Typical Retirement Expenses to Prepare For

Many people dream about how their retirement years will play out. Some want to spend their golden years spoiling the grandkids, while others envision traveling the world. As long as retirees have saved enough during their working years to fund the expenses, these goals are attainable.

Unfortunately, not all Americans know what to expect regarding living expenses during their retirement years. They may not know how to budget for ordinary costs in retirement, like housing and transportation, or make the most out of retirement income. Here’s a look at typical retirement expenses so individuals can get a handle on how much they’re likely to spend and how much they need to budget for retirement.

This article is part of SoFi’s Retirement Planning Guide, our coverage of all the steps you need to create a successful retirement plan.


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Average Monthly Cost of Retirement Expenses

According to the Bureau of Labor Statistics, an American household headed by someone aged 65 and older spent an average of $48,791 per year, or $4,065.95 per month, between 2016 and 2020. More specifically, households headed by someone between the ages of 65 and 74 spent $53,916 annually during these five years, while spending dropped to $41,637 annually for people aged 75 and older.

Retirees usually spent less than the American average, which was $60,593 per year, or $5,049.42 per month. Retirees also less than people nearing retirement, those aged 55 to 64, who spent $65,392 annually between 2016 and 2020.

💡 Recommended: Average Retirement Savings by Age

5 Common Retirement Expenses by Category

The typical budget for retirees needs to cover expenses for a retirement that could stretch over two or three decades. Drilling down to specific categories can help retirement savers determine benchmarks for their own budget.

1. Housing

Housing expenses, such as mortgage payments, insurance, and maintenance costs, are among the highest costs retirees face.

average housing expenses during retirement

From 2016 through 2020, Americans aged 65 and older spent an average of $16,880 annually, or $1,406.68 per month, on housing-related costs.

These expenses can vary dramatically by location and housing type. For example, housing costs are typically much higher in a coastal California community than in a real estate market in a state with relatively low property taxes, such as Wyoming, South Carolina, or Colorado. This might be a factor to consider when weighing the best states to retire in.

2. Transportation

Many retirees want an action-packed retirement full of entertainment, socializing, visiting family, and traveling the country. That means that transportation costs can be a significant factor in retirement expenses, especially early in retirement.

average transportation expenses during retirement

Americans spent an average of $11,910 per year getting from point A to point B between 2016 and 2020, but retirees spent a little less. Those over age 65 spent an average of $7,062 annually on transportation, or $588.50 per month. People aged 65 to 74 spent $8,497 per year, and people 75 and older spent $5,073 per year. These numbers cover everything from buying a car to filling up the gas tank and could be significantly higher for those who spend a lot of time traveling.

Retirees who don’t own a car may still need to factor the cost of public transportation into their annual retirement costs. Buses, subways, and other public transportation sources cost older generations $526.80 per year.

3. Healthcare

Americans’ healthcare costs — including health insurance, medical services, medical supplies, and prescription drugs — increase as they grow older. With age comes aching joints, injuries from falling, and sometimes chronic diseases like arthritis, diabetes, or Alzheimer’s. Americans spent an average of $4,976 on healthcare annually between 2016 and 2020, but this is one area where retirees spend more than their younger peers.

average healthcare expenses during retirement

People over age 65 spent an average of $6,583 per year, or $548.62 per month, on healthcare from 2016 through 2020. Costs vary from person to person depending on their genetics, injuries, and lifestyle choices. For example, if heart disease runs in the family or you are a smoker, you may want to save extra for retirement healthcare costs.

If you have a high deductible health insurance plan, consider saving with a health savings account (HSA), which offers tax-advantaged savings to cover healthcare costs.

4. Food

Households run by someone age 65 or older spent $6,207 annually, or $517.23 monthly, buying food from 2016 through 2020. Those aged 65 to 74 spent $6,864 per year, and those over 75 spent $5,274. These food expenses include groceries, alcohol expenditures, and meals eaten at restaurants.

average food expenses during retirement

An individual’s food costs will vary depending on their diet and habits. For example, people who buy organic vegetables will likely spend more on produce than people who don’t. There’s also a good chance that eating at home more frequently will cost less than eating out five times per week.

5. Entertainment

Having fun isn’t just for the young. From 2016 through 2020, people over 65 spent an average of $2,527 annually on entertainment, or $210.55 monthly, on fees and admissions to places like museums, theater performances, and movies. Entertainment expenses also include hobbies and pet costs.

average entertainment expenses during retirement

People aged 65 to 74 spent $3,080 per year on entertainment during the past five years. However, once they hit age 75, spending on entertainment dropped to $1,749 annually, perhaps as mobility decreased.

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What Is the Most Costly Retirement Expense?

Of all of the expenses in retirement, the most expensive is generally housing. While of course exact retirement costs will vary from individual to individual depending on their situation, the average cost of housing even far exceeds costs like health care. As mentioned previously, Americans who are 65 and up spend an average of $16,880 per year on housing-related costs.

There are steps retirees can take to potentially reduce this expense though. For instance, they may aim to pay off their mortgage before they retire. Or, they could consider moving to a less costly state with lower taxes.

What Are Some Unexpected Retirement Expenses?

Even a well-laid retirement plan can leave someone open to surprise. Some unexpected retirement expenses that retirees might want to factor into their retirement planning include:

•   Uncovered health care costs: Health care might not cover anything, and to get total coverage, it might be necessary to get multiple plans under Medicare. However, it’s important to weigh the cost of that over any out-of-pocket costs. Of course, it’s hard to predict the future and because of that, it can be challenging to get the math just right.

•   Long-term care: This retirement expense can be steep, and the costs involved continue to rise. Especially for retirees who don’t have family to turn to for assistance, this can constitute a significant portion of a retirement budget. It’s estimated in Genworth’s Cost of Care Survey that the average cost for an in-home health aid is $61,776, while a private room in a nursing home facility runs $108,405 on average.

•   Unanticipated housing costs: Retirees’ budgets might also get thrown off by housing costs they didn’t factor into their calculations. For instance, while a retiree may have noted the cost of their monthly mortgage payments, they may not have taken into account potential home repairs and maintenance, or needed additions, like a wheelchair-accessible ramp.

What Will You Spend Less on in Retirement?

We’ve talked a lot about the costs of retirement, but there are some areas where you’ll spend less in this stage of life. One place you’ll shell out less is on insurance — Kiplinger estimates that the average retiree spends almost 65% less on insurance, at an average of $2,840 a year, compared to $8,100 a year on average for those under the age of 65. You’ll also likely spend less on taxes, thanks to tax breaks for those over the age of 65.

Other areas where costs might be lower in retirement include on pets and pet supplies; alcohol and tobacco; clothing; and, if you’re giving up your rush-hour commute, transportation.

5 Steps to Set Up a Retirement Budget

Once you have an idea of potential retirement expenses, you can start to save and comprehensively budget for them. Since every retirement looks different, there’s no average retirement budget — a good monthly retirement income for a couple will be different than for a single person. Nonetheless, these are the steps to create a budget that may work for you.

5 steps to retire

Step 1. Contribute to a Retirement Account

You may already have retirement savings in your company-sponsored 401(k) or a similar retirement plan. But those who don’t have access to a 401(k) or want to increase their savings can also save in an individual retirement account like a Traditional IRA or Roth IRA. These accounts can provide tax-advantaged ways to start retirement with adequate savings to build a budget.

💡 Recommended: 5 Steps to Investing in Your 401(k) Savings Account

Step 2: Make a List of Expected Monthly Expenses

Most expenses can fit into one of three categories: fixed, variable, and one-time. Fixed expenses are payments that occur regularly and stay the same from month to month, like mortgage/rent payments, property taxes, and car payments.

Variable expenses change from month to month, depending on personal usage and price fluctuations. Standard variable costs include utility bills and groceries. Likewise, any entertainment expenses, medical expenses, pet care, and personal care expenses may be variable.

One-time or non-recurring expenses are costs that don’t occur regularly. These might include a new roof, a vacation, or a wedding. You may want to set aside money in an emergency fund for unexpected expenses (like that new roof) and have other funds earmarked for non-essential, one-time expenses (like a wedding or vacation).

To get an idea of your various expenses, gather payment information from bank statements, credit card statements, receipts, and bills. Take a look at what you spend now, then deduct expenses you won’t have at retirement (perhaps you’ll eliminate a car payment or pay off your mortgage). Then you can tally what’s left to get an estimate of your projected expenses and build a line-item budget.

Step 3: Estimate Retirement Income

To get a sense of your potential retirement income, look at projected monthly withdrawals from Social Security, retirement accounts, pensions, real estate investments (like a rental property), and any savings or part-time income. Total them up to figure out what your monthly income will be.

Step 4: Compare Expected Expenses to Expected Income

Ideally, your expected income will be larger than your projected expenses. If this is not the case, you can remedy this issue by reducing costs or increasing income.

To reduce expenses, you may consider downsizing your home or going from owning two cars to one. You may also consider streamlining entertainment expenses as a better way to cut costs.

To increase income, you may consider taking on a part-time job when you retire or look to passive income sources to boost the money that you have to spend during retirement.

Step 5: Figure Out When You Can Retire

Once you know how much money you may need in retirement and how long you’ll need to save to get there, you can plan a realistic timeline for when you can retire.

Keep in mind that the plan will likely change over time as you get closer to retirement, depending on how much you’re able to save and how your retirement goals change. Along the way, it could be necessary to boost your retirement savings if you decide you want to retire sooner than later, or you find you’re not quite on-track for your planned age.

The Takeaway

Budgeting for retirement can feel overwhelming, but taking it step by step allows you to create a plan for a retirement you’ll enjoy. It’s helpful to know the average monthly costs and to know in which major categories retirees regularly spend. You might be surprised by where you need to budget more, or where costs might be lower than expected.

Ready to start saving to cover your retirement expenses? Consider an investment account with SoFi Invest®. Investors can trade stocks, exchange-traded funds, and even fractional shares. SoFi members also have access to SoFi Financial Planners, who can provide personalized insights and financial advice so members can make the most of their retirement savings.

Learn more about how SoFi Invest can help you save for retirement.

FAQ

What are common expenses in retirement?

Common expenses in retirement include housing, health care, transportation, food, and entertainment. Of course, where you spend — and how much you spend in each category — will vary from retiree to retiree.

What is a reasonable retirement budget?

This depends on a person’s anticipated expenses and the lifestyle they’d like to lead in retirement. That said, the average retiree in America spends $60,593 per year, or $5,049.42 per month.

Which is the biggest expense for most retirees?

The largest cost in retirement is generally housing. Americans who are age 65 and up spend an average of $16,880 per year on housing-related costs.


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

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

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

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.

Advisory services are offered through SoFi Wealth LLC, an SEC-registered investment adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at adviserinfo.sec.gov .

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What Is an Annuity and How Does It Work?

We hear a lot about retirement savings options like IRAs and 401(k) plans, but a less talked about investing strategy for retirement is buying an annuity. An annuity is a contract with an insurance company. The buyer pays into the annuity for a certain number of years, at which point the company pays back the money in monthly payments.

An annuity guarantees a certain amount of monthly income in retirement. In essence, buyers pay the insurance company to take on the risk of them outliving their retirement savings. There are both pros and cons to annuities, as well as a number of types of annuities you can buy.

How Does an Annuity Work?

After signing up for an annuity, the account holder begins making payments, either over time or as a lump sum. The years of paying into an annuity are known as the accumulation phase. Sometimes, the payments can be made from an IRA or 401(k).

The money paid into the annuity account may be invested into the stock market or mutual funds, or it might earn a fixed interest rate over time.

Money paid into the annuity can’t be withdrawn for a certain amount of time, called the surrender period. After the accumulation phase is over, the company begins making regular income payments to the annuity owner. This is known as the distribution phase, or amortization period. Similar to 401(k) accounts, annuity payments begin after age 59 ½; a penalty may apply to withdrawals made before this.

One can choose the length and start date of the distribution phase. For example, you might choose to receive payments for 10 years, or perhaps you prefer guaranteed payments for the rest of your life. Terms and fees depend on the structure of the distribution phase.

Types of Annuities

The main annuity categories are fixed, variable, and indexed, but within those types there are various options and subcategories.

Fixed Annuities

The principal paid into a fixed annuity earns a fixed amount of interest, usually around 5%. Although the interest is typically not as high as the returns one might get from investing in the stock market, this type of annuity provides predictable and guaranteed payments.

Variable Annuities

This type of annuity lets buyers invest in different types of securities, usually mutual funds that hold stocks and bonds. Although this can result in a higher payout if the securities do well, it also comes with the risk of losing everything. Some variable annuities do come with a guarantee that investors will at least get back the money they put in.

Indexed Annuities

An indexed annuity is pegged to a particular index, such as the S&P 500. How the index performs will determine how much the annuity pays out. Usually, indexed annuities cap earnings in order to ensure that investors don’t lose money.

For example, they might cap annual earnings at 6% even if the index performed better than that. But then in a bad year, they would pay out 0% earnings rather than taking a loss, so investors would still receive their base payment amount.

Immediate Annuities

With immediate annuities, investors begin receiving regular payments almost as soon as they open an account. Immediate annuities can be expensive.

Deferred-Income Annuities

This type of annuity, also called a longevity annuity, is for people who are concerned they might outlive their retirement savings. Investors must wait until around age 80 to begin receiving payments, but they are guaranteed payments until they die.

The monthly payouts for deferred-income annuities are much higher than for immediate annuities, but risk is involved. If the investor dies before starting to receive payments, heirs do not receive the money in the annuity account. Married couples might opt for a joint-life version, which has lower monthly payouts but continues payments for as long as either spouse lives.

There is also a deferred annuity called a qualifying longevity annuity contract, which is funded all at once from an investor’s IRA or 401(k). One can invest up to 25% of the money from retirement accounts, or a maximum of $200,000.

Equity-Indexed Annuities

With equity-indexed annuities, investors receive a fixed minimum amount of income. That amount may increase if the index the annuity is pegged to increases.

Fixed Period Annuities

Fixed period annuities allow buyers to receive payments for a specific number of years.

Retirement Annuities

With retirement annuities, investors pay into the account while still working. Once they retire, they begin receiving payments.

Direct-Sold Annuities

These annuities have no sales commission or surrender charge, making them less expensive than other types of annuities.

Pros of Annuities

There are several reasons people choose to pay into annuities as part of their retirement plan. The upsides of annuities include:

•   Guaranteed and predictable payments: Depending on the annuity, a guaranteed minimum income benefit can be set for a specific number of years or for the buyer’s life. Payments may even be made to a buyer’s spouse or other beneficiary in case of death.

•   Tax-deferred growth: Interest earned on annuity deposits is not taxed immediately. Annuity owners generally don’t pay taxes on their principal investment; they pay income taxes on the earnings portion in the year they receive payments.

•   Low-stress management: The annuity company uses an annuity formula to figure out how much each payment should be and to keep track of account balances. All the investor has to do is pay into the account during the accumulation phase.

•   No investment limits or required minimum distributions: Unlike an IRA or 401(k), there is no limit to the amount of money that can be invested into an annuity. Further, there is no specific age at which investors must begin taking payments.

•   Option to bolster other retirement savings: For those closer to retirement, an annuity may be a good option if they’ve maxed out their other retirement savings options and are concerned about having enough money for living expenses.

Cons of Annuities

Like any type of investment, annuities come with downsides:

•   Lower interest compared to stocks or bonds: The interest earned by annuities is generally lower compared to what investors would earn in the stock market or bonds.

•   Penalty for early withdrawals: Once money is invested in an annuity, it can’t be withdrawn without a penalty until age 59 ½.

•   Fees: Annuities can have fees of 3% or more each year. There may also be administrative fees, and fees if the investor wants to change the terms of the contract. It’s important before buying an annuity to know the fees attached and to compare the costs with other types of retirement accounts.

•   Possible challenges in passing on the money: If investors die before they start receiving payments, they miss out on that income. Some annuities pass the money on to heirs, but others do not. There may be a fee for passing the money on.

•   Potential to lose savings in certain circumstances: If the insurance company that sold the annuity goes out of business, the investor will most likely lose their savings. It’s important for investors to research the issuer and make sure it is credible.

•   Inflation isn’t factored in: Annuity payments usually don’t account for inflation. However, some annuities pay out higher amounts over time to account for cost of living increase.

•   Risk: Variable annuities in particular are risky. Buyers could lose a significant amount, or even all of the money they put into them.

•   Complexity: With so many choices, buying annuities can be confusing. The contracts can be dozens of pages long, requiring close scrutiny before purchasing.

What Are Annuity Riders?

When investors buy an annuity, there are extra benefits, called riders, that they can purchase for an additional fee. Optional riders include:

•   Lifetime income rider: With this rider, buyers are guaranteed to keep getting monthly payments even if their annuity account balance runs out. Some choose to buy this rider with variable annuities because there’s a chance that investments won’t grow a significant amount and they’ll run out of money before they die.

•   COLA rider: As mentioned above, annuities don’t usually account for inflation and increased costs of living. With this rider, payouts start lower and then increase over time to keep up with rising costs.

•   Impaired risk rider: Annuity owners receive higher payments if they become seriously ill, since the illness may shorten their lifespan.

•   Death benefit rider: An annuity owner’s heirs receive any remaining money from the account after the owner’s death.

How to Buy Annuities

Annuities can be purchased from insurance companies, banks, brokerage firms, and mutual fund companies. As mentioned, it’s important to look into the seller’s history and credibility, as annuities are a long-term contract.

The buyer can find all information about the annuity, terms, and fees in the annuity contract. If there are investment options, they will be explained in a mutual fund prospectus.

Some of the fees to be aware of when investing in annuities include:

•   Rider fees: If you choose to buy one of the benefits listed above, there will be extra fees.

•   Administrative fees: There may be one-time or ongoing fees associated with an annuity account. The fees may be automatically deducted from the account, so contract holders don’t notice them, but it’s important to know what they are before sealing the deal.

•   Penalties and surrender charges: An annuity owner who wants to withdraw money from an account before the date specified in the contract will be charged a fee. Owners who want to withdraw money before age 59 ½ will be charged a 10% penalty by the IRS as well as taxes on the income from the annuity.

•   Mortality and expense risk charge: Generally annuity account holders are charged about 1.25% per year for the risk that the insurance company is taking on by agreeing to the annuity contract.

•   Fund expenses: If there are additional fees associated with mutual fund investments, annuity owners will have to pay them as well.

•   Commissions: Insurance agents are paid a commission when they sell an annuity. Commissions may be up to 10%.

Building Your Portfolio

No matter what stage of life you’re in, it’s not too early or too late to build an investment portfolio. Younger investors may not be ready to buy into an annuity, but they can still start saving for retirement. For those who are considering an annuity as a retirement investment, it’s important to weigh both the pros and cons. Carefully evaluate the seller, any offered riders, and the fees associated with the annuity.

If you’re feeling torn on where to invest your money, that’s understandable. With so many investing options available, it can be overwhelming to decide how to begin. Fortunately, there are easy-to-use platforms like SoFi Invest®, which offers a full suite of investing tools right at your fingertips.

With just a few clicks, you can buy and sell stocks and build a portfolio. It’s also possible to research and track favorite stocks, set personalized financial goals, and see all of your accounts in one place. SoFi offers active investing, where you pick and choose each security you want to invest in, or automated investing.

Take a step toward reaching your financial goals with SoFi Invest.


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

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

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

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Is Automated Tax-Loss Harvesting a Good Idea?

Automated tax-loss harvesting can be a tool for tax-efficient investing because it involves using an algorithm to sell securities at a loss so as to offset capital gains and potentially lower an investor’s tax bill.

Standard tax-loss harvesting uses the same principle, but the process is complicated and an advisor might only harvest losses once or twice a year versus automated tax-loss harvesting which can be done more frequently.

That said, automated tax-loss harvesting — which is sometimes a feature of robo-advisor accounts — may give investors only limited (or possibly no) tax benefits. Here’s a breakdown of whether an automated tax-loss strategy makes sense.

🛈 Currently, SoFi does not offer automated tax loss harvesting to members.

Tax-Loss Harvesting: The Basics

First, a quick recap of how standard tax-loss harvesting works. Tax-loss harvesting is a way of selling securities at a loss, and then “harvesting” that loss to offset capital gains or other taxable income, thereby reducing federal tax owed.

The reason to consider this strategy is that capital gains are taxed at two different federal tax rates: long-term (when you’ve held an asset for a year or more) and short-term (when you’ve held an asset for under a year).

•   Long-term capital gains are taxed at 0%, 15%, or 20%, depending on the investor’s tax bracket.

•   Short-term capital gains are taxed at a typically higher rate based on the investor’s ordinary income tax rate.

The one-year mark is crucial, because the IRS taxes short-term investments at the higher marginal income tax rate of the investor. For high-income earners that can be 37% plus a 3.8% net investment income tax (NIIT). That means the taxes on those quick gains can be as much as 40.8% — and that’s before state and local taxes are factored in.

Example of Basic Tax-Loss Harvesting

For example, consider an investor in the highest tax bracket who sells security ABC after a year, and realizes a long-term capital gain of $10,000. They would owe 20%, or $2,000.

But if the investor sells XYZ security and harvests a loss of $3,000, that can be applied to the gain from security ABC. So their net capital gain will be $7,000 ($10,000 – $3,000). This means that they would owe $1,400 in capital gains tax.

The differences can be even greater when investors can harvest short-term losses to offset short-term gains, because these are typically taxed at a higher rate. In this case, using the losses to offset the gains can make a big difference in terms of taxes owed.

According to IRS rules, short-term or long-term losses must be used first to offset gains of the same type, unless the losses exceed the gains from the same type. When losses exceed gains, up to $3,000 per year can be used to offset ordinary income or carried over to the following year.

What Is Automated Tax-Loss Harvesting?

Until the advent of robo-advisor services some 15 years ago, tax-loss harvesting was typically carried out by qualified financial advisors or tax professionals in taxable accounts. But as robo-advisors and their automated portfolios became more widely accepted, many of these services began to offer automated tax-loss harvesting as well, though the strategy was executed by a computer program.

Just as the algorithm that underlies an automated portfolio can perform certain basic functions like asset allocation and portfolio rebalancing, some automated programs can execute a tax-loss harvesting strategy as well. SoFi’s automated platform does not offer automated tax-loss harvesting, but others may, for example.

So whereas tax-loss harvesting once made sense only for higher-net-worth investors owing to the complexity of the task, automation has enabled some retail investors to reap the benefits of tax-loss harvesting as well. The idea has been that automated tax-loss harvesting can be conducted more often and with less room for error, thanks to the precision of the underlying algorithm — which can also take into account the effects of the wash-sale rule.

The Wash-Sale Rule

It’s important that investors understand the “wash-sale rule” as it applies to tax-loss harvesting.

What Is the Wash-Sale Rule?

The wash-sale rule prevents investors from selling a security at a loss and buying back the same security, or one that is “substantially identical”, within 30 days. If you sell a security in order to harvest a loss and then replace it with the same or a substantially similar security, the IRS will disallow the loss — and you won’t reap the desired tax benefit.

In the example above, the investor who sells security XYZ in order to apply the loss to the gain from selling security ABC may then want to replace security XYZ because it gives them exposure to a certain market sector. While the investor can’t turn around and buy XYZ again until 30 days have passed, they could buy a similar, but not substantially identical security, to maintain that exposure.

That said, it can be tricky to follow this guidance because the IRS hasn’t established a precise definition of what a “substantially identical security” is. This is another reason why automated tax-loss harvesting may be more efficient: It may be simpler for a computer algorithm to make these choices based on preset parameters.

How ETFs Help With the Wash-Sale Rule

This is how the proliferation of exchange-traded funds (ETFs) has benefited the strategy of tax-loss harvesting. Exchange-traded funds, or ETFs, are baskets of securities that typically track an index of stocks, bonds, commodities or other assets, similar to a mutual fund. Unlike mutual funds, though, ETFs trade on exchanges like stocks.

In some ways, ETFs may make tax-loss harvesting a little easier. For instance, if an investor harvests a loss from an emerging-market stocks ETF, he or she can soon after buy a “similar” but non-identical emerging-market stocks ETF because the fund may have slightly different constituents.

Because most robo-advisors generate automated portfolios comprised of low-cost ETFs, this can also support the process of automated tax-loss harvesting.

Other Important Tax Rules to Know

Tax losses don’t expire. So an investor can apply a portion of losses to offset profits or income in one year and then “save” the remaining losses to offset in another tax year. Investors tend to practice tax-loss harvesting at the end of a calendar year, but it can really be done all year.

As noted above, another potential perk from tax-loss harvesting is that if the losses from an investment exceed any taxable profits from trades, the losses can actually be used to offset up to $3,000 of ordinary income per year.

How Much Does Automated Tax-Loss Harvesting Save?

It’s hard to say whether automated tax-loss harvesting definitively and consistently delivers a reduced tax bill to investors. A myriad of variables — such as the fluctuating nature of both federal tax rates and market price moves — make it difficult to calculate precise figures.

The Upside of Automated Tax-Loss Harvesting

One study of standard (not automated) tax-loss harvesting that was published by the CFA Institute in 2020 found that from 1926 to 2018, a simulated tax-loss harvesting strategy delivered an average annual outperformance of 1.08% versus a passive buy-and-hold portfolio.

Taking into account transaction costs and the wash-sale rule, the outperformance or “alpha” fell to 0.95%.

The study found the strategy did better when the stock market was volatile, such as between 1926 and 1949, a period which includes the Great Depression. The average outperformance was 2.13% a year during that period, as investors found more opportunities to harvest losses. Meanwhile, between 1949 and 1972 — a quieter period in the market as the U.S. underwent economic expansion after World War II — tax-loss harvesting only delivered an alpha of 0.51%.

The Downside of Automated Tax-Loss Harvesting

While the research cited above identifies some benefits of tax-loss harvesting, like many investment studies it’s based on historical data and simulations of a portfolio, not real-world investments.

Another fact to bear in mind: This study does not factor in the impact of automated tax-loss harvesting, which is typically conducted more frequently — and may not deliver a tax benefit.

Indeed, in 2018 the Securities and Exchange Commission (SEC) charged a robo-advisor for making misleading claims about the benefits of automated tax-loss harvesting in terms of higher portfolio returns. Investors should know that there could be no or little tax savings, or even a bigger tax bill, depending on how different securities perform after they’re sold (or bought back).

For instance, if the underlying algorithm that automates trades in a robo portfolio harvests a loss from one ETF (to offset the gains from a sale of another ETF), it might then purchase a replacement ETF that’s not substantially identical, per the wash-sale rule.

If the second ETF is sold later, the gains realized from this second sale could be so high that they cancel out or be greater than the tax benefits from selling the first fund to harvest the loss.

In that case, the investor could end up paying more taxes down the road — effectively deferring, not eliminating, the tax burden.

Continuously trading assets in automated tax-loss harvesting also means an investor may incur additional costs, such as more transaction fees.

Pros of Automated Tax-Loss Harvesting

1.    Standard tax-loss harvesting is complex and time-consuming, but the benefits are well established. Therefore using automated tax-loss harvesting may be an efficient way to reap the benefits of this strategy because it can be done more automatically and consistently.

2.    To realize the benefits of tax-loss harvesting investors must obey the IRS wash-sale rule, which imposes restrictions that can be tricky to follow. In this way, an automated strategy may limit the potential for human error and may increase the tax benefits for investors.

Cons of Automated Tax-Loss Harvesting

1.    Because an algorithm performs tax-loss harvesting on an automated cadence, investors cannot choose which investments to sell and when and therefore have less control.

2.    An automated tax-loss program may not be able to anticipate a security’s future gains that could reduce or eliminate the tax benefit of harvested losses.

3.    Automated tax-loss harvesting could increase the amount an investor pays in transaction fees, which can lower portfolio returns.

The Takeaway

Automated tax-loss harvesting is a feature primarily offered by robo-advisors, which use a computer algorithm to automatically sell securities at a loss in order to potentially reduce the tax impact of capital gains realized from the sale of other securities.

While this practice can offer tax benefits in some cases, and academic studies have used portfolio simulations to gauge the potential for outperformance, it’s unclear whether automated tax-loss harvesting offers the same benefits. Because the strategy is carried out by an underlying algorithm, a computer program may not be capable of making more nuanced choices about which assets to sell and when.

Investors could potentially end up still owing capital gains taxes or paying more in transaction fees and brokerage fees.


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.

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.

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

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Investing in the Pharmaceutical Industry

The pharmaceutical industry, with nearly $1.5 trillion in global sales a year, offers many opportunities for investors. Some pharma stocks provide dividends, while others have potential for significant growth. Beyond these potential upsides, investing in pharmaceuticals also helps expand health care for people around the world.

But as with any industry, pharmaceutical stocks have risks, and investors would be wise to research each company before they buy stock. Here’s some key information about the industry and ways to find pharmaceutical stocks for interested investors.

An Intro to the Pharmaceutical Industry

Pharmaceutical companies research, develop, make, and sell medications, including preventive medicines, treatments, and vaccines. Two segments of therapeutics make up the industry: pharmaceuticals and biologics. It’s also important to know the difference between pharmaceutical stocks and biotech stocks.

Pharmaceutical drugs are tablets or pills made out of synthetic or plant-based chemicals. Because they are small and fairly easy to make, companies can produce hundreds of thousands of them. When drugs are first approved, they generally have a patent or market exclusivity, meaning that only the pharma company that developed them can manufacture and sell the drugs.

Once the patent or exclusivity ends, other companies can create generic forms of the drug and begin to compete with the pharma company. The generic drugs are chemical copies of the original drug but sell at lower prices, making it hard for the original pharma company to compete. This can lead to its stock losing value.

Meanwhile, biologics are products such as vaccines, gene therapies, and medications for blood disorders that are large, protein-based molecules made out of living cells. Biologics are more complex to manufacture, which is one reason they’re more expensive.

They also have tighter restrictions on distribution than pharmaceuticals do. These factors make it more challenging for companies to enter this space and for competitors to succeed. If competitors do create a similar product, it is called a biosimilar. Unlike generics, biosimilars aren’t interchangeable, so biologics don’t have the same stock drop-off that pharmaceuticals do.

It takes about 10 years and an average of $1.3 billion to $2.8 billion to bring a new drug to market, but in special circumstances, the FDA can expedite approval.

Why Invest in Pharmaceuticals?

With pharmaceuticals, whether investors are looking for high growth potential, long-term value, or stable dividends, they can find a pharma stock that will fit the bill. There are hundreds of early-stage and established stocks, mutual funds, and exchange-traded funds out there.

About 10,000 Americans turn 65 every day, according to the AARP. And by 2030, the country will have more residents 65 and older than children, the Census Bureau has projected.

This means more people needing health care and pharmaceutical drugs, which in turn is expected to make pharma stocks grow. U.S. health spending is projected to reach nearly $6.8 trillion by 2030, according to the Centers for Medicare & Medicaid Services.

Pharmaceutical stocks don’t always follow the same trends as other stocks because people need medications no matter what is going on in the market. This doesn’t mean that pharma stocks always perform better than the broader market, but sometimes they don’t follow the same lines. Certain pharmaceutical exchange-traded funds (ETFs) have historically performed quite a bit better than the S&P 500 Index.

The health care sector can perform well during tough economic times, since people always need health care no matter what is going on in the world. About 49% of people in the U.S. report having used at least one prescription drug in the past 30 days, with 24% using three or more, according to the Centers for Disease Control and Prevention.

This translates to the companies that make those drugs consistently earning revenue even when the rest of the stock market is down. Larger companies have fairly consistent income streams, while smaller companies that show promise get funding from investors and sometimes get acquired by larger companies.

A few other reasons pharmaceutical stocks look promising as a long-term investment are:

•   People are living longer, and the majority of elderly Americans take prescription medications. The longer people live, the more years they will be paying for those drugs.

•   The health care sector is expanding in countries outside the United States.

•   The government has been spending more on health care research.

•   New types of therapies, such as gene therapy, are getting more sophisticated. Some of these are very expensive.

How to Choose Pharmaceutical Stocks

With so much potential in pharma, it can be difficult to navigate the hype and figure out what’s really a good investment. Billions of dollars are invested in medical research and drugs each year. But not every company becomes a success.

As with any stocks, investors will want to research pharma stocks before buying. Here are a few key factors to look at when evaluating stocks.

Growth Prospects

By looking at a company’s earnings and revenue, one can see how much it’s been growing and whether growth is slowing down. Investors can also look into each company’s pipeline to see how close to market a drug being developed is.

Pharma companies have to go through certain steps to develop, test, and get drugs approved. They often make pipelines available to the public, so investors can see which drugs are in the early stages of development, preclinical testing, going through clinical trials in humans, or getting FDA approval or other necessary regulatory approvals.

Drugs may get approval for treatment of certain diseases or for specific demographics, but the makers can then apply for approval for additional uses. If they get the expanded approval, this can lead to growth for the company.

Knowing when to buy stocks is challenging, and trying to time the market generally isn’t a good strategy. That said, investors can follow different pharmaceutical companies to see when they have the potential to grow and become successful. If a pharma company has patents that are close to expiring, for instance, this may slow down growth, as competitors can create generic forms of the same drugs.

The process companies go through to develop and bring drugs to market is generally as follows:

•   Drug discovery: During this phase, drugs and the diseases they can potentially treat are discovered.

•   Preclinical trials: Potential drugs get tested in test tubes or on live animals.

•   Clinical trials: Small human trials determine a safe dosage and how humans react to it. Then, groups of 100 or more people test the drug to discover short-term side effects and optimal dosage. Finally, groups of hundreds or thousands of people test the drug to determine efficacy and safety. When drugs reach the clinical trial stage, this could be a good time for investors to keep an eye on them. If a drug makes it through trials, the company has potential for significant growth. But if the drug fails during testing, the stock is unlikely to do well.

•   Regulatory approval: In the United States, the Food and Drug Administration’s Center for Drug Evaluation and Research assesses and approves new drugs, and in the EU, approval is completed by the European Medicines Agency. If the benefits of the drug outweigh the side effects and risks, and the drug is a good alternative or additional treatment for the disease it is targeting, these agencies will consider approving the drug.

Types of FDA Application

There are different types of pharmaceutical FDA applications, some of which give companies more potential for stock growth than others. The application types are:

•   Investigational new drug application: This is the first application step that companies must go through.

•   New drug application: This is an application to market and sell a new drug. Companies filing this application have the most potential for stock growth because they are introducing a new product to market.

•   Abbreviated new drug application: Companies developing a generic form of an existing drug go through this application.

•   Therapeutic biologics application: This is required under the PHS Act for biologics.

•   Over-the-counter drug application: This is for companies looking to sell over-the-counter drugs, which are categorized as being safe to distribute without a prescription.

Dividends

Not all pharmaceutical companies pay dividends, but some of them do provide consistent payouts to investors. The dividends can add up.

Qualitative and Quantitative Metrics

The same rules apply to pharmaceutical stocks as to any other stock when it comes to evaluation. Investors should look at a company’s valuation, revenues, growth, leadership team, product pipeline, and other key metrics to decide whether to invest. Stock valuation ratios, such as price-to-earnings ratio and price-to-earnings-growth ratio, are very useful when comparing different stocks within the same industry.

However, some pharmaceutical companies are not yet profitable if they are in the drug development and trial phases. In this case, investors can look at the rate of cash burn: how much money the company is spending each quarter to develop a drug. It’s very expensive to develop a drug, so if a company is burning through cash and doesn’t have much left to work with, this might not bode well for the stock.

Another useful metric to look at is the price-to-sales ratio. This compares a company’s sales to the price of its stock. If the company doesn’t have sales yet, investors can make predictions about what those sales figures might look like.

Trends and Developments

Over time, trends in the types of diseases being targeted and the types of therapies being developed change. Investors can look into stocks in popular areas of treatment to find stocks with growth potential.

For instance, many drugs are in development to treat breast cancer and non-small-cell lung cancer. Treatments that are bringing in significant revenue globally include oncologics, antidiabetics, respiratory therapies, and autoimmune disease drugs. Additional lucrative treatment areas include antibiotics, anticoagulants, pain, and mental health.

Risks of Investing in Pharmaceutical Stocks

As with any type of investment, pharma stocks come with some risks. Some of the main risks to be aware of are:

•   Clinical failure: Many drugs don’t make it through the phases of clinical trials. If a drug has made it to the final stage, it’s more likely to succeed, but even at this phase, drugs can fail.

•   Inability to obtain approval: Just because a drug does well in trials doesn’t mean it will be approved by regulatory agencies.

•   Difficulties getting reimbursement and pricing drugs: Health insurance companies, government programs, or individuals must cover the cost of drugs, and companies aren’t always able to secure the money they need. Sometimes, companies are pressured to lower the price of drugs to make them more accessible, and this can result in financial struggles for the company.

•   Industry competition: As mentioned, when patents run out, pharma companies can struggle to keep up with competitors that develop cheaper generic versions of drugs. In addition, during the drug development phase, it’s not uncommon for multiple companies to be working on medications to treat the same illness. If one company can make it to trials or get approval first, this can put them way ahead of the competition, especially if it results in patent exclusivity.

•   Litigation and liability: In the pharmaceutical industry, lawsuits are common. Drugs can also be recalled from the market if they’re found to be unsafe.

Investing in Pharmaceutical Stocks

If you’re looking to start investing in the pharmaceutical industry, you might consider buying pharmaceutical ETFs. Or, you could do your due diligence and choose individual stocks, aiming for stable dividends or growth potential. Before investing, it helps to familiarize yourself with the pharmaceutical industry to better understand how to choose pharma investments, and also ensure you understand the potential risks of investing in pharmaceutical stocks.

Online platforms are a great tool to use if you’re investing in ETFs and other stocks, whether in the pharmaceutical industry or elsewhere. SoFi Invest®, for instance, offers a suite of tools to track specific stocks, select individual stocks, trade fractions of stocks, or purchase ETFs.

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


SoFi Invest®

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

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

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

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.

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

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Participating Preferred Stock, Explained

You may have heard mention of preferred shareholders or preferred stocks in investment circles. And you may have wondered: How do I get preferred stocks? Preferred stocks are available to individual investors. That being said, there is a type of preferred stocks that may be out of reach to most, and that’s participating preferred stocks.

Here’s a look at what participating preferred stock is, as well as when one might have the option to own participating preferred stock and what the benefits of participating preferred stock are.

What Is Preferred Stock?

Preferred stock shares characteristics of both common stocks and bonds. Preferred stocks allow investors to own shares in a given company and also receive a set schedule of dividends (much like bond interest payments).

Because the payout is predictable and expected, there isn’t the same potential for price fluctuations as with common stocks — and thus there’s less potential for volatility. But, the shares may rise in value over time.

Recommended: Preferred Stock vs. Common Stock

How Preferred Stocks Work

Shares of preferred stock tend to pay a fixed rate of dividend. Preferred stocks have dividend preference; they’re paid to shareholders before dividends are paid out to common shareholders.

These dividends may or may not be cumulative. If they are, all unpaid preferred stock dividends must be paid out prior to common stock shareholders receiving a dividend.

For example, if a company has not made dividend payments to cumulative preferred stock shareholders for the previous two years, they must make two years’ worth of back payments and the current year’s dividend payments to preferred shareholders before common stock shareholders are paid any dividend at all.

Because of the fixed nature of the dividend, the investments themselves tend to behave more like how a bond works. When an investment pays a fixed and predictable rate of interest, they tend to trade in a smaller and more predictable bandwidth. Compare that to stocks, whose future income stream and total return on investment are less predictable, which lends itself to plenty of price disagreement in the short-term.

Preferred stockholders do not typically enjoy voting rights at shareholder meetings. But, preferred stock shareholders are paid out before common shareholders in a liquidity event.

Participating Preferred Stocks

Participating preferred stock takes on all of the above features, but they may receive some bonus benefits, such as an additional dividend payment. This additional payment may be triggered when certain conditions are met, often involving the common stock. For example, an additional dividend may be paid out in the event that the dividend paid to common shareholders exceeds a certain level.

Upon liquidation, participating preferred shareholders may receive additional benefits, usually in excess of what was initially stated. For example, they may have the right to get back the value of the stock’s purchasing price. Or, participating preferred shareholders may have access to some pro-rata cut of the liquidation proceeds that would otherwise go to common stock shareholders.

Non-participating preferred stocks do not get additional consideration for dividends or benefits during a liquidation event.

For those with access, participating preferred stock is an enticing investment. That said, the average individual investor may not have the chance to invest in participating preferred stock. This type of stock is typically offered as an incentive for private equity investors or venture capital firms to invest in private companies.

The Takeaway

Preferred stock offers some benefits that common stock does not — such as a regular dividend schedule and the potential to increase in value without threat of volatility. Participating preferred stock offers investors even more potential benefits, including additional dividends and the opportunity to participate in liquidity events. However, participating preferred stocks are generally an option only for private equity investors or venture capitalists.

Though an investor might not have the chance to get involved with this particular investment opportunity, there are other ways to trade stocks online and invest in the market. SoFi Invest® offers both active investing and automated investing options to suit every type of investor.

Take a step toward reaching your financial goals with SoFi Invest.


SoFi Invest®

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

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

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

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