

•   Having tuition expenses in elementary and/or secondary schools

•   Experiencing unusual medical or dental expenses not covered by insurance

•   Having a family member become unemployed recently

•   Experiencing changes in income and/or assets that could affect aid eligibility

31. You’ll Have to Reapply Every Year

Once you’ve filed your FAFSA, you may want to keep your login information in a safe place. You’ll need that information to file for FAFSA every year your child is in school, and losing your FSA login information may delay your ability to apply next year. You may also want to set a reminder on your phone or calendar to apply next year, although FAFSA will send you an email reminder when next year’s FAFSA is open.

The Takeaway

Filing for FAFSA is an important first step in helping your child pay for college. Knowing how FAFSA works and how to optimize the amount of aid your child receives can help increase the amount of federal aid they’re offered.

However, if their financial aid package isn’t enough to cover college costs, they may want to consider private student loans. Private student loans aren’t required to offer the same borrower protections as federal student loans, and are, therefore, generally considered as an option only after all other sources of funding have been exhausted.

If you’re considering private loans to pay for college, you may want to review the differences between private and federal student loans to ensure that you and your child choose the best options for them to pay for college. SoFi offers private student loans that have no hidden fees and allow borrowers to choose between four repayment options.

Cover up to 100% of school-certified costs including tuition, books, supplies, room and board, and transportation with a private student loan from SoFi.

Photo credit: iStock/wagnerokasaki

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SoFi Private Student Loans
Please borrow responsibly. SoFi Private Student Loans are not a substitute for federal loans, grants, and work-study programs. You should exhaust all your federal student aid options before you consider any private loans, including ours. Read our FAQs. SoFi Private Student Loans are subject to program terms and restrictions, and applicants must meet SoFi’s eligibility and underwriting requirements. See SoFi.com/eligibility-criteria for more information. To view payment examples, click here. SoFi reserves the right to modify eligibility criteria at any time. This information is subject to change.

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

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

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

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Jan
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2024
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Roth IRA Conversion: Rules and Examples

By | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off on Roth IRA Conversion: Rules and Examples

A Roth IRA is a retirement savings account that offers tax-free withdrawals during retirement. You can convert a traditional IRA or a qualified distribution from a previous employer-sponsored plan, such as a 401(k), into a Roth IRA. This is known as a Roth IRA conversion.

A Roth IRA conversion may be worth considering for the potential tax benefits. Along with tax-free qualified withdrawals in retirement, the money in a Roth IRA has the potential to grow tax-free. Read on to learn how a conversion works, the Roth IRA conversion rules, and whether a Roth IRA conversion may make sense for you.

What Is a Roth IRA Conversion?

With a Roth IRA conversion, an individual moves the funds from another retirement plan into a Roth IRA. You pay taxes on the money in your existing account in order to move it to a Roth IRA.

Many retirement plans, such as 401(k)s and traditional IRAs are tax-deferred. The money is contributed to your account with pre-tax dollars. In retirement, you would pay taxes on your withdrawals. But by doing a Roth conversion, you pay taxes on the money you convert to a Roth IRA, and the money can then potentially grow tax-free. In retirement, you can make qualified withdrawals from the Roth IRA tax-free.

You can convert all or part of your money to a Roth IRA.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

How Does a Roth IRA Conversion Work?

As mentioned, when converting to a Roth IRA, an individual must pay taxes on the contributions and gains in their current retirement plan because only after-tax contributions are allowed to a Roth IRA. They can typically convert their funds to a Roth IRA in one of three ways:

•   An indirect rollover: With this method, the owner of the account receives a distribution from a traditional IRA and can then contribute it to a Roth IRA within 60 days.

•   A trustee-to-trustee, or direct IRA rollover: The account owner tells the financial institution currently holding the traditional IRA assets to transfer an amount directly to the trustee of a new Roth IRA account at a different financial institution.

•   A same-trustee transfer: This is used when a traditional IRA is housed in the same financial institution as the new Roth IRA. The owner of the account alerts the institution to transfer an amount from the traditional IRA to the Roth IRA.

Get a 1% IRA match on rollovers and contributions.

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

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.

Roth IRA Conversion Rules

There are a number of rules that govern a Roth IRA conversion. Before you proceed with a conversion, it’s important to understand what;’s involved. Roth IRA conversion rules include:

Taxes

You’ll pay taxes on a traditional IRA or 401(k) before you convert it to a Roth IRA. This includes the tax-deductible contributions you’ve made to the account as well as the tax-deferred earnings. They will be taxed as ordinary income in the year that you make the conversion. Because they’re considered additional income, they could put you into a higher marginal tax bracket. You’ll also need to make sure you have the money on hand to pay the taxes.

Limits

There are two types of limits to be aware of with a Roth IRA conversion. First, there is no limit to the number or size of Roth IRA conversions you can make. You might want to convert smaller amounts of money into a Roth IRA over a period of several years to help manage the amount of taxes you’ll need to pay in one year.

Second, Roth IRAs have contribution limits. For instance, in 2024, you can typically contribute up to $7,000, or up to $8,000 if you’re 50 or older.

Withdrawals

The withdrawals you make from a Roth IRA are tax-free. However, with a Roth IRA conversion, if you are under age 59 ½, you will need to wait at least five years before withdrawing the money or you’ll be subject to a 10% early withdrawal penalty (more on that below).

Backdoor Roth IRAs

A Roth IRA conversion may be an option to consider if you earn too much money to otherwise be eligible for a Roth IRA. Roth IRAs have contribution phase-out ranges, and individuals whose income exceeds those limits cannot contribute to a Roth fully or at all. For 2024, the income limits begin to phase out at $230,000 for those who are married and filing jointly, and $146,000 for those who are single.

However, if you have a traditional IRA and convert it to a Roth IRA — a process known as a backdoor Roth IRA — those income phase-out rules don’t apply. You can use a backdoor IRA as long as you pay taxes on any contributions to the traditional IRA that you deducted from your taxes, as well as any profits you earned.

5-Year Rule

According to the 5-year rule, if you are under age 59 ½, the funds that you convert to a Roth IRA must remain in your account for at least five years or you could be subject to a 10% early withdrawal penalty.

The five years starts at the beginning of the calendar year in which you do the conversion. So even if you don’t do the conversion until, say, December 2024, the five years still begins in January 2024. That means you could withdraw your funds in January 2029.

Also, if you complete separate Roth IRA conversions in different years, the 5-year rule would apply to each of them, so keep this in mind.

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

Is Converting to a Roth IRA Right for You?

Doing a Roth IRA conversion means paying taxes now on the funds you are converting in order to withdraw money tax-free in retirement. Here’s how to decide if converting a Roth IRA may be right for you

Reasons For

If you anticipate being in a higher tax bracket in retirement than you’re in now, a Roth IRA conversion may make sense for you. That’s because you’ll pay taxes on the money now at a lower rate, rather than paying them when you retire, when you expect your tax rate will be higher.

In addition, with a Roth IRA, you won’t have to take required minimum distributions (RMDs) every year after the age of 73 as you would with a traditional IRA. Instead, the money can stay right in the account — where it may continue to grow — until it’s actually needed.

If your income is too high for you to be eligible for a Roth IRA, a Roth IRA conversion might be beneficial through a backdoor IRA. You will just need to put your funds into a traditional IRA first and pay the taxes on them.

Finally, if you won’t need the funds in your Roth IRA for at least five years, a conversion may also be worth considering.

Reasons Against

A Roth IRA conversion may not be the best fit for those who are nearing retirement and need their retirement savings to live on. In this case, you might not be able to recoup the taxes you’d need to pay for doing the conversion.

Additionally, if you receive Social Security or Medicare benefits, a Roth IRA conversion would increase your taxable income, which could increase the taxes you pay on Social Security. The cost of your Medicare benefits might also increase.

Those who don’t have the money readily available to pay the taxes required by the conversion should also think twice about an IRA conversion.

And if you expect to be in a lower tax bracket in retirement, a conversion also likely doesn’t make sense for you.

Finally, if you think you might need to withdraw funds from your account within five years, and you’re under age 59 ½, you could be subject to an early withdrawal penalty if you convert to a Roth IRA.

The Takeaway

A Roth IRA conversion may help individuals save on taxes because they can make qualified withdrawals tax-free withdrawals in retirement. For those who expect to be in a higher tax bracket in retirement, a Roth IRA may be worth considering.

It’s important to be aware of the tradeoffs involved, especially the amount of taxes you might have to pay in order to do the conversion. Making the right decisions now can help you reach your financial goals as you plan and save for retirement.

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FAQ

How much tax do you pay on a Roth IRA conversion?

You pay tax on the money you convert, but the specific amount of tax you’ll pay depends on the marginal tax rate you’re in. Before doing a Roth IRA conversion, you may want to calculate to see if the funds you’re converting will put you into a higher tax bracket.

How many Roth iRA conversions are allowed per year?

There is no limit to the number of Roth conversions you can do in one year.

When is the deadline for Roth IRA conversions?

The deadline for a Roth IRA conversion is December 31 of the year you’re doing the conversion.

Is there a loophole for Roth IRA conversions?

A backdoor IRA might be considered a loophole for a Roth IRA conversion. Roth IRAs have contribution phase-out ranges, and individuals whose income exceeds those limits cannot contribute to a Roth fully or at all. However, a backdoor IRA may be a way to get around the income limits. To do it, you will need to have a traditional IRA that you convert to a Roth IRA.

How do I avoid taxes on Roth conversion?

You cannot avoid paying taxes on a Roth conversion. You must pay taxes on the money you convert.

How do you not lose money in a Roth IRA conversion?

To reduce the tax impact of a Roth IRA conversion, you may want to split the conversion into multiple conversions of smaller amounts over several years. If possible, try to do the conversions in years when your taxable income is lower.

Do you have to pay taxes immediately on Roth conversion?

Taxes on a Roth conversion are not due until the tax deadline of the following year.

Should a 65 year old do a Roth conversion?

It depends on an individual’s specific situation, but a Roth conversion may not make sense for a 65 year old if they need to live off their retirement savings or if they are receiving Social Security or Medicare benefits. A Roth IRA conversion could increase the taxes they pay on Social Security, and the cost of their Medicare benefits might rise.

Does a Roth conversion affect my Social Security?

It might. A Roth IRA conversion increases your taxable income, which could potentially increase the taxes you pay on Social Security.

Does a Roth conversion affect Medicare premiums?

A Roth IRA conversion may affect your Medicare premiums. Because it increases your taxable income, the cost of your Medicare benefits might increase as well.

What is the best Roth conversion strategy?

The best Roth conversion strategy depends on your particular situation, but in general, to help reduce your tax bill, you can aim to make the conversion in a year in which you expect your taxable income to be lower. You may also want to do multiple smaller conversions over several years, rather than one big conversion in one year, to help manage the taxes you owe.

Can you do Roth conversions after age 72?

Yes, you can do Roth conversions at any age. Some individuals may want to consider a Roth IRA conversion at 72 if they prefer to avoid paying the required minimum distributions (RMDs) for traditional IRAs that begin at age 73. If you convert before you turn 73, you will not be required to take RMDs.

How do I calculate my Roth conversion basis?

The concept of basis, or money that you’ve paid taxes on already, might be applicable if you’ve made non-deductible contributions to a tax-deferred retirement account. When you convert the money in that account, in order to calculate the percentage that’s tax-free, you need to divide your total nondeductible contributions by the end-of-year value of your IRA account plus the amount you’ve converting.

Do you have to wait 5 years for each Roth conversion?

No. There is no time limit for doing Roth conversions, and in fact, you can do as many as you like in one year. However, if you’re under age 59 ½, you do have to wait five years after each conversion to be able to withdraw money from the account without being subject to an early withdrawal penalty.

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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