An SEP IRA, or Simplified Employee Pension IRA, is a retirement plan set up by employers, including those who are self-employed. Although SEP IRAs can be used by any size business, they are geared towards sole proprietors and small business owners.

What is a SIMPLE IRA and How Does it Work?

SIMPLE IRAs, or Savings Incentive Match Plan for Employees Individual Retirement Accounts, like the SEP IRA, are set up for business owners and their employees. Unlike the SEP IRA, both the employer and the employees can contribute to them, making them better for larger businesses with 100 employees or less.

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Feb

2024

SEP IRA vs SIMPLE IRA: Differences & Pros and Cons

By Laurel Tincher | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

One of the most common retirement plans is an IRA, or individual retirement account, which allows individuals to contribute and save money for retirement over time. The money can be withdrawn during retirement to cover living expenses and other costs.

There are several different types of IRAs. Two of the most popular types are the Roth IRA and the Traditional IRA.

Perhaps less well-known are the SEP IRA and the SIMPLE IRA. These IRAs are designed for business owners, sole proprietors, and the self-employed.

For small business owners who would like to offer their employees — and themselves — a retirement savings plan, a SEP IRA and a Simple IRA can be options to explore. According to a 2023 study by Fidelity, only 34% of small business owners offer their employees a retirement plan. This is because they believe they can’t afford to do so (48%), are too busy running their company to do it (22%), or don’t know how to start (21%). SEP or Simple IRAs are generally easy to set up and manage and have lower fees than other types of accounts.

There are a number of similarities and differences between the SEP IRA vs. the SIMPLE IRA. Exploring the pros and cons of each and comparing the two plans can help self-employed people, small business owners, and also employees make informed decisions about retirement savings.

How SEP IRAs Work

A SEP IRA, or Simplified Employee Pension IRA, is a retirement plan set up by employers, sole proprietors, and the self-employed. Although SEP IRAs can be used by any size business, they are geared towards sole proprietors and small business owners. SEP IRAs are typically easy to set up and have lower management fees than other types of retirement accounts.

Employers make contributions to the plan for their employees. They are not required to contribute to a SEP every year. This flexibility can be beneficial for businesses with fluctuating income because the employer can decide when and how much to contribute to the account.

Employers can contribute up to 25% of an employee’s annual salary or $69,000 in 2024, whichever is less. The employer and all employees must receive the same rate of contribution.

Employees cannot make contributions to their SEP accounts.

💡 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.

SEP IRA Pros and Cons

There are advantages to a SEP IRA, but there are disadvantages as well. Here are some of the main benefits and drawbacks to be aware of.

Pros

The pros of a SEP IRA include:

• A SEP IRA is an easy way for a small business owner or self-employed individual to set up a retirement plan.

• The contribution limit is higher than that for a SIMPLE IRA. In 2024, the contribution limit is $69,000 to a SEP IRA.

• Employers can deduct contributions to the account from their taxes up to certain amounts, and employees don’t have to include the contributions in their gross income. The money in the account is tax-deferred, and employees don’t pay taxes on the money until it gets withdrawn.

• For self-employed individuals, a SEP IRA may help reduce certain taxes, such as self-employment tax.

• An employer isn’t required to make contributions to a SEP IRA every year. This can be helpful if their business has a bad year, for example.

• For employees, the money in a SEP is immediately 100% vested, and each employee manages their own assets and investments.

• Having a SEP IRA does not restrict an individual from having other types of IRAs.

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.

Cons

There are some drawbacks to a SEP IRA for employees and employers. These include:

• Employees are not able to make contributions to their own SEP accounts.

• Individuals cannot choose to pay taxes on the contributions in their SEP now, even if they’d like to.

• Employers must contribute the same percentage to all employees’ SEP accounts that they contribute to their own account.

• There are no catch-up contributions for those 50 and older.

How SIMPLE IRAs Work

SIMPLE IRAs, or Savings Incentive Match Plan for Employees Individual Retirement Accounts, are set up for businesses with 100 or fewer employees. Unlike the SEP IRA, both the employer and the employees can contribute to a SIMPLE IRA.

Any employee who earns more than $5,000 per year (and has done so for any two- year period prior to the current year) is eligible to participate in a SIMPLE IRA plan. Employees contribute pre-tax dollars to their plan — and they may have the funds automatically deducted from their paychecks.

Employers are required to contribute to employee SIMPLE IRAs, and they may do so in one of two ways. They can either match employee contributions up to 3% of the employee’s annual salary, or they can make non-elective contributions whether the employee contributes or not. If they choose the second option, the employer must contribute a flat rate of 2% of the employee’s salary up to a limit of $345,000 in 2024.

Both employer contributions and employee salary deferral contributions are tax-deductible.

As of 2024, the annual contribution limit to SIMPLE IRAs is $16,000. Workers age 50 and up can contribute an additional $3,500.

SIMPLE IRA Pros and Cons

There are benefits and drawbacks to a SIMPLE IRA.

Pros

These are some of the pros of a SIMPLE IRA:

• A SIMPLE IRA is a way to save for retirement for yourself and your employees. And the plan is typically easy to set up.

• Both employees and employers can make contributions.

• Money contributed to a SIMPLE IRA may grow tax-deferred until an individual withdraws it in retirement.

• For employees, SIMPLE IRA contributions can be deducted directly from their paychecks.

• Employers can choose one of two ways to contribute to employees’ plans — by either matching employee contributions up to 3% of the employee’s annual salary, or making non-elective contributions of 2% of the employee’s salary up to an annual compensation limit.

• Employees are immediately 100% vested in the SIMPLE IRA plan.

• A SIMPLE IRA has higher contribution limits compared to a traditional or Roth IRA.

• Catch-up contributions are allowed for those 50 and up.

Cons

SIMPLE IRAs also have some drawbacks, including:

• A SIMPLE IRA is only for companies with 100 employees or fewer.

• mployers are required to fund employees’ accounts.

• The SIMPLE IRA contribution limit ($16,000 in 2024) is much lower than the SEP IRA contribution limit ($69,000 in 2024).

Main Differences Between SEP and Simple IRAs

While SEP IRAs and SIMPLE IRAs share many similarities, there are some important differences between them that both employers and employees should be aware of.

Eligibility

On the employer side, a business of any size is eligible for a SEP IRA. However, SIMPLE IRAs are for businesses with no more than 100 employees.

For employees to be eligible to participate in a SIMPLE IRA, they must earn $5,000 or more annually and have done so for at least two years previously. To be eligible for a SEP IRA, an employee must have worked for the employer for at least three of the last five years and earned at least $750.

Who Can Contribute

Only employers may contribute to a SEP IRA. Employees cannot contribute to this plan.

Both employers and employees can contribute to a SIMPLE IRA. Employers are required to contribute to their employees’ plans.

Contribution limits

Employers are required to contribute to employee SIMPLE IRAs either by matching employee contributions up to 3% of the employee’s annual salary, or making non-elective contributions of 2% of the employee’s salary up to a limit of $345,000 in 2024.

With a SEP IRA, employers can contribute up to 25% of an employee’s annual salary or $69,000 in 2024, whichever is less. A business owner and all employees must receive the same rate of contribution. Employers are not required to contribute to A SEP plan every year.

Taxes

For both SEP IRAS and SIMPLE IRAs, contributions are tax deductible. Individuals typically pay taxes on the money when they withdraw it from the plan.

Vesting

All participants in SIMPLE IRAs and SEP IRAS are immediately 100% vested in the plan.

Paycheck Deductions

Employees contributing to a SIMPLE IRA can have their contributions automatically deducted from their paychecks.

Employees cannot contribute to a SEP IRA, thus there are no paycheck deductions.

Withdrawals

For both SEP IRAs and SIMPLE IRAS, participants may withdraw the money penalty-free at age 59 ½ . Withdrawals are taxable in the year they are taken.

If an individual makes an early withdrawal from a SEP IRA or a SIMPLE IRA, they will generally be subject to a 10% penalty. For a SIMPLE IRA, if the withdrawal is taken within the first two years of participation in the plan, the penalty is raised to 25%.

SEP IRAs may be rolled over into other IRAs or certain other retirement plans without penalty. SIMPLE IRAs are eligible for rollovers into other IRAs without penalty after two years of participation in the plan. Before then, they may only be rolled over into another SIMPLE IRA.

Here’s an at-a-glance comparison of a SEP IRA vs. SIMPLE IRA:

	SEP IRA	SIMPLE IRA
Eligibility	Businesses of any size Employee must have worked for the employer for at least three of the last five years and earn at least $750 annually	Business must have no more than than 100 employees Employees must earn $5,000 or more per year and have done so for two years prior to the current year
Who can contribute	Employers only	Employers and employees (employers are required to contribute to their employees’ plans)
Contribution limits	Employers can contribute up to 25% of an employee’s annual salary or $69,000 in 2024, whichever is less No catch-up contributions	$16,000 per year in 2024 Catch-up contributions of $3,500 for those 50 and up
Taxes	Contributions are tax deductible. Taxes are paid when the money is withdrawn	Contributions are tax deductible. Taxes are paid when the money is withdrawn
Vesting	100% immediate vesting	100% immediate vesting
Paycheck deductions	No (employees cannot contribute to the plan)	Yes
Withdrawals	Money can be withdrawn without penalty at age 59 ½. There is generally a 10% penalty if money is withdrawn early, before age 59 ½	Money can be withdrawn without penalty at age 59 ½. There is generally a 10% penalty if money is withdrawn early, before age 59 ½ (or 25% if the account has been open for less than 2 years)

The Takeaway

Both the SEP IRA and the SIMPLE IRA were created to help small business owners and their employees save for retirement. Each account may benefit employers and employees in different ways.

With the SEP IRA, the employer (including a self-employed person) contributes to the plan. They are not required to contribute every year. With the SIMPLE IRA, the employer is required to contribute, and the employee may contribute but can choose not to.

In addition to these plans, there are other ways to save for retirement. For instance, individuals can contribute to their own personal retirement plans, such as a traditional or Roth IRA, to help save money for their golden years. Just be sure to be aware of the contribution limits.

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.

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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Feb

2024

What Is a SIMPLE 401(k) Plan & How Do You Utilize It?

By Austin Kilham | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

The Savings Incentive Match Plan for Employees 401(k), or SIMPLE 401(k), is a simplified version of a traditional 401(k). SIMPLE plans were created so that small businesses could have a cost-efficient way to offer a retirement account to their employees.

Unlike many other workplace retirement plans, SIMPLE 401(k) plans do not require annual nondiscrimination tests to ensure that a plan is in line with IRS rules. This type of testing can be prohibitively expensive for small employers, preventing them from using other types of 401(k)s.

A SIMPLE 401(k) retirement plan is available to businesses with 100 or fewer employees including sole proprietorships, partnerships, and corporations. For small business owners or self-employed individuals, understanding how SIMPLE plans work can help decide whether it makes sense to set one up.

For employees whose employer already offers a SIMPLE 401(k), getting to know the ins and outs of the plan can help to understand the role they play in saving for retirement.

How Does a SIMPLE 401(k) Work?

A SIMPLE 401(k) functions much like a regular 401(k). Employees contribute pre-tax money directly from their paycheck and invest that money in a handful of options offered by the plan administrator.

In 2024, the SIMPLE 401(k) limits are as follows: The maximum for employee elective deferrals is $16,000 ($15,500 in 2023); employees 50 and older could make an additional “catch-up” contribution of $3,500 to boost their savings as they neared retirement.

One significant difference between traditional 401(k) plans and SIMPLE 401(k) plans is that while employer contributions are optional with a 401(k) plan, under a SIMPLE 401(k) plan they are mandatory and clearly defined. Employers must make either a matching contribution of up to 3% of each employee’s pay or make a nonelective contribution (independent of any employee contributions) of 2% of each eligible employee’s pay. The contribution must be the same for all plan participants: For example, an employer couldn’t offer himself a 3% match while offering his employees a 2% nonelective contribution.

There are other limits on how much an employer can contribute. The maximum compensation that could be used to figure out employer contributions and benefits is $345,000 for 2024 ($330,000 for 2023). So if an employer offered a 2% nonelective contribution and an employee made $355,000 a year, the maximum contribution the employer could make would be 2% of $345,000, or $6,900.

As with a regular 401(k), contributions to a SIMPLE plan grow tax-deferred — meaning an employee contributes pre-tax dollars to their plan, and doesn’t pay income tax on that money until they withdraw funds upon retirement. Typically, the tax-deferred growth means that there is more money subject to compounding interest, the returns investments earn on their returns.

Withdrawals made during retirement are subject to income tax.

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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 Is Eligible for a SIMPLE 401(k)?

To be eligible for a SIMPLE 401(k), employers must have 100 or fewer employees. They cannot already offer these employees another retirement plan, and must offer the plan to all employees 21 years and older.

Employers must also file Form 5500 every year if they establish a plan.

For employees to be eligible, they must have received at least $5,000 in compensation from their employer in the previous calendar year. Employers cannot require that employees complete more than one year of service to qualify for the SIMPLE plan.

A SIMPLE IRA is also one of a number of retirement options for the self-employed.

What Are the Pros of a SIMPLE 401(k) Plan?

SIMPLE 401(k)s offer a number of benefits that make them attractive to employers and employees.

• Simplified rules: While large companies may have the money and staff to devote to nondiscrimination testing, smaller companies may not have the same resources. SIMPLE 401(k)s do not have these compliance rules, making them more accessible for small employers. What’s more, the straightforward benefit formula is easy for employers to administer.

• “Free money”: Employees are guaranteed employer contributions to their retirement account, whether via 3% matching contributions or 2% nonelective contributions.

• Fully-vested contributions: All contributions — those made by employees and their employers — are fully vested immediately. Employees who qualify for distributions can take money out whenever they need it. While this can be good news for employees, for employers it removes the option to incentivize workers to stay in their job longer by having their contributions vest several years into their tenure with the company.

• Loans and hardship withdrawals: While withdrawals made before age 59 ½ are subject to tax and a possible 10% early withdrawal penalty, employees can take out loans against their SIMPLE 401(k) just as they can with a traditional 401(k). These options add flexibility for individuals who need money in an emergency. It’s important to note that 401(k) loans come with strict rules for paying them back. Failing to follow these rules may result in penalties.

What Are the Cons of a SIMPLE 401(k) Plan?

While there are plenty of positives that come from offering or contributing to a SIMPLE 401(k), there are also some important downsides.

• Plan limitations: Employers cannot offer employees covered by a SIMPLE 401(k) another retirement plan.

• Lower contribution limits: For 2024, a traditional 401(k) plan allows for $23,000 annual maximum 401(k) contributions from employees, with an additional $7,500 catch-up contribution for those 50 and older. These contribution limits are considerably higher than SIMPLE plan limits, which in 2024 are $16,000 with an additional “catch-up” contribution of $3,500 for employees over age 50. This means an employee could potentially contribute an additional $7,000 in elective deferrals and $4,000 in catch-up contributions with a traditional 401(k) rather than a SIMPLE 401(k).

• Limited size: SIMPLE Plans are only available to employers with fewer than 100 employees. That means if a business grows beyond that point, they have a two-year grace period to switch from their SIMPLE plan to another option.

SIMPLE 401(k) vs SIMPLE IRA

Generally speaking, when comparing SIMPLE IRAs and SIMPLE 401(k)s, the rules are similar:

• They’re only available to businesses with 100 or fewer employees.

• Employers must either offer a 3% matching contribution or a 2% nonelective contribution.

• Employers can only make contributions on up to $345,000 in employee compensation in 2024.

• Employee contribution limits to SIMPLE IRAs are the same as their 401(k) counterparts.

• Employer and employee contributions are fully vested immediately.

There are a few differences worth mentioning:

• Whereas all employer contributions are subject to the cap for SIMPLE 401(k)s, only nonelective contributions are subject to the $345,000 compensation cap for SIMPLE IRAs. (This makes it possible that employees making more than $345,000 annually may receive higher matching contributions from a SIMPLE IRA than they would from a SIMPLE 401(k).)

• If employers make matching contributions of 3%, they may elect to limit their contribution to no less than 1% for two out of every five years.

• SIMPLE IRAs do not allow employees to take out loans from their account for any reason.

• There are no minimum age requirements for SIMPLE IRA contributions.

The Takeaway

SIMPLE 401(k) plans can be especially attractive for self-employed individuals or small business owners, as they have many of the same benefits of a traditional 401(k) plan — including tax-deferred contributions and loan options — but without the administrative compliance costs that come with a regular 401(k) plan.

SIMPLE 401(k) plans can be especially attractive for self-employed individuals or small business owners.

Some of the requirements and rules associated with a SIMPLE 401(k) plan might be unattractive to some employers, however, including the fact that the IRS prohibits employers from offering other types of retirement plans to employees who are covered by a SIMPLE 401(k).

There are many answers to the question of which retirement savings plan is right for you or your business. Beyond traditional 401(k) and SIMPLE (401)k plans, there are traditional, Roth, SIMPLE and SEP IRAs, among other 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

Who is a SIMPLE IRA best for?

A SIMPLE IRA may be a good option for small business owners with no more than 100 employees who want to offer a retirement savings plan to their employees. These plans tend to be fairly simple to set up and administer compared to some other plans. A SIMPLE IRA allows employers to contribute to their own and their employees’ retirement savings.

What is the 2 year rule for SIMPLE IRAs?

The 2-year rule says that during the first two years an individual participates in a SIMPLE IRA plan, they can only transfer money to another SIMPLE IRA. After the two years are up, they can make tax-free rollovers to other non-Roth IRAs or to another employer-sponsored retirement plan.

Does money grow in a SIMPLE IRA?

Money may grow tax-deferred in a SIMPLE IRA until distributions are taken from the plan in retirement. Withdrawals can be made without penalty at age 59 ½.

What happens to my SIMPLE IRA if I quit my job?

If you have participated in the SIMPLE IRA plan for at least two years, you can make a tax-free rollover to another non-Roth IRA or to a new employer’s workplace retirement plan. However, if you’ve participated in the plan for less than two years, you can only transfer your money to another SIMPLE IRA.

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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

2024

How to Write a Will Online in 8 Steps

By Kelly Boyer Sagert | Insurance | Comments Off

When you’re creating a will, you generally have two options: hire an attorney who specializes in estate planning or write a will online using software and templates. The second path is often used when someone has a more straightforward financial situation.

Either way, a will (or, more formally, a last will and testament) is an important legal document that makes clear how you’d like your assets to be distributed after you die. If there are minor children involved, it can also name the guardian.

If you think creating an online will is right for your situation, read on for a step-by-step guide for how to write a will online.

8 Steps to Writing a Will Online

To legally make a will, the testator (the person making the will) must be at least 18 years old and of sound mind — meaning they are generally aware of how much property and other assets they have and understand what they’re signing.

Assuming these conditions are met, here are the general steps to follow for writing a will online.

Step 1: Be Clear About Your State’s Laws

Each state has distinct laws when it comes to the number of people who must witness the will, whether the document needs to be notarized and more. Know what your state requires before you get started.

💡 Quick Tip: We all know it’s good to have a will in place, but who has the time? These days, you can create a complete and customized estate plan online in as little as 15 minutes.

Step 2: Choose the Software You’ll Use

A quick search of terms like “how to do a will online” will provide you with plenty of template options. You might also consider asking friends and family members if they’ve used a software that worked well for them.

Then, compare your options. Pay attention to factors such as:

• Cost: Check pricing structures and fees. Some services will charge a flat fee for services rendered, while others may require a subscription to the site before you can make a will. What services are included in those fees? Which ones aren’t? Some sites have a yearly fee, which you may find worthwhile if the will is being reviewed one or more times a year by an estate planning attorney.

• Ease of use: Just like with any other DIY service, some companies will guide you through how to make a will online more seamlessly than others. Find out how you can get answers to questions and if there’s any extra cost for this. Some sites may offer online support or provide a phone number to call. Check, too, to see if the company offers information on estate planning basics.

• Company reputation: Only work with reputable companies. To investigate, you can read online reviews, search for news coverage of the company and check with the Better Business Bureau (BBB) for any complaints about deceptive practices.

Recommended: How Much Does It Cost to Make a Will?

Step 3: Name an Executor

After selecting a software, you’ll need to choose an executor, which is the person who manages the estate after the testator dies. Assets (what you own) and liabilities (what you owe) typically go into the estate, and it’s up to you to decide which assets to include in your will.

When you die, the executor is responsible for paying off outstanding debts and then appropriately distributing remaining assets to the beneficiaries, which are the people who receive assets from your estate as set out in your will. This process will include overseeing probate, a court-supervised proceeding where a will is confirmed as authentic, debts are paid off, and assets get distributed.

Additionally, it is the executor’s duty to keep your assets safe before distribution and otherwise manage financial issues until the estate is closed.

You’ll typically want to pick someone you trust as your executor, such as a family member or even an attorney. You can also choose more than one person to serve as your executor.

Step 4: Decide How You Want to Distribute Assets

As part of writing a will online, you’ll list your beneficiaries and what they will receive. For example, you might leave 100% of your estate to a spouse or significant other. Or, you may leave one-third of your estate to each of your three children.

For each of your beneficiaries, list their full legal name, contact information, date of birth and what assets they should receive. Focus on who would inherit your house, cars, bank accounts, and any other significant asset.

You may also decide to list a secondary beneficiary. This person (or people) would inherit your assets if the primary beneficiaries were to pass away before you do or otherwise won’t inherit. The will making software may refer to secondary beneficiaries as contingent beneficiaries.

Also keep in mind that there are asset distributions that aren’t covered by a last will and testament — in other words, your non-probate assets. Accounts where you name beneficiaries outside of your will can include retirement or pension accounts, life insurance policies, and certain bank accounts, among others. Because you’ve already named beneficiaries here, you won’t need to include these accounts in your will.

Recommended: Types of Wills

Step 5: Name a Guardian for Minor Children

In a will, you can also list who would take in your minor children (if any) in the event you were to die. This is an important decision, and you should verify that the guardian you plan to name would be willing to serve in this role.

This is also the area of the will where you can list specific wishes about how your child would be brought up, whether that’s related to religion or their education, and so forth.

Step 6: Follow State Laws to Sign Your Will

To make your will legal and binding, you’ll need to sign it according to your state’s laws. Typically, this means that you must sign the document in the presence of two witnesses who are not beneficiaries or direct relatives.

Step 7: Let Key People Know Where Your Will Is Located

Knowing how to make a will online and appropriately completing the process is important — but the process doesn’t quite end there. You’ll also want to let the executor and other key people know where the document can be found. You can put it in a safe or store it electronically as two possibilities.

Step 8: Update Your Will As Necessary

Every few years, review your will to see if any updates should be made. Also review the document if you encounter any major life changes, including:

• Having a child or grandchild

• Getting married or divorced

• Becoming widowed

• Experiencing a substantial change in your finances (for better or worse)

• Developing significant health issues

• Moving to a different state

Also update your will if you want to change your beneficiaries or what they’ll inherit.

💡 Quick Tip: It’s recommended that you update your will every 3-5 years, and after any major life event. With online estate planning, changes can be made in just a few minutes — no attorney required.

The Takeaway

When wondering how to write a will online, these steps will take you through the process. Once you’ve chosen a software service that’s right for you and your will is created, make sure to store it somewhere safe (and that people know where that is) and that you continue to make updates to your will as your life continues to change and evolve.

When you want to make things easier on your loved ones in the future, SoFi can help. We partnered with Trust & Will, the leading online estate planning platform, to give our members 15% off their trust, will, or guardianship. The forms are fast, secure, and easy to use.

Create a complete and customized estate plan in as little as 15 minutes.

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Feb

2024

Unlocking the Potential of Private Company Investments

By Samuel Becker | Growing Wealth, invest, Investing | Comments Off

Investing in a private company means acquiring equity in a company that doesn’t sell shares on public stock markets. Broadly speaking, there are two types of companies: public and private. And while you are likely more familiar with public-company investments — stocks traded on stock exchanges — there are also investment opportunities to be had with private companies.

There can be benefits that come with investing in privately held companies. Depending on your current circumstances, risk tolerance, and financial goals, you will likely approach the types of companies you consider investing in differently. And it’s important to understand that there are significant risks involved, and develop your expectations accordingly.

Understanding Private Companies

A private company is one that has not or does not sell shares of itself on public exchanges. Conversely, a public company has undergone an initial public offering (IPO), which means that it has publicly issued stock in hopes of raising more capital and making more shares available for purchase by the public.

As a general rule of thumb, until a company has an IPO, it’s considered private.

Classification of Private Companies

Again, private companies are those that are not publicly traded.

Unlike the world of public investing, private investing happens off of Wall Street and takes place anywhere new, buzzy ventures are cropping up.

Public companies, especially ones that are bigger, are more easily bought and sold on the stock market, and individuals are able to invest in them. These companies are also regulated by organizations like the Securities and Exchange Commission (SEC).

The SEC is a government body that makes sure these businesses stay accountable to their investors and shareholders, and it requires publicly traded companies to share how they are doing, based on their revenue and other financial metrics.

In contrast, a privately held company is owned by either a small number of shareholders or employees and does not trade its shares on the stock market. Instead, company shares are owned, traded, or exchanged in private.

The landscape of investing in private companies can sometimes be mystifying, in part because private stock transactions happen behind closed doors. But even though private companies may be less visible than their public counterparts, they still play an important role in the economy and can be a worthwhile investment.

Investing in a private company can also be incredibly risky, and it’s important to understand some of the pros and cons of investing in this landscape.

The Growth Journey: Startups to Unicorns

Generally speaking, the goal of a startup (a small business with aims to grow quickly and possibly go public) is to become a “unicorn.” A “unicorn” company is a private company that’s valued at more than $1 billion. Very few companies become unicorns, and for investors, a primary goal is to find and invest in companies that will become unicorns.

Alternative investments,
now for the rest of us.

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

Strategic Pathways to Private Investments

There are several ways to invest in private companies, though not all of them will be available to every investor.

Early Stage Investments and Angel Investing

Early-stage investing, often called “angel investing,” involves making an investment in a very small-stage company in exchange for ownership of that company. This tends to be the riskiest stage to invest, as companies at this stage are small, young, and often unproven.

Joining Private Equity Firms

Investors can also get involved in private company investing through private equity. Private equity firms invest in private companies, like angel investors, in hopes that the equity they acquire will one day be much more valuable. Again, this is likely not an option for the average investor, as private equity is usually an area reserved for high-net-worth individuals.

💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

Investing in Pre-IPO Companies

Some investors attempt to invest in companies before they go public to take advantage of any post-IPO spikes in share value. There are a few ways to invest in pre-IPO companies.

Leveraging Pre-IPO Investing Platforms

There are certain platforms that allow investors to make investments in pre-IPO companies. An internet search will yield some of them. Those platforms tend to work in one of a few ways, usually by offering investors access to specialized brokers who work with private equity firms, or by directly connecting investors with companies, allowing them to make direct purchases of stock.

You’ll need to dig in and do your own research into these platforms if this is a route you plan to pursue, but also know that there are significant risks with these types of investments.

The Accredited Investor’s Guide

For some private company investments, investors will need to be “accredited.” An accredited investor is an individual or entity that meets certain criteria, and can thus invest in hedge funds, private equity, and more.

Qualifications and Opportunities

For individuals to qualify as accredited investors, the SEC says that they need to have a net worth of more than $1 million (excluding primary residence), and income of more than $200,000 individually, or $300,000 with a spouse or partner for the prior two years.

There are also professional criteria which may be met, which includes being an investment professional in good standing and holding certain licenses. There are a few other potential qualifications, but those are the most broad.

Exclusive Markets for the Accredited Investor

Becoming an accredited investor basically means that you can invest in markets shut off from other investors. This includes private companies, and private equity. Effectively, being “accredited” comes along with the assumption that the investor has enough capital to be able to make riskier investments, and that they’re likely sophisticated enough to be able to know their way around private markets.

The Pros and Cons of Private Company Investments

There are pros and cons to investing in private companies that investors should be aware of.

Advantages of Private Market Engagement

Because private companies are often smaller businesses, they may offer investors an opportunity to get more involved behind the scenes. This might mean that an investor could play a role in operational decisions and have a more integrated relationship with the business than they could if they were investing in a large, public company.

In an ideal scenario, if you invest in a private company, you’ll get in earlier than you would when a company goes public. (Note: This is the ideal scenario.) And getting in early can potentially produce impressive results — if you’ve made a sound investment decision.

Another possible benefit of investing in a private company is that there is generally less competition for equity than with a public company. This means you could end up with a bigger slice of the pie.

Investing in a private company might also mean that you are able to set up an exit provision for your investment — meaning you could set conditions under which your investment will be repaid at an agreed upon rate of return by a certain date.

Generally speaking, investing in a private company can have some strong benefits, including increased potential for financial gain and the opportunity to become more involved in the future of a business.

Risks and Considerations

One of the biggest risks involved in investing in a private company is that you may have less access to information as an investor. Not only is it more challenging to get hold of data in order to understand how the company performance compares to the rest of the industry, private companies are also not held to the same standards as publicly-traded ones.

For example, because of SEC oversight, public companies are held to rigorous transparency and accounting standards. In contrast, private companies generally are not. From an investor’s standpoint, this means that you may sometimes be in the dark about how the business is doing.

In addition to this, many private companies may lack access to the capital they need to grow. And even though there may be an opportunity to set up an exit provision as an investor in a private company, unless you make such a provision, it could be a huge challenge to get out of your investment.

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

Critical Steps for Investing in Private Companies

Just like investing in the public stock exchanges, there are some steps that investors may want to follow as a sort of best-practices approach to investing in private companies.

Conducting Thorough Research

Always do your homework — or, as much research as you can before investing in a private company. As noted, this may be difficult, as there’s going to be less available information about private companies versus public ones. You also won’t be able to research charts and look at stock performance to get a sense of what a company’s future holds.

Identifying and Assessing Potential Deals

Through the research you are able to do (perhaps as a part of a private equity or hedge fund), you’ll want to do your best to zero-in on some potential investment opportunities. Like investing in stocks, you’ll be looking for companies that appear healthy, are competitive, and that you think have a good chance of surviving the years ahead.

There’s no magic formula, of course, but investors should do as much due diligence as possible.

The Transaction: Making Your First Private Investment

Depending on how you choose to invest, making your first private company investment may be as simple as hitting a button — such as on a private crowdfunding website or something similar. Or, if you’re directly investing with the company, it may be more involved. Just know that it’ll probably be a bit different than buying stocks or shares on an exchange.

Post-Investment Vigilance

As with any investment — public, or private — investors will want to keep an eye on their holdings.

Monitoring Your Investment

Monitoring your investment in a private company is not going to be the same as monitoring the stocks in your portfolio. You won’t be able to go on a financial news website and look at the day’s share prices. Instead, you’ll likely need to be in touch with the company directly (or through intermediaries), reading status reports and financial statements, and doing your best to learn how business is operating.

It’ll be a bit opaque, and the process will vary from company to company. So, keep that in mind.

Exit Strategies and Liquidity Events

When an investor “exits” an investment in a private company, it means that they sell their shares or equity and effectively “cash out.” If an investor bought in at an early stage and the company gained a lot of value over the years, the investor can “exit” with a big return. But returns vary, of course.

Liquidity events present themselves as times to exit investments, and for many private investors, the time to exit is when a company ultimately goes public and IPOs. But there may be other times that are more favorable to investors, if they present themselves.

Investment Myths Debunked

As with any type of investment, there may be myths or misunderstandings related to private company investments.

Setting Realistic Expectations

A good rule of thumb for investors is to keep their expectations in check. In all likelihood, you’re not going to stumble upon the next Mark Zuckerberg or Jeff Bezos, desperately looking for cash to fund their scrappy startup. Instead, you may be more likely to find a company that has good growth potential but no guarantee of survival. For that reason, it’s important to always keep the risks in mind, as well as what you actually expect from an investment.

Common Misconceptions

Some further misconceptions about private investing include that it’s only for the ultra-rich (not necessarily true, but may often be the case), that every investment may offer high returns (along with high risks), and that profits will come quickly. An investment may take years to ultimately pay off — if it does at all.

Ready to Invest? Questions to Ask Yourself

If you feel comfortable with the idea of investing in private companies and are ready to take the next step, be sure to know your own preferences before making any moves.

Assessing Your Risk Tolerance

Are you okay with taking on a lot of risk? Because you’ll probably need a high risk tolerance to be able to stomach private company investing. So, be sure to take stock of how much risk you can realistically handle, as the importance of knowing your risk tolerance will become abundantly clear as you progress in your investing journey.

Aligning Investments with Personal Goals

Also think about how your investments in private markets relate or mesh with your overall investing goals. That’s to say that you don’t necessarily want to invest in private companies just for the sake of investing in private companies — instead, think about how these investments fit into your larger portfolio.

The Takeaway

Investing in private companies entails buying or acquiring equity in companies that are not publicly traded, meaning you can’t buy shares on the public stock exchanges. This often involves investing in small companies with high growth potential — but not always, and not necessarily. Because this is a risky type of investing, there tends to be high potential rewards, too.

Investing in private companies is not for everyone, and there may be stipulations involved that prevent some investors from doing it. If you’re interested, it may be best to speak with a financial professional before making any moves.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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

FAQ

How much capital is needed to start?

There isn’t a limit to how much capital needed to invest in private companies, but to be an accredited investor, there are income and net worth limits that may apply.

What are the time commitments and expectations?

There are no hard and fast time commitments or expectations of private investors, in a general sense. But that may differ on a case by case basis, especially if an investor takes a broader role with managing a company they’re investing in.

SoFi Invest®

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

Feb

2024

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A Guide to Tax-Efficient Investing

By Krystal Etienne | Growing Wealth, invest, Investing, Terminology | Comments Off

As the saying goes: It’s not how much you earn, it’s how much you keep. And when you make money from your investments you need to consider the impact taxes might have on your earnings.

Fortunately, there are a range of tax-efficient investment strategies that can help minimize the bite that taxes take out of your returns.

What is tax-efficient investing, and how does it work? By understanding the tax implications of different types of accounts, as well as the types of investments you choose (e.g. stocks, bonds, mutual funds), you can determine the most tax-efficient strategies for your portfolio.

The Importance of Tax-Efficient Investing

Investing comes with an assortment of costs, and the taxes you pay on investing profits can be one of the biggest. By learning how to be a more tax-efficient investor, you may be able to keep more of what you earn.

The Impact of Taxes on Returns

Investment tax rules are complicated. Profits from many stock and bond investments are taxed at the capital gains rate; but some bonds aren’t taxed at all. Qualified dividends are taxed in one way; non-qualified dividends another. Investments in a taxable account are treated differently than those in a tax-advantaged account.

And, of course, there is the process of applying investment losses to gains in order to reduce your taxable gains — a strategy known as tax-loss harvesting.

In addition, the location of your investments — whether you hold them in a taxable account or a tax-advantaged account (where taxes can be deferred, or in some cases avoided) — also has an impact on your returns. In a similar way, you can refocus your charitable giving strategy to be tax efficient as well.

Knowing the ins and outs of investment taxes can help you establish a tax-efficient strategy that makes sense for you.

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

Types of Tax-Efficient Accounts

Investment accounts can generally be divided into two categories based on how they’re taxed: taxable and tax-advantaged.

Taxable Accounts

In order to understand tax-deferred and tax-exempt accounts, it helps to first understand taxable accounts, e.g. brokerage accounts. A taxable brokerage account has no special tax benefits, and profits from the securities in these accounts may be taxed according to capital gains rules (unless other rules apply).

Taxable accounts can be opened in the name of an individual or trust, or as a joint account. Money that is deposited into the investment account is post-tax, i.e. income taxes have already been paid or will be paid on those funds (similar to the money you’d put into a checking or savings accounts).

Taxes come into play when you sell investments in the account and make a profit. You may owe taxes on the gains you realize from those investments, as well as earned interest and dividends.

With some securities, like individual stocks, the length of time you’ve held an investment can impact your tax bill. Other investments may generate income or gains that require a different tax treatment.

For example:

• Capital gains. The tax on an investment gain is called capital gains tax. If an investor buys a stock for $40 and sells it for $50, the $10 is a “realized” gain and will be subject to either short- or long-term capital gains tax, depending on how long the investor held the investment.

The short-term capital gains rate applies when you’ve held an investment for a year or less, and it’s based on the investor’s personal income tax bracket and filing status — up to 37%.

The long-term capital gains rate, which is generally 0%, 15%, or 20% (depending on your income), applies when you’ve held an investment for more than a year.

• Interest. Interest that’s generated by an investment, such as a bond, is typically taxed as ordinary income. In some cases, bonds may be free from state or local taxes (e.g. Treasuries, some municipal bonds).

But if you sell a bond or bond fund at a profit, short- or long-term capital gains tax could apply.

• Dividends. Dividends are distributions that may be paid to investors who hold certain dividend stocks. Dividends are generally paid in cash, out of profits and earnings from a corporation — and can be taxed as short- or long-term capital gains within a taxable account.

Recommended: How Do Dividends Work?

But the terms are different when it comes to tax-advantaged accounts.

Tax-Advantaged Accounts

Tax-advantaged accounts fall into two categories, and are generally used for long-term retirement savings.

Tax-Deferred Retirement Accounts

A 401(k), 403(b), traditional IRA, SEP IRA, and Simple IRA fall under the tax-deferred umbrella, a tax structure typical of retirement accounts. They’re considered tax efficient for a couple of reasons.

• Pre-tax contributions. First, the money you contribute to a tax-deferred account is not subject to income tax; you owe taxes when you withdraw the funds later, e.g. in retirement. Thus the tax is deferred.

This means the amount you contribute to a tax-deferred account for a given year can be deducted from your taxable income, potentially reducing your tax bill for that year.

Speaking hypothetically: If your taxable income for a given year is $100,000, and you’ve contributed $5,000 to a traditional IRA or SEP IRA, you would deduct that contribution and your taxable income would be $95,000. You wouldn’t pay taxes on the money until you withdrew that funds later, likely in retirement.

• Tax-free growth. The money in a tax-deferred retirement account (e.g. a traditional IRA) grows tax free. Thus you don’t incur any taxes until the money is withdrawn.

• Potentially lower taxes. By deducting the contribution from your taxable income now, you may avoid paying taxes at your highest marginal tax rate. The idea is that investors’ effective (average) tax rate might be lower in retirement than their highest marginal tax rate while they’re working.

Tax-Exempt Accounts

Typically known as Roth accounts — e.g. a Roth IRA or a Roth 401(k) — allow savers to deposit money that’s already been taxed. These funds, plus any gains, then grow tax free, and qualified withdrawals are also tax free in retirement.

Because contributions to Roth accounts are made post-tax, there is also more flexibility on when the money can be withdrawn. You can withdraw the amount of your contributions tax and penalty free at any time. However earnings on those investments may incur a penalty for early withdrawal, with some exceptions.

Recommended: What Is the Roth IRA 5-Year Rule?

Tax Benefits of College Savings Plans

529 College Savings Plans are a special type of tax-exempt account. The contributions and earnings in these accounts can be withdrawn tax free for qualified education expenses. In some cases you may be able to deduct your contributions from your state taxes, but the rules vary from state to state.

While you can invest the money in these accounts, they are limited in scope so aren’t generally considered one of the broader investment account categories.

Tax-Efficient Accounts Summary

As a quick summary, here are the main account types, their tax structure, and what that means for the types of investments you might hold in each.

• Generally you want to hold more tax-efficient investments in a taxable account.

• Conversely, you may want to hold investments that can have a greater tax impact in tax-deferred and tax-exempt accounts, where investments can grow tax free.

Types of Accounts	When Taxes Apply	Investment Implications
Taxable (e.g. brokerage or investment account)	Investors deposit post-tax funds and owe taxes on profits from securities they sell, and from interest and dividends.	Investments with a lower tax impact make sense in a taxable account (e.g. long-term stocks, municipal and Treasury bonds).
Tax-deferred (e.g. 401(k), 403(b), traditional, SEP, and Simple IRAs)	Investors contribute pre-tax money, but owe taxes on withdrawals.	Investments grow tax free until funds are withdrawn, giving investors more tax flexibility when choosing securities.
Tax-exempt (e.g. Roth 401(k), Roth IRA)	Investors deposit post-tax funds, and don’t owe taxes on withdrawals.	These accounts offer the most tax flexibility as investments grow tax free and investors withdraw the money tax free.

The Tradeoffs of Tax-Free Growth

Because of the advantages tax-deferred accounts offer investors, there are restrictions around contribution limits and the timing (and sometimes the purpose) of withdrawals. Taxable accounts are generally free of such restrictions.

• Contribution limits. The IRS has contribution limits for how much you can save each year in most tax-advantaged accounts. Be sure to know the rules for these accounts, as penalties can apply when you exceed the contribution limits.

• Income limits. In order to contribute to a Roth IRA, your income must fall below certain limits. (These caps don’t apply to Roth 401(k) accounts, however.)

• Penalties for early withdrawals. For 401(k) plans and traditional as well as Roth IRAs, there is a 10% penalty if you withdraw money before age 59 ½, with some exceptions.

• Required withdrawals. Some accounts, such as traditional, SEP, and Simple IRAs require that you withdraw a minimum amount each year after age 72 (or 73 if you turned 72 after Dec. 31, 2022). These are known as required minimum distributions (RMDs).

The rules governing RMDs are complicated, and these required withdrawals can have a significant impact on your taxable income, so you may want to consult a professional in order to plan this part of your retirement tax plan.

When choosing the location of different investments, be sure to understand the rules and restrictions governing tax-advantaged accounts.

Choosing Tax-Efficient Investments

Next, it is helpful to know that some securities are more tax efficient in their construction, so you can choose the best investments for the type of account that you have.

For example, ETFs are considered to be more tax efficient than mutual funds because they don’t trigger as many taxable events. Investors can trade ETFs shares directly, while mutual fund trades require the fund sponsor to act as a middle man, activating a tax liability.

Here’s a list of some tax-efficient investments:

• ETFs: These are similar to mutual funds but more tax efficient due to their construction. Also, most ETFs are passive and track an index, and thus tend to be more tax efficient than their actively managed counterparts (this is also true of index mutual funds versus actively managed funds).

• Treasury bonds: Investors will not pay state or local taxes on interest earned via U.S. Treasury securities, including Treasury bonds. Investors do owe federal tax on Treasury bond interest.

• Municipal bonds: These are bonds issued by local governments, often to fund municipal buildings or projects. Interest is generally exempt from federal taxes, and state or local taxes if the investor lives within that municipality.

• Stocks that do not pay dividends: When you sell a non-dividend-paying stock at a profit, you’ll likely be taxed at the long-term capital gains rate, assuming you’ve held it longer than a year. That’s likely lower than the tax you’d pay on ordinary dividends, which are generally taxed as income at your ordinary tax rate.

• Index funds vs. actively managed funds: Generally speaking, index funds (which are passively managed) have less churn, and lower capital gains. Actively managed funds are the opposite, and may incur higher taxes as a result.

Note that actively trading stocks can have additional tax implications because more frequent trades, specifically those that fall into the short-term capital gain category, incur a higher tax rate on gains.

Typically, tax consequences will vary from person to person. A tax professional can help navigate your specific tax questions.

Estate Planning and Charitable Giving

Another important aspect of tax-efficient investing is adjusting your estate plan and establishing a strategy for charitable bequests. Because both these areas — inheritances and philanthropy — can be extremely complex taxwise, it may be wise to consult with a professional.

Taxes and Estate Planning

There are a number of ways to structure inheritances in a tax-efficient manner, including the use of gifts, trusts, and other vehicles. With a sophisticated estate-planning strategy, taxes can be minimized for the donor as well as the receiver.

For example, while there is a federal estate tax, there is no federal inheritance tax. And only six states tax your inheritance as of 2024 (Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania). Iowa is phasing out their inheritance tax for deaths after 2025.

Yet your heirs may owe capital gains if you bequeath assets that then appreciate. But if you leave stock to your heirs, they can enjoy a step-up in cost basis based on when they inherited the stock, so they’d be taxed on gains from that time, not from the original price at purchase.

Tax Benefits of Charitable Contributions

Tax-efficient charitable giving is possible using a variety of strategies and accounts. For example a charitable remainder trust can reduce the donor’s taxable income, provide a charity with a substantial gift, while also creating tax-free income for the donor.

This is only one example of how charitable gifts can be structured as a win-win on the tax front. Understanding all the options may benefit from professional guidance.

💡 Quick Tip: Newbie investors may be tempted to buy into the market based on recent news headlines or other types of hype. That’s rarely a good idea. Making good choices shouldn’t stem from strong emotions, but a solid investment strategy.

Advanced Tax-Efficient Strategies

It may also be possible to minimize taxes by incorporating a few more strategies as you manage your investments.

Asset Location Considerations

As noted above, one method for minimizing the tax impact on your investments is through the careful practice of asset location. A well-considered combination of taxable, tax-deferred, and tax-exempt accounts can help mitigate the impact of taxes on your investment earnings.

For example, with some investment accounts — such as IRAs and 401(k)s — your tax bracket can have a substantial impact on the tax you’ll pay on withdrawals. Having alternate investments to pull from until your tax bracket is more favorable is a smart move to avoid that excess tax.

Also, with multiple investment accounts, you could potentially pull tax-free retirement income from a Roth IRA, assuming you’re at least 59 ½ and have held the account for at least five years (also known as the 5-year rule). and leave your company-sponsored 401(k) to grow until RMDs kick in.

Having a variety of investments spread across account types gives you an abundance of options for many aspects of your financial plan.

• Need to cover a sudden large expense? Long-term capital gains are taxed at a significantly lower rate than short-term capital gains, so consider using those funds first.

• Want to help with tuition costs for a loved one? A 529 can cover qualified education costs at any time, without incurring taxes or a penalty.

• Planning to leave your heirs an inheritance? Roth IRAs are tax free and transferrable. And because your Roth IRA does not have required distributions (as a traditional IRA would), you can allow the account to grow until you pass it on to your heir(s).

Tax-Loss Harvesting

Within taxable accounts, there may be an additional way to minimize some of the tax bill created by selling profitable investments: tax-loss harvesting. This advanced move involves reducing the taxes from an investment gain with an investment loss.

For example, an investor wants to sell a few investments and the sale would result in $2,000 in capital gains. Tax-loss harvesting rules allow them to sell investments with $2,000 in total capital losses, effectively canceling out the gains. In this scenario, no capital gains taxes would be due for the year.

Note that even though the investor sold the investment at a loss, the “wash sale” rule prevents them from buying back the same investment within 30 days after those losses are realized. This rule prevents people from abusing the ability to deduct capital gain losses, and applies to trades made by the investor, the investor’s spouse, or a company that the investor controls.

Because this strategy involves the forced sale of an investment, many investors choose to replace it with a similar — but not too similar — investment. For example, an investor that sells an S&P 500 index fund to lock in losses could replace it with a similar U.S. stock market fund.

Tax-Loss Carryover

Tax-loss harvesting rules also allow an investor to claim some of that capital loss on their income taxes, further reducing their annual income and potentially minimizing their overall income tax rate. This can be done with up to $3,000 in realized investment losses, or $1,500 if you’re married but filing separately.

Should your capital losses exceed the federal $3,000 max claim limit ($1,500 if you’re married and filing separately), you have the option to carry that loss forward and claim any amounts excess of that $3,000 on your taxes for the following year.

For example, if you have a total of $5,000 in capital losses for this year, by law you can only claim $3,000 of those losses on your taxes. However, due to tax-loss carryover, you are able to claim the remaining $2,000 as a loss on your taxes the following year, in addition to any capital gains losses you happen to experience during that year. This in turn lowers your capital gains income and the amount you may owe in taxes.

Roth IRA Conversions

It’s also possible in some cases to convert a traditional IRA to a Roth IRA. This is a complicated strategy, with pluses and minuses on the tax front.

• By converting funds from a traditional IRA to a Roth, you will immediately owe taxes on the amount you convert. The conversion amount could also push you into a higher tax bracket; meaning, you’d potentially owe more in taxes.

• Unlike funding a standard Roth IRA, there is no income limit for doing a Roth conversion, nor is there a cap on how much can be converted.

• Once the conversion is complete, you would reap the benefits of tax-free withdrawals from the Roth IRA in retirement.

• According to the 5-year rule, if you’re 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.

Final Thoughts on Tax-Efficient Investing

Given the impact of investment taxes on your returns, it makes sense to consider all the various means of tax-efficient investing. After all, not only are investment taxes an immediate cost to you, that money can’t be invested for further growth.

Key Strategies Recap

Once you understand the tax rules that govern different types of investment accounts, as well as the tax implications of your investment choices, you’ll be able to create a strategy that minimizes taxes on your investment income for the long term. Ideally, investors should consider having a combination of tax-deferred, tax-exempt, and taxable accounts to increase their tax diversification. To recap:

• A taxable account (e.g. a standard brokerage account) is flexible. It allows you to invest regardless of your income, age, or other parameters. You can buy and sell securities, and deposit and withdraw money at any time. That said, there are no special tax benefits to these accounts.

• A tax-deferred account (e.g. 401(k), traditional IRA, SEP IRA, Simple IRA) is more restrictive, but offers tax benefits. You can deduct your contributions from your taxable income, potentially lowering your tax bill, and your investments grow tax free in the account. Your contributions are capped according to IRS rules, however, and you will owe taxes when you withdraw the money.

• A tax-exempt account (e.g. a Roth IRA or Roth 401(k)) is the most restrictive, with income limits as well as contributions limits. But because you deposit money post-tax, and the money grows tax free in the account, you don’t owe taxes when you withdraw the money in retirement.

Further Learning in Tax-Smart Investing

Being smart about tax planning applies to the present, to educational expenses, to the future (in terms of taxes you could owe in retirement), and to your estate plan and your heirs as well. Maximizing your tax-efficient strategies across the board can make a significant difference over time.

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

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

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

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SEP IRA vs SIMPLE IRA: Differences & Pros and Cons

How SEP IRAs Work

SEP IRA Pros and Cons

Pros

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

Cons

How SIMPLE IRAs Work

SIMPLE IRA Pros and Cons

Pros

Cons

Main Differences Between SEP and Simple IRAs

Eligibility

Who Can Contribute

Contribution limits

Taxes

Vesting

Paycheck Deductions

Withdrawals

The Takeaway

What Is a SIMPLE 401(k) Plan & How Do You Utilize It?

How Does a SIMPLE 401(k) Work?

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

Who Is Eligible for a SIMPLE 401(k)?

What Are the Pros of a SIMPLE 401(k) Plan?

What Are the Cons of a SIMPLE 401(k) Plan?

SIMPLE 401(k) vs SIMPLE IRA

The Takeaway

FAQ

Who is a SIMPLE IRA best for?

What is the 2 year rule for SIMPLE IRAs?

Does money grow in a SIMPLE IRA?

What happens to my SIMPLE IRA if I quit my job?

How to Write a Will Online in 8 Steps

8 Steps to Writing a Will Online

Step 1: Be Clear About Your State’s Laws

Step 2: Choose the Software You’ll Use

Step 3: Name an Executor

Step 4: Decide How You Want to Distribute Assets

Step 5: Name a Guardian for Minor Children

Step 6: Follow State Laws to Sign Your Will

Step 7: Let Key People Know Where Your Will Is Located

Step 8: Update Your Will As Necessary

The Takeaway

Unlocking the Potential of Private Company Investments

Understanding Private Companies

Classification of Private Companies

The Growth Journey: Startups to Unicorns

Alternative investments, now for the rest of us.

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

Strategic Pathways to Private Investments

Early Stage Investments and Angel Investing

Joining Private Equity Firms

Investing in Pre-IPO Companies

Leveraging Pre-IPO Investing Platforms

The Accredited Investor’s Guide

Qualifications and Opportunities

Exclusive Markets for the Accredited Investor

The Pros and Cons of Private Company Investments

Advantages of Private Market Engagement

Risks and Considerations

Critical Steps for Investing in Private Companies

Conducting Thorough Research

Identifying and Assessing Potential Deals

The Transaction: Making Your First Private Investment

Post-Investment Vigilance

Monitoring Your Investment

Exit Strategies and Liquidity Events

Investment Myths Debunked

Setting Realistic Expectations

Common Misconceptions

Ready to Invest? Questions to Ask Yourself

Assessing Your Risk Tolerance

Aligning Investments with Personal Goals

The Takeaway

FAQ

How much capital is needed to start?

What are the time commitments and expectations?

A Guide to Tax-Efficient Investing

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

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

Alternative investments,
now for the rest of us.

Student Loan
Refinancing

Personal
Loans

Online
Investments