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SEP IRA vs SIMPLE IRA: Differences & Pros and Cons

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 The money can be withdrawn during retirement to cover living expenses and other costs.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. In 2025, employers can contribute up to $70,000 or 25% of an employee’s salary, 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, and in 2025, the contribution limit is $70,000.

•   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.

Get a 1% IRA match on rollovers and contributions.

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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.

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, and up to a limit of $350,000 in 2025.

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. In 2025, the annual contribution limit is $16,500, and 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.

•   Employers are required to fund employees’ accounts.

•   The SIMPLE IRA contribution limit ($16,000 in 2024, and $16,500 in 2025) is much lower than the SEP IRA contribution limit ($69,000 in 2024, and $70,000 in 2025).

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, and up to a limit of $350,000 in 2025.

With a SEP IRA, employers can contribute up to 25% of an employee’s annual salary or $69,000 in 2024, whichever is less. In 2025, an employer can contribute up to 25% of an employee’s annual salary or $70,000, whiever 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, and up to $70,000 in 2025, whichever is less

No catch-up contributions

$16,000 per year in 2024, and $16,500 in 2025

Catch-up contributions of $3,500 for those 50 and up in 2024 and 2025

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.

SoFi Invest®

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

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

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What Is The Difference Between a Pension and 401(k) Plan?

401(k) vs Pension Plan: Differences and Which is Better For You

A 401(k) plan is a retirement savings plan in which employees contribute to a tax-deferred account via paycheck deductions (and often with an employer match). A pension plan is a different kind of retirement savings plan in which a company sets money aside to give to future retirees.

Over the past few decades, defined-contribution plans like the 401(k) have steadily replaced pension plans as the private-sector, employer-sponsored retirement plan of choice. While both a 401(k) plan and a pension plan are employer-sponsored retirement plans, there are some significant differences between the two.

Here’s what you need to know about a 401(k) vs. pension.

Key Points

•   A 401(k) is primarily funded by employee contributions, often matched by employers, whereas pensions are predominantly employer-funded.

•   Pensions guarantee a fixed income for life, unlike 401(k)s where the value depends on contributions and investment performance.

•   Employees can choose their 401(k) investments, but employers control pension fund investments.

•   Annual contribution limits for 401(k)s in 2025 are $23,500, or $31,000 for those 50 and older (including the $7,500 catch-up amount). Thanks to SECURE 2.0, those ages 60 to 63 can make a “super catch-up” contribution, up to $11,250 instead of $7,500.

•   Pensions offer a stable retirement income, but 401(k)s provide more control over investment choices and potential growth.

What Is the Difference Between a Pension and a 401(k)?

The main distinction between a 401(k) vs. a pension plan is that pension plans are largely employer driven, while 401(k)s are employee driven.

These are some of the key differences between the two plans.

Pension

401(k)

Funding Typically funded by employers Funded mainly by the employee; employer may offer a partial matching contribution
Annual Contribution Limits No more than $275,000 in 2024 or 100% of employee’s average compensation for the highest 3 consecutive years $23,000 in 2024 and $23,500 in 2025; for those 50 and up it’s $30,500 and $31,000. And in 2025, those aged 60 to 63 may contribute an additional $11,250 instead of $7,500, thanks to SECURE 2.0.
Investments Employers choose the investments for the plan Employees choose the investments from a list of options
Value of the Plan Set amount designed to be guaranteed for life Determined by how much the employee contributes, the investments they make, and the performance of the investments

Funding

Employees typically fund 401(k) plans through regular contributions from their paychecks to help save for retirement, while employers typically fund pension plans.

Investments

Employees can choose investments (from several options) in their 401(k). Employers choose the investments that fund a pension plan.

Value

The value of a 401(k) plan at retirement depends on how much the employee has saved, in addition to the performance of the investments over time. Pensions, on the other hand, are designed to guarantee an employee a set amount of income for life.


💡 Quick Tip: The advantage of opening an IRA and a tax-deferred account like a 401(k) or traditional IRA is that by the time you retire, you’ll have tax-free income from your Roth, and taxable income from the tax-deferred account. This can help with tax planning.

Pension Plan Overview

A pension plan is a type of retirement savings plan where an employer contributes funds to an investment account on behalf of their employees. The earnings are paid out to the employees once they retire.

Types of Pension Plans

There are two common types of pension plans:

•   Defined-benefit pension plans, also known as traditional pension plans, are the most common type of pension plans. These employer-sponsored retirement investment plans are designed to guarantee the employee will receive a set benefit amount upon retirement (usually calculated with set parameters, i.e. employee earnings and years of service). Regardless of how the investment pool performs, the employer guarantees pension payments to the retired employee. If the plan assets aren’t enough to pay out to the employee, the employer is typically on the hook for the rest of the money.

According to the IRS, annual contributions to a defined-benefit pension plan cannot exceed 100% of the employee’s average compensation for the highest three consecutive calendar years of their employment or $275,000 for 2024, $280,000 for 2025.

•   Defined-contribution pension plans are employer-sponsored retirement plans to which employers make plan contributions on their employee’s behalf and the benefit the employee receives is based solely on the performance of the investment pool. Meaning: There is no guarantee of a set monthly payout.

Like 401(k) plans, employees can contribute to these plans, and in some cases, employers match the contribution made by the employee. Unlike defined-benefit pension plans, however, the employee is not guaranteed a certain amount of money upon retirement. Instead, the employee receives a payout based on the performance of the investments in the fund.

Recommended: What Is a Money Purchase Pension Plan (MPPP)?

When it comes to pension plan withdrawals, employees who take out funds before the age of 59 ½ must pay a 10% early withdrawal penalty as well as standard income taxes. This is similar to the penalties and taxes associated with early withdrawal from a traditional 401(k) plan.

Pros and Cons

There are benefits to and drawbacks of pension plans. It’s important to understand both in order to maximize your participation in the plan.

Advantages of a pension plan include:

Funded by employers

For employees, a pension plan is retirement income from your employer. In most cases, an employee does not need to contribute to a defined-benefit pension plan in order to get consistent payouts upon retirement.

Higher contribution limits

When compared to 401(k)s, defined-contribution pension plans have significantly higher contribution limits and, as such, present an opportunity to set aside more money for retirement.

A set amount in retirement

A pension plan typically provides employees with regular fixed payments in retirement,usually for life.

Disadvantages of a pension plan include:

Lack of control

Employees can’t choose how the money in a pension plan is invested. If the investments don’t pan out, the plan could struggle to pay out the funds.

Vesting

Employees may need to work for the employer for a set number of years to become fully vested in the plan. If you leave the company before then, you might end up forfeiting the pension funds. Find out what the vesting schedule is for your pension plan.

Earnings and years employed

How much an employee gets in retirement with a pension plan generally depends on their salary and how long they work for the employer.

401(k) Overview

A traditional 401(k) plan is a tax-advantaged defined-contribution plan where workers contribute pre-tax dollars to the investment account via automatic payroll deductions. These contributions are sometimes fully or partially matched by their employers, and withdrawals are taxed at the participant’s marginal tax rate.

With a 401(k), employees and employers may both make contributions to the account (up to a certain IRS-established limit), but employees are responsible for selecting the specific investments. They can typically choose from offerings from the employer, which may include a mixture of stocks and bonds that vary in levels of risk depending on when they plan to retire.

Recommended: 401(a) vs 401(k): What’s the Difference?

Contribution Limits and Withdrawals

To account for inflation, the IRS periodically adjusts the maximum amount an employer or employee can contribute to a 401(k) plan.

•  For 2024, annual employee contributions can’t exceed $23,000 for workers under 50, and $30,500 for workers 50 and older (this includes a $7,500 catch-up contribution). The total annual contribution by employer and employee in 2024 is capped at $69,000 for workers under 50, and $76,500 for workers 50 and over.

•   For 2025 the total employer + employee limit is $70,000, $77,500 with standard catch-up, or $81,250 with the SECURE 2.0 catch-up for those ages 60 to 63 only.

Some plans allow employees to make additional after-tax contributions to their 401(k) plan, within the contribution limits outlined above.

•   Money can be withdrawn from a 401(k) in retirement without penalties. But taxes will be owed on the funds withdrawn. The IRS considers the removal of 401(k) funds before the age of 59 ½ an “early withdrawal.” The penalty for removing funds before that time is an additional tax of 10% of the withdrawal amount (there are exceptions, notably a hardship distribution, where plan participants can withdraw funds early to cover “immediate and heavy financial need”).

Pros and Cons

While a 401(k) plan might not offer as clearly-defined a retirement savings picture as a pension plan, it still comes with a number of upsides for participants who want a more active role in their retirement investments.

Advantages of a 401(k) include:

Self-directed investment opportunities

Unlike employer-directed pension plans, in which the employee has no say in the investment strategy, 401(k) plans offer participants more control over how much they invest and where the money goes (within parameters set by their employer). Plans typically offer a selection of investment options, including mutual funds, individual stocks and bonds, exchange traded funds (ETFs).

Tax advantages

Contributions to a 401(k) come from pre-tax dollars through payroll deductions, reducing the gross income of the participant, which may allow them to pay less in income taxes. Also, 401(k) contributions and earnings in the plan may grow tax-deferred.

Employer matching

Many 401(k) plan participants are eligible for an employer match up to a certain amount, which essentially means free money.

Disadvantages of a 401(k) include:

No guaranteed amount in retirement

How much you have in your 401(k) by retirement depends on how much you contributed to the plan, whether your employer offered matching funds, and how the investments you chose fared.

Contributions are capped

The amount you can contribute to a 401(k) annually is capped by the IRS, as described above.

Less stability

How the market performs generally affects the performance of 401(k) investments. That could make it difficult to know how much money you’ll have for retirement, which could complicate retirement planning.


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

Which Is Better, a 401(k) or a Pension Plan?

When considering a 401(k) vs. pension, most people prefer the certainty that comes with a pension plan.

But for those who seek more control over their retirement savings and more investment vehicles to choose from, a 401(k) plan could be the more advantageous option.

In the case of the 401(k), it really depends on how well the investments perform over time. Without the safety net of guaranteed income that comes with a pension plan, a poorly performing 401(k) plan has a direct effect on a retiree’s nest egg.

Did 401(k)s Replace Pension Plans?

The percentage of private sector employees whose only retirement account is a defined benefit pension plan is just 4% today, versus 60% in the early 1980s. The majority of private sector companies stopped funding traditional pension plans in the last few decades, freezing the plans and shifting to defined-contribution plans like 401(k)s.

When a pension fund isn’t full enough to distribute promised payouts, the company still needs to distribute that money to plan participants. In several instances in recent decades, pension fund deficits for large enterprises like airlines and steel makers were so enormous they required government bailouts.

To avoid situations like this, many of today’s employers have shifted the burden of retirement funding to their workers.

What Happens to a 401(k) or Pension Plan If You Leave Your Job?

With a 401(k), if you leave your job, you can take your 401(k) with you by rolling it over to your new employer’s 401(k) plan or into an IRA. The process is fairly easy to do.

If you leave your job and you have a pension plan, however, the plan generally stays with your employer. You’ll need to keep track of it through the years and then apply in retirement to begin receiving your money.

The Takeaway

Pension plans are employer-sponsored, employer-funded retirement plans that are designed to guarantee a set income to participants for life. On the other hand, 401(k) accounts are employer-sponsored retirement plans through which employees make their own investment decisions and, in some cases, receive an employer match in funds. The post-retirement payout varies depending on market fluctuations.

While pension plans are far more rare today than they were in the past, if you have worked at a company that offers one, that money will still come to you after retirement even if you change jobs, as long as you stayed with the company long enough for your benefits to vest.

Some people have both pensions and 401(k) plans, but there are also other ways to take an active role in saving for retirement. An IRA is an alternative to 401(k) and pension plans that allows anyone to open a retirement savings account. IRAs have lower contribution limits but a larger selection of investments to choose from. And it’s possible to have an IRA in addition to a 401(k) or pension plan.

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

Can you have both a 401(k) and a pension plan?

Yes. An individual can have both a pension plan and a 401(k) plan, though the two plans may not be from the same employer. If an employee leaves a company after becoming eligible for a pension and opens a 401(k) with a new employer, their previous employer will still typically maintain their pension. An employee can access the pension funds by applying for them in retirement.

How much should I put in my 401k if I have a pension?

If you have both a pension and a 401(k), it’s wise to contribute as much as you can to your 401(k) up to the annual contribution limit. While a pension can help supplement your retirement income, it may not be enough to cover all your retirement expenses, so contributing to your 401(k) can help fill the gap. One rule of thumb says to contribute at least 10% of your salary to a 401(k) if possible to help ensure that you’ll have enough savings for retirement.


Photo credit: iStock/Sam Edwards

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

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

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

SoFi Invest®

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

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


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

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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Roth IRA Conversion: Rules and Examples

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

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

What Is a Roth IRA Conversion?

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

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

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

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

How Does a Roth IRA Conversion Work?

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

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

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

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

Get a 1% IRA match on rollovers and contributions.

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


1Terms and conditions apply. Roll over a minimum of $20K to receive the 1% match offer. Matches on contributions are made up to the annual limits.

Roth IRA Conversion Rules

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

Taxes

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

Limits

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

Second, Roth IRAs have contribution limits. For instance, in 2024 and 2025, you can typically contribute up to $7,000, or up to $8,000 if you’re 50 or older.

Withdrawals

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

Backdoor Roth IRAs

A Roth IRA conversion may be an option to consider if you earn too much money to otherwise be eligible for a Roth IRA. Roth IRAs have contribution phase-out ranges, and individuals whose income exceeds those limits cannot contribute to a Roth fully or at all. For 2024, the income limits begin to phase out at $230,000 for those who are married and filing jointly, and $146,000 for those who are single. For 2025, the income limits phase-out begins at $236,000 for those who are married and filing jointly, and $150,000 for single filers.

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

5-Year Rule

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

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

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

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

Is Converting to a Roth IRA Right for You?

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

Reasons For

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

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

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

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

Reasons Against

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

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

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

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

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

The Takeaway

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

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

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

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

FAQ

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

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

How many Roth iRA conversions are allowed per year?

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

When is the deadline for Roth IRA conversions?

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

Is there a loophole for Roth IRA conversions?

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

How do I avoid taxes on Roth conversion?

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

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

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

Do you have to pay taxes immediately on Roth conversion?

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

Should a 65 year old do a Roth conversion?

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

Does a Roth conversion affect my Social Security?

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

Does a Roth conversion affect Medicare premiums?

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

What is the best Roth conversion strategy?

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

Can you do Roth conversions after age 72?

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

How do I calculate my Roth conversion basis?

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

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

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


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

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

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

SoFi Invest®

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

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

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IRA vs 401(k): What Is the Difference?

IRA vs 401(k): What Is the Difference?

The biggest difference between an IRA vs. a 401(k) is the amount you can save. You can save over three times as much in a 401(k) vs. an IRA — $23,000 versus $7,000 for tax year 2024, and $22,500 versus $6,500 for tax year 2023. But not everyone has access to a 401(k), because these are sponsored by an employer, typically for full-time employees.

“A 401(k) is probably one of the most common retirement vehicles,” says Brian Walsh, a CFP® at SoFi. “A 401(k) will be available through work. Your employer is going to choose whether or not to make a 401(k) available to all the employees. Generally speaking, 401(k)s are the most popular retirement plan employers provide.”

Other than that, a traditional IRA and a 401(k) are similar in terms of their basic provisions and tax implications. Both accounts are considered tax deferred, which means you can deduct the amount you contribute each year — unless you have a Roth account, which has a different tax benefit.

Before you decide whether one or all three types of retirement accounts might make sense for you, it helps to know all the similarities and differences between a 401(k) and a traditional IRA and Roth IRA.

Key Points

•   An IRA (Individual Retirement Account) and a 401(k) are both retirement savings accounts, but they have different features and eligibility requirements.

•   IRAs are typically opened by individuals, while 401(k)s are offered by employers to their employees.

•   IRAs offer more investment options and flexibility, while 401(k)s may have employer matching contributions and higher contribution limits.

•   Both accounts offer tax advantages, but the timing of tax benefits differs: IRAs provide tax benefits during retirement, while 401(k)s offer tax benefits upfront.

•   Choosing between an IRA and a 401(k) depends on factors like employment status, employer contributions, investment options, and personal financial goals.

How Are IRAs and 401(k)s Different?

The government wants you to prioritize saving for retirement. As a result, they provide tax incentives for IRAs vs. 401(k)s.

In that respect, a traditional IRA and a 401(k) are somewhat similar; both offer tax-deferred contributions, which may lower your taxable income, and tax-deferred investment growth. Also, you owe taxes on the money you withdraw from these accounts in retirement (or beforehand, if you take an early withdrawal).

There is a bigger difference between a Roth IRA and a 401(k). Roth accounts are funded with after-tax contributions — so they aren’t tax deductible. But they provide tax-free withdrawals in retirement.

And while you can’t withdraw the contributions you make to a traditional IRA until age 59 ½ (or incur a penalty), you can withdraw Roth contributions at any time (just not the earning or growth on your principal).

These days, you may be able to fund a Roth 401(k), if your company offers it.

Get a 1% IRA match on rollovers and contributions.

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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.

Other Key Differences Between IRAs and 401(k)s

As with anything that involves finance and the tax code, these accounts can be complicated. Because there can be stiff penalties when you don’t follow the rules, it’s wise to know what you’re doing.

Who Can Set Up a 401(k)?

As noted above, a key difference between an IRA and a 401(k) is that 401(k)s are qualified employer-sponsored retirement plans. You typically only have access to these plans through an employer who offers them as part of a full-time compensation package.

In addition, your employer may choose to provide matching 401(k) funds as part of your compensation, which is typically a percentage of the amount you contribute (e.g. an employer might match 3%, dollar for dollar).

Not everyone is a full-time employee. You may be self-employed or work part-time, leaving you without access to a traditional 401(k). Fortunately, there are other options available to you, including solo 401(k) plans and opening an IRA online (individual retirement accounts).

Who Can Set Up an IRA?

Anyone can set up an individual retirement account (IRA) as long as they’re earning income. (And if you’re a non-working spouse of someone with earned income, they can set up a spousal IRA on your behalf.)

If you already have a 401(k), you can still open an IRA and contribute to both accounts. But if you or your spouse (if you’re married) are covered by a retirement plan at work, you may not be able to deduct the full amount of your IRA contributions.

Understanding RMDs

Starting at age 73 (for those who turn 72 after December 31, 2022), you must take required minimum distributions (RMDs) from your tax-deferred accounts, including: traditional IRAs, SEP and SIMPLE IRAs, and 401(k)s. Be sure to determine your minimum distribution amount, and the proper timing, so that you’re not hit with a penalty for skipping it.

It’s worth noting, though, that RMD rules don’t apply to Roth IRAs. If you have a Roth IRA, or inherit one from your spouse, the money is yours to withdraw whenever you choose. The rules change if you inherit a Roth from someone who isn’t your spouse, so consult with a professional as needed.

However, RMD rules do apply when it comes to a Roth 401(k), similar to a traditional 401(k). The main difference here, of course, is that the Roth structure still applies and withdrawals are tax free.

A Closer Look at IRAs

An IRA is an individual retirement account that has a much lower contribution limit than a 401(k) (see chart below). Anyone with earned income can open an IRA, and there are two main types of IRAs to choose from: traditional and Roth accounts.

Self-employed people can also consider opening a SEP-IRA or a SIMPLE IRA, which are tax-deferred accounts that have higher contribution limits.

Traditional IRA

Like a 401(k), contributions to a traditional IRA are tax deductible and may help lower your tax bill. In 2024, IRA contribution limits are $7,000, or $8,000 for those aged 50 or older. In 2023, IRA contribution limits are $6,500, or $7,500 for those aged 50 or older.

With a traditional IRA, investments inside the account grow tax-deferred. And unlike 401(k)s where an employer might offer limited options, IRAs are more flexible because they are classified as self-directed and you typically set up an IRA through a brokerage firm of your choice.

Thus it’s possible to invest in a wider range of investments in your IRA, including stocks, bonds, mutual funds, exchange-traded funds, and even real estate.

When making withdrawals at age 59 ½, you will owe income tax. As with 401(k)s, any withdrawals before then may be subject to both income tax and the 10% early withdrawal penalty.

What Are Roth Accounts?

So far, we’ve discussed traditional 401(k) and IRA accounts. But each type of retirement account also comes in a different flavor — known as a Roth.

The main difference between traditional and Roth IRAs lies in when your contributions are taxed.

•   Traditional accounts are funded with pre-tax dollars. The contributions are tax deductible and may provide an immediate tax benefit by lowering your taxable income and, as a result, your tax bill.

•   Money inside these accounts grows tax-deferred, and you owe income tax when you make withdrawals, typically when you’ve reached the age of 59 ½.

Roth accounts, on the other hand, are funded with after-tax dollars, so your deposits aren’t tax deductible. However, investments inside Roth accounts also grow tax-free, and they are not subject to income tax when withdrawals are made at or after age 59 ½.

As noted above, Roths have an additional advantage in that you can withdraw your principal at any time (but you cannot withdraw principal + earnings until you’ve had the account for at least five years, and/or you’re 59 ½ or older — often called the five-year rule).

Roth accounts may be beneficial if you anticipate being in a higher tax bracket when you retire versus the one you’re in currently. Then tax-free withdrawals may be even more valuable.

It’s possible to hold both traditional and Roth IRAs at the same time, though combined contribution limits are the same as those for traditional accounts. And those limits can’t be exceeded.

Additionally, the ability to fund a Roth IRA is subject to certain income limits: above a certain limit you can’t contribute to a Roth. There are no income limits for a designated Roth 401(k), however.

A Closer Look at a 401(k)

Contributions to your 401(k) are made with pre-tax dollars. This makes them tax-deductible, meaning the amount you save each year can lower your taxable income in the year you contribute, possibly resulting in a smaller tax bill.

In 2024, you can contribute up to $23,000 to your 401(k). If you’re 50 or older, you can also make catch-up contributions of an extra $7,500, for a total of $30,500. In 2025, you can contribute up to $23,500 each year to your 401(k). If you’re 50 or older, you can also make catch-up contributions of an extra $7,500, for a total of $31,000. For 2025, those aged 60 to 63 may contribute an additional $11,250 instead of $7,500, thanks to SECURE 2.0, for a total of $34,750,

401(k) catch-up contributions allow people nearing retirement to boost their savings. In addition to the contributions made, an employer can also match their employee’s contribution, up to a combined employer and employee limit of $69,000 in 2024 and $70,000 in 2025.

An employer may offer a handful of investment options to choose from, such as exchange-traded funds (ETFs), mutual funds, and target date mutual funds. Money invested in these options grows tax-deferred, which can help retirement investments grow faster.

When someone begins taking withdrawals from their 401(k) account at age 59 ½ (the earliest age at which you can start taking penalty-free withdrawals), those funds are subject to income tax. Any withdrawals made before 59 ½ may be subject to a 10% early withdrawal penalty, on top of the tax you owe.

When Should You Use a 401(k)?

If your employer offers a 401(k), it may be worth taking advantage of the opportunity to start contributing to your retirement savings. After all, 401(k)s have some of the highest contribution limits of any retirement plans, which means you might end up saving a lot. Here are some other instances when it may be a good idea:

1. If your employer matches your contributions

If your company matches any part of your contribution, you may want to consider at least contributing enough to get the maximum employer match. After all, this match is tantamount to free money, and it can add up over time.

2. You can afford to contribute more than you can to an IRA

For tax year 2024, you can put up to $7,000 in an IRA, but up to $23,000 in a 401(k) — if you’re 50 or over, those amounts increase to $8,000 for an IRA and $30,500 for a 401(k).

For tax year 2025, you can put up to $7,000 in an IRA, but up to $23,500 in a 401(k) — if you’re 50 or over, those amounts increase to $8,000 for an IRA and $31,000 for a 401(k). And again, if you’re aged 60 to 63, you can contribute up to $34,750 for 2025. If you’re in a position to save more than the IRA limit, that’s a good reason to take advantage of the higher limits offered by a 401(k).

3. When your income is too high

Above certain income levels, you can’t contribute to a Roth IRA. How much income is that? That’s a complicated question that is best answered by our Roth IRA calculator.

And if you or your spouse are covered by a workplace retirement plan, you may not be able to deduct IRA contributions.

If you can no longer fund a Roth, and can’t get tax deductions from a traditional IRA, it might be worth throwing your full savings power behind your 401(k).

When Should You Use an IRA?

If you can swing it, it may not hurt to fund an IRA. This is especially true if you don’t have access to a 401(k). But even if you do, IRAs can be important tools. For example:

1. When you leave your company

When you leave a job, you can rollover an old 401(k) into an IRA — and it’s generally wise to do so. It’s easy to lose track of old plans, and companies can merge or even go out of business. Then it can become a real hassle to find your money and get it out.

You can also roll the funds into your new company’s retirement plan (or stick with an IRA rollover, which may give you more control over your investment choices).

Recommended: How to Roll Over Your 401(k)

2. If your 401(k) investment choices are limited

If you have a good mix of mutual funds in your 401(k), or even some target date funds and low-fee index funds, your plan is probably fine. But, some plans have very limited investment options, or are so confusing that people can’t make a decision and end up in the default investment — a low interest money market fund.

If this is the case, you might want to limit your contributions to the amount needed to get your full employer match and put the rest in an IRA.

3. When you’re between jobs

Not every company has a 401(k), and people are not always employed. There may be times in your life when your IRA is the only option. If you have self-employment income, you can make higher contributions to a SEP IRA or a Solo 401(k) you set up for yourself.

4. If you can “double dip.”

If you have a 401(k), are eligible for a Roth IRA, or can deduct contributions to a traditional IRA, and you can afford it — it may be worth investing in both. After all, saving more now means more money — and financial security — down the line. Once again, you can check our IRA calculator to see if you can double dip. Just remember that the IRA contribution limit is for the total contributed to both a Roth and traditional IRA.

The real question is not: IRA vs. 401(k), but rather — which of these is the best place to put each year’s contributions? Both are powerful tools to help you save, and many people will use different types of accounts over their working lives.

When Should You Use Both an IRA and 401(k)?

Using an IRA and a 401(k) at the same time may be a good way to save for your retirement goals. Funding a traditional or Roth IRA and 401(k) at once can allow you to save more than you would otherwise be able to in just one account.

Bear in mind that if you or your spouse participate in a workplace retirement plan, you may not be able to deduct all of your traditional IRA contributions, depending on how high your income is.

Having both types of accounts can also provide you some flexibility in terms of drawing income when you retire. For example, you might find a 401(k) as a source of pre-tax retirement income. At the same time you might fund a Roth IRA to provide a source of after-tax income when you retire.

That way, depending on your financial and tax situation each year, you may be able to strategically make withdrawals from each account to help minimize your tax liability.

The Takeaway

What is the difference between an IRA and a 401(k)? Most simply, the biggest difference is the amount you can save in each. However, as you can see now, the answer can be pretty complicated, depending on which type of IRA you’re talking about.

Roth accounts — whether a Roth IRA or a Roth 401(k) — have a different tax treatment. You deposit after-tax funds in these types of accounts. And then you don’t pay any tax on your withdrawals in retirement.

Another difference is that a 401(k) is generally sponsored by your employer, so you’re beholden to the investment choices of the firm managing the company’s plan, and the fees they charge. By contrast, you set up an IRA yourself, so the investment options are greater — and the fees can be lower.

Generally, you can have an IRA as well as a 401(k). The rules around contribution limits, and how much you can deduct may come into play, however.

If you’re ready to open an IRA, it’s easy when you set up an Active Invest account with SoFi Invest.

Not sure what the right strategy is for you? SoFi Invest® offers educational content as well as access to financial planners. The Active Investing platform lets investors choose from an array of stocks, ETFs or fractional shares. For a limited time, funding an account gives you the opportunity to win up to $1,000 in the stock of your choice. All you have to do is open and fund a SoFi Invest account.

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

Is a 401(k) considered an IRA for tax purposes?

No. A 401(k) is a completely separate account than an IRA because it’s sponsored by your employer.

Is it better to have a 401(k) or an IRA?

You can save more in a 401(k), and your employer may also offer matching contributions. But an IRA often has a much wider range of investment options. It’s wise to weigh the differences, and decide which suits your situation best.

Can you roll a 401(k) Into an IRA penalty-free?

Yes. If you leave your job and want to roll over your 401(k) account into an IRA, you can do so penalty free within 60 days. If you transfer the funds and hold onto them for longer than 60 days, you will owe taxes and a penalty if you’re under 59 ½.

Can you lose money in an IRA?

Yes. You invest all the money you deposit in an IRA in different securities (i.e. stocks, bonds, mutual funds, ETFs). Ideally you’ll see some growth, but you could also see losses. There are no guarantees.


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

SoFi Invest®

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

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

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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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How Much Retirement Money Should I Have at 40?

At some point or another, you’ve probably wondered if you have enough money for the future and asked yourself, “how much retirement should I have at 40?”

It’s an important question. Hopefully, you’re already saving some money for retirement. However, you might not be saving enough to retire when you want.

There are different ways to save money for retirement. The sooner, the better—so that it can start adding up. Here’s how to maximize your retirement savings at age 40 and beyond.

Understanding Your Retirement Savings at 40

Now, to answer the question: How much money should I have saved by 40? A general rule of thumb recommended by many financial advisors is to have about three times your annual salary saved in retirement money by the time you’re 40.

Knowing this general benchmark is helpful for your retirement planning.

What Does the Average 40-Year-Old Have Saved?

According to a recent study from Northwestern Mutual, people in their forties say they currently have $77,400 saved for retirement. However, that’s a long way from the amount they expect to need for retirement, which is $1.28 million.

How Your Retirement Savings Compare to National Averages

Compared to the guideline of having three times your annual salary saved by the time you’re 40, if you only have the amount reported by the respondents in the Northwestern study — $77,400 — you’ve got some work to do. The good news is, you’ve probably got around 20 years or more to help get where you need to be by the time you’re ready to retire.

Factors Influencing Your Retirement Savings So Far

As you reach your 40s, it’s likely that your income is increasing, but so are the obligations that are tied to your money.

You might be saving money for your kids’ college; you probably have mortgage payments and existing debt, including your own student loans; you may even be taking care of aging parents. It’s a lot of financial multitasking and you have to prioritize.

In addition to all that, inflation over the past couple of years has made many prices higher, which could increase your cost of living. Overall, prices are 13% higher than they were two years ago, according to Consumer Price Index data. You might also be dealing with unemployment or a job layoff. All these factors can make saving for retirement more challenging.

The Right Retirement Savings Path for You

To map out a savings plan that makes sense, you can start by estimating how much money you’ll need for retirement. It’s also a good idea to look at your goals. That includes figuring out when you might want to retire, what kind of lifestyle you want in retirement, and how much money you might have coming in during your golden years. That will help you determine how much you need to save.

Projecting Your Retirement Needs

Start by thinking about the kind of lifestyle you’d like to have in retirement. Will you move to a smaller home? If so, you may save money on housing costs. On the other hand, if you’d like to travel frequently, your expenses may increase.

Also, estimate what your budget as a retiree might be. Include housing, utilities, insurance, food, transportation, clothes, and so on. And don’t forget entertainment expenses like movies, concerts, and meals out.

Next, factor in healthcare expenses. Health-related costs can be significant in retirement, depending on your medical situation.

Retirement Savings Rate: How Much of Your Income to Save

While each person’s situation and needs are unique, there are some general guidelines that can help project your financial needs during retirement.

For instance, according to Fidelity, you should try to save 15% of your pre-tax income each year if you plan to retire at age 67.

Another rule, known as the 80% rule, says you should have enough money by the time you retire to cover 80% of your pre-retirement income.

Milestones for Retirement Savings By Decade

As discussed, when you plan to retire and what kind of lifestyle you’d like to have in retirement are two of the main factors that affect how much money you’ll need to save. The milestones below are general, but they will give you an idea about how much to save at various ages.

Retirement Savings By:

•  Age 30: 1x your annual income

•  Age 40: 3x your annual income

•  Age 50: 6x your annual income

•  Age 60: 8x your annual income

•  Age 67: 10x your annual income

Maximizing Your Retirement Savings in Your 40s

If you haven’t saved 3 times your annual income by your 40s, or even if you have, here are some ways to make the most of your retirement funds in this decade.

Benefits of a Roth 401(k) and When to Consider It

Some 401(k) plans give you the opportunity of choosing a Roth 401(k) to save for retirement. If your employer offers such a plan you may want to consider it.

The difference between a Roth 401(k) and a traditional 401(k) is that with a Roth 401(k), contributions are made using after-tax funds. That means they aren’t tax deductible, but the withdrawals you make in retirement are tax-free. In addition, you don’t pay taxes on your annual investment earnings in a Roth 401(k). With a traditional 401(k), the contributions you make are tax deductible, however, you will pay taxes on your retirement withdrawals. So a Roth 401(k) can be beneficial if you expect to be in a higher tax bracket by the time you retire.

The good news is, you can contribute to both a Roth 401(k) and a traditional 401(k) as long as your plan allows it. Just know that there are yearly limits on your contributions. Across both types of plans, individuals under age 50 can contribute up to $23,000 annually for 2024, and up to $23,500 annually for 2025.

If you have a traditional 401(k), there are a number of strategies to max out your 401(k) that are worth looking into. For example, it makes sense to contribute at least enough to qualify for any employer matching that your company offers. Why lose out on the “free” money your employer is willing to contribute to your retirement savings?

Catch-Up Contributions: Leveraging Them When the Time Comes

Once you reach age 50, you can make catch-up contributions to your 401(k) plan, as long as your plan allows them, which could help you save even more for retirement. In 2023, the catch-up contribution is an additional $7,500. That means, in total, individuals 50 and older could contribute up to $30,000 to their 401(k) in 2023.

Knowing about catch-up contributions when you’re in your forties could help you plan and prepare for them when you reach 50. Catch-up contributions can help you make the most of your retirement plan.

Investment Strategies for Mid-Career Savers

There are many other ways to save for retirement, even beyond the employer-sponsored 401(k) and Roth 401(k).

Some people choose to put their retirement savings in more than one type of account. This is useful if you want to set aside more than the yearly contribution limits on 401(k) plans. In that case, it might make sense to open an IRA savings account to save beyond the 401(k) limits, as long as you meet the necessary criteria.

Recommended: A Look at Traditional IRAs vs Roth IRAs

The Role of Expenses in Retirement Planning

Figuring out how much your retirement living expenses will be is important for calculating how money you’ll need to save. These are some of the things you may want to consider and budget for.

Emergency Savings vs. Retirement Savings

Your retirement savings are extremely important. However, if you don’t have an emergency fund that can cover three to six months’ worth of living expenses, consider putting that at the top of your priority list.

Why? While retirement is still likely to be years away if you’re 40 now, an emergency could happen at any time. For instance, you may be faced with an unexpected medical procedure that you’ll need to pay for if insurance doesn’t cover it all. Or your heater might break in the middle of winter and need to be replaced. If you don’t have the emergency funds to cover these things, you risk taking on debt. And that could in turn limit your retirement savings as you work to pay off that debt.

Of course, if you can afford to contribute to both an emergency fund and your retirement savings, by all means, do so.

Planning for Healthcare Expenses in Retirement

As people grow older, their healthcare needs and costs typically increase. For many, healthcare can be one of the biggest retirement expenses.

Fidelity estimates that the average person may need $157,500 to cover healthcare costs in retirement. If you have a high-deductible health insurance plan, you might want to look into a Health Savings Account (HSA), which could potentially help you save money to cover some healthcare costs.

Incorporating Home Costs Into Retirement Savings

Housing costs are another major retirement expense. You may have mortgage payments, homeowner’s insurance, and home maintenance and repairs to pay for. If you rent, you’ll have to cover your monthly rental fee plus renters’ insurance.

Additionally, where you live — the city and state — can impact how much you pay for housing. In general, living on the coasts can be more expensive. You may want to take the cost of living into consideration when you’re thinking about where you want to live in retirement.

Family and Retirement: Balancing the Present and Future

Of course, along with saving for retirement, you have present-day expenses and events to pay for as well. This includes important family milestones, such as college and a child’s wedding. Fortunately, with proper budgeting and planning, it is possible to help cover these expenses and save for retirement at the same time.

Budgeting for College Savings While Prioritizing Retirement

To keep building a retirement nest egg while saving for college for your kids, consider some college-savings plans. One good option to consider: a 529 plan that you fund with after-tax dollars. You can contribute to the plan on a regular basis, or whenever you have extra money, and family members and friends can contribute as well. For instance, instead of birthday gifts, ask loved ones to contribute to your child’s 529 instead.

Virtually every state offers a 529 plan and you can shop around to find one that has the best tax benefits and lowest costs. Open the plan as early as you can when your child is young so that the money invested has more time to grow.

Weddings and Other Major Family Expenses

If you’d like to help pay for your child’s wedding, you could put some money in a savings or investment account so that it can grow over time. If the wedding is coming up relatively soon, you could put your money into a high-yield savings account, for instance, to get a higher interest rate than you’d get from a regular savings account. If the wedding is farther in the future, you might want to invest in mutual funds or a stock index fund, which could deliver more growth.

Expert Strategies to Increase Retirement Savings

There are a number of smart ways to maximize your savings and be on track for retirement. Here are a few strategies experts advise.

Salary Negotiations and Their Long-Term Impact on Savings

If it’s been a while since you’ve received a raise, this may be a good time to ask for one. By age 40, you’ve probably developed skills that make you valuable to your employer.

If you need some incentive for negotiating for a higher salary, consider this: Even an extra $100 a week invested for the next 20 years with a 10% annual return could give you approximately $300,000 more in retirement savings.

Building a Solid Financial Foundation with a Six-Month Emergency Fund

As we discussed earlier, having an emergency fund is critical for any unexpected expenses that arise. Ideally, it’s wise to have six months’ worth of expenses saved up. That can help tide you over in case of job loss or some other significant event that affects your income.

You can open a high-yield savings account for your emergency fund to help it grow. Consider automating your savings to make sure you’re contributing to your emergency fund regularly.

Then, once you’ve reached six month’s worth, you can allocate the money you had been contributing to the emergency fund to your retirement savings.

Why Prioritizing Roth Retirement Accounts Can Pay Off

Investing in a Roth IRA can be helpful if you want to withdraw money in retirement without paying taxes on it. After-tax accounts can be appealing to individuals who plan to achieve financial independence at a younger age and retire early. Unlike qualified plans, which place penalties on withdrawing funds before a certain age, an after-tax account is a pool of money that you can withdraw from without having to worry about penalties if you access the account before age 59 ½.

Even if you wait until age 67 to retire, if you expect to be in a higher tax bracket at retirement, a Roth IRA can make sense since you won’t have to pay taxes on retirement withdrawals.

For 2023, you can contribute up to $6,500 annually in a Roth IRA. Individuals 50 and older can contribute $7,500. That said, there are income limits on Roth IRAs. The amount you can contribute starts to phase out if you earn more than $138,000 as a single tax filer, or $218,000 for married couples who file jointly.

The Takeaway

While there are conventional rules of thumb as to how much money you should have saved by 40, the truth is everyone’s path to a comfortable retirement looks different. One piece of advice is universal, however: The sooner you start saving for retirement, the better your chances of being in a financially desirable position later in life.

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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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