Preparing for Retirement Archives | Page 5 of 29

May

2024

Roth 401(k) vs Traditional 401(k): Which Is Best for You?

By AJ Smith | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

A traditional 401(k) and a Roth 401(k) are tax-advantaged retirement plans that can help you save for retirement. While both types of accounts follow similar rules — they have the same contribution limits, for example — the impact of a Roth 401(k) vs. traditional 401(k) on your tax situation, now and in the future, may be quite different.

In brief: The contributions you make to a traditional 401(k) are deducted from your gross income, and thus may help lower your tax bill. But you’ll owe taxes on the money you withdraw later for retirement.

Conversely, you contribute after-tax funds to a Roth 401(k) and can typically withdraw the money tax free in retirement — but you don’t get a tax break now.

To help choose between a Roth 401(k) vs. a traditional 401(k) — or whether it might make sense to invest in both, if your employer offers that option — it helps to know what these accounts are all about.

Key Points

• Traditional 401(k) contributions are made with pre-tax dollars, reducing taxable income for the year of contribution.

• Roth 401(k) contributions are made with after-tax dollars, offering tax-free withdrawals in retirement.

• Withdrawals from traditional 401(k)s are taxed as income, whereas Roth 401(k) withdrawals are tax-free if rules are followed.

• Early withdrawals from both accounts may incur taxes and penalties, though Roth contributions can be withdrawn tax-free.

• Starting January 2024, Roth 401(k)s are not subject to required minimum distributions, unlike traditional 401(k)s.

5 Key Differences Between Roth 401(k) vs Traditional 401(k)

Before deciding on a Roth 401(k) or traditional 401(k), it’s important to understand the differences between each account, and to consider the tax benefits of each in light of your own financial plan. The timing of the tax advantages of each type of account is also important to weigh.

1. How Each Account is Funded

• A traditional 401(k) allows individuals to make pre-tax contributions. These contributions are typically made through elective salary deferrals that come directly from an employee’s paycheck and are deducted from their gross income.

• Employees contribute to a Roth 401(k) also generally via elective salary deferrals, but they are using after-tax dollars. So the money the employee contributes to a Roth 401(k) cannot be deducted from their current income.

💡 Quick Tip: Did you know that you must choose the investments in your IRA? Once you open a new IRA account and start saving, you get to decide which mutual funds, ETFs, or other investments you want — it’s totally up to you.

2. Tax Treatment of Contributions

• The contributions to a traditional 401(k) are tax-deductible, which means they can reduce your taxable income now, and they grow tax-deferred (but you’ll owe taxes later).

• By contrast, since you’ve already paid taxes on the money you contribute to a Roth 401(k), the money you contribute isn’t deductible from your gross income, and withdrawals are generally tax free (some exceptions below).

3. Withdrawal Rules

• You can begin taking qualified withdrawals from a traditional 401(k) starting at age 59 ½, and the money you withdraw is taxed at ordinary income rates.

• To withdraw contributions + earnings tax free from a Roth 401(k) you must be 59 ½ and have held the account for at least five years (often called the 5-year rule). If you open a Roth 401(k) when you’re 57, you cannot take tax-free withdrawals at 59 ½, as you would with a traditional 401(k). You’d have to wait until five years had passed, and start tax-free withdrawals at age 62.

4. Early Withdrawal Rules

• Early withdrawals from a 401(k) before age 59 ½ are subject to tax and a 10% penalty in most cases, but there are some exceptions where early withdrawals are not penalized, including certain medical expenses; a down payment on a first home; qualified education expenses.

You may also be able to take a hardship withdrawal penalty-free, but you need to meet the criteria, and you would still owe taxes on the money you withdrew.

• Early withdrawals from a Roth 401(k) are more complicated. You can withdraw your contributions at any time, but you’ll owe tax proportional to your earnings, which are taxable when you withdraw before age 59 ½.

For example: If you have $100,000 in a Roth 401(k), including $90,000 in contributions and $10,000 in taxable gains, the gains represent a 10% of the account. Therefore, if you took a $20,000 early withdrawal, you’d owe taxes on 10% to account for the gains, or $2,000.

5. Required Minimum Distribution (RMD) Rules

With a traditional 401(k), individuals must take required minimum distributions starting at age 73, or face potential penalties. While Roth 401(k)s used to have RMDs, as of January 2024, they no longer do. That means you are not required to withdraw RMDs from a Roth 401(k) account.

For a quick side-by-side comparison, here are the key differences of a Roth 401(k) vs. traditional 401(k):

Traditional 401(k)	Roth 401(k)
Funded with pre-tax dollars.	Funded with after-tax dollars.
Contributions are deducted from gross income and may lower your tax bill.	Contributions are not deductible.
All withdrawals taxed as income.	Withdrawals of contributions + earnings are tax free after 59 ½, if you’ve had the account for at least 5 years. (However, matching contributions from an employer made with pre-tax dollars are subject to tax.)
Early withdrawals before age 59 ½ are taxed as income and are typically subject to a 10% penalty, with some exceptions.	Early withdrawals of contributions are not taxed, but earnings may be taxed and subject to a 10% penalty.
Account subject to RMD rules starting at age 73.	No longer subject to RMD rules as of January 2024.

Bear in mind that a traditional 401(k) and Roth 401(k) also share many features in common:

• The annual contribution limits are the same for a 401(k) and a Roth 401(k). For 2024, the total amount you can contribute to these employer-sponsored accounts is $23,000; if you’re 50 and older you can save an additional $7,500 for a total of $30,500. This is an increase over the 2023 limit, which was capped at $22,500 ($30,000 if you’re 50 and older).

• For both accounts, employers may contribute matching funds up to a certain percentage of an employee’s salary.

• In 2024, total contributions from employer and employee cannot exceed $69,000 ($76,500 for those 50 and up). In 2023, total contributions from employer and employee cannot exceed $66,000 ($73,500 for those 50 and up).

• Employees may take out a loan from either type of account, subject to IRS restrictions and plan rules.

Because there are certain overlaps between the two accounts, as well as many points of contrast, it’s wise to consult with a professional when making a tax-related plan.

How to Choose Between a Roth and a Traditional 401(k)

In some cases it might make sense to contribute to both types of accounts (more on that below), but in other cases you may want to choose either a traditional 401(k) or a Roth 401(k) to maximize the specific advantages of one account over another. Here are some considerations.

When to Pay Taxes

Traditional 401(k) withdrawals are taxed at an individual’s ordinary income tax rate, typically in retirement. As a result these plans can be most tax efficient for those who will have a lower marginal rate after they retire than they did while they were working.

In other words, a traditional 401(k) may help you save on taxes now, if you’re in a higher tax bracket — and then pay lower taxes in retirement, when you’re ideally in a lower tax bracket.

On the other hand, an investor might look into the Roth 401(k) option if they feel that they pay lower taxes now than they will in retirement. In that case, you’d potentially pay lower taxes on your contributions now, and none on your withdrawals in retirement.

Your Age

Often, younger taxpayers may be in a lower tax bracket. If that’s the case, contributing to a Roth 401(k) may make more sense for the same reason above: because you’ll pay a lower rate on your contributions now, but then they’re completely tax free in retirement.

If you’re older, perhaps mid-career, and in a higher tax bracket, a traditional 401(k) might help lower your tax burden now (and if your tax rate is lower when you retire, even better, as you’d pay taxes on withdrawals but at a lower rate).

Where You Live

The tax rates where you live, or where you plan to live when you retire, are also a big factor to consider. Of course your location some years from now, or decades from now, can be difficult to predict (to say the least). But if you expect that you might be living in an area with lower taxes than you are now, e.g. a state with no state taxes, it might make sense to contribute to a traditional 401(k) and take the tax break now, since your withdrawals may be taxed at a lower rate.

💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

The Benefits of Investing in Both a Roth 401(k) and Traditional 401(k)

If an employer offers both a traditional and Roth 401(k) options, employees might have the option of contributing to both, thus taking advantage of the pros of each type of account. In many respects, this could be a wise choice.

Divvying up contributions between both types of accounts allows for greater flexibility in tax planning down the road. Upon retirement, an individual can choose whether to withdraw money from their tax-free 401(k) account or the traditional, taxable 401(k) account each year, to help manage their taxable income.

It is important to note that the $23,000 contribution limit ($30,500 for those 50 and older) for 2024 is a total limit on both accounts.

So, for instance, you might choose to save $13,500 in a traditional 401(k) and $9,500 in a Roth 401(k) for the year. You are not permitted to save $23,000 in each account.

What’s the Best Split Between Roth and Traditional 401(k)?

The best split between a Roth 401(k) and a traditional 401(k) depends on your individual financial situation and what might work best for you from a tax perspective. You may want to do an even split of the $23,000 limit you can contribute in 2024. Or, if you’re in a higher tax bracket now than you expect to be in retirement, you might decide that it makes more sense for you to put more into your traditional 401(k) to help lower your taxable income now. But if you expect to be in a higher income tax bracket in retirement, you may want to put more into your Roth 401(k).

Consider all the possibilities and implications before you decide. You may also want to consult a tax professional.

The Takeaway

Employer-sponsored Roth and traditional 401(k) plans offer investors many options when it comes to their financial goals. Because a traditional 401(k) can help lower your tax bill now, and a Roth 401(k) generally offers a tax-free income stream later — it’s important for investors to consider the tax advantages of both, the timing of those tax benefits, and whether these accounts have to be mutually exclusive or if it might benefit you to have both.

When it comes to retirement plans, investors don’t necessarily have to decide between a Roth or traditional 401(k). Some might choose one of these investment accounts, while others might find a combination of plans suits their goals. After all, it can be difficult to predict your financial circumstances with complete accuracy — especially when it comes to tax planning — so you may decide to hedge your bets and contribute to both types of accounts, if your employer offers that option.

Another step to consider is a 401(k) rollover, where you move funds from an old 401(k) into an IRA. When you do a 401(k) rollover it can help you manage your retirement funds.

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

Easily manage your retirement savings with a SoFi IRA.

FAQ

Is it better to contribute to 401(k) or Roth 401(k)?

Whether it’s better to contribute to a traditional 401(k) or Roth 401(k) depends on your particular financial situation. In general, if you expect to be in a lower tax bracket in retirement, a traditional 401(k) may make more sense for you since you’ll be able to deduct your contributions when you make them, which can lower your taxable income, and then pay taxes on the money in retirement, when you’re in a lower income tax bracket.

But if you’re in a lower tax bracket now than you think you will be later, a Roth 401(k) might be the preferred option for you because you’ll generally withdraw the money tax-free in retirement.

Can I max out both 401(k) and Roth 401(k)?

No, you cannot max out both accounts. Per IRS rules, the annual 401(k) limits apply across all your 401(k) accounts combined. So for 2024, you can contribute a combined amount up to $23,000 (or $30,500 if you’re 50 or older) to your Roth 401(k) and your traditional 401(k) accounts.

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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.

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

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May

2024

Should I Put My Bonus Into My 401(k)? Here’s What You Should Consider

By Paulina Likos | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

If you received a bonus and you’re wondering what to do with the bonus money, you’re not alone. Investing your bonus money in a tax-advantaged retirement account like a 401(k) has some tangible advantages. Not only will the extra cash help your nest egg to grow, you could also see some potential tax benefits.

Of course, we live in a world of competing financial priorities. You could also pay down debt, spend the money on something you need, save for a near-term goal — or splurge! The array of choices can be exciting — but if a secure future is your top goal, it’s important to consider a 401(k) bonus deferral.

Here are a few strategies to think about before you make a move.

Key Points

• Investing a bonus in a 401(k) can significantly enhance retirement savings and offer potential tax benefits.

• Bonuses are subject to income tax withholding, which may reduce the expected amount.

• The 2024 contribution limit for a 401(k) is $23,000, with an additional $7,500 allowed for those 50 and older.

• If 401(k) contributions are maxed out, considering an IRA or a taxable brokerage account is beneficial.

• Allocating a bonus to a 401(k) or IRA can reduce taxable income for the year, potentially lowering the tax bill.

Receiving a Bonus Check

First, a practical reminder. When you get a bonus check, it may not be in the amount that you expected. This is because bonuses are subject to income tax withholding. Knowing how your bonus is taxed can help you understand how much you’ll end up with so you can determine what to do with the money that’s left, such as making a 401(k) bonus contribution. The IRS considers bonuses as supplemental wages rather than regular wages.

Ultimately, your employer decides how to treat tax withholding from your bonus. Employers may withhold 22% of your bonus to go toward federal income taxes. But some employers may add your whole bonus to your regular paycheck, and then tax the larger amount at normal income tax rates. If your bonus puts you in a higher tax bracket for that pay period, you may pay more than you expected in taxes.

Also, your bonus may come lumped in with your paycheck (not as a separate payout), which can be confusing.

Whatever the final amount is, or how it arrives, be sure to set aside the full amount while you weigh your options — otherwise you might be tempted to spend it.

💡 Quick Tip: Want to lower your taxable income? Start saving for retirement by opening an IRA account. The money you save each year in a traditional IRA is tax deductible (and you don’t owe any taxes until you withdraw the funds, usually in retirement).

What to Do With Bonus Money

There’s nothing wrong with spending some of your hard-earned bonus from your compensation. One rule of thumb is to set a percentage of every windfall (e.g. 10% or 20%) — whether a bonus or a birthday check — to spend, and save the rest.

To get the most out of a bonus, though, many people opt for a 401k bonus deferral and put some or all of it into their 401(k) account. The amount of your bonus you decide to put in depends on how much you’ve already contributed, and whether it makes sense from a tax perspective to make a 401(k) bonus contribution.

Contributing to a 401(k)

The contribution limit for 401(k) plans in 2024 is $23,000; for those 50 and older you can add another $7,500, for a total of $30,500. The contribution limit for 401(k) plans in 2023 is $22,500; for those 50 and older you can add another $7,500, for a total of $30,000. If you haven’t reached the limit yet, allocating some of your bonus into your retirement plan can be a great way to boost your retirement savings.

In the case where you’ve already maxed out your 401(k) contributions, your bonus can also allow you to invest in an IRA or a non-retirement (i.e. taxable) brokerage account.

Contributing to an IRA

If you’ve maxed out your 401k contributions for the year, you may still be able to open a traditional tax-deferred IRA or a Roth IRA. It depends on your income.

In 2024, the contribution limit for traditional IRAs and Roth IRAs is $7,000; with an additional $1,000 if you’re 50 or older. In 2023, the contribution limit for traditional IRAs and Roth IRAs is $6,500; with an additional $1,000 if you’re 50 or older. But if your income is over $161,000 (for single filers) or over $240,000 (for married filing jointly) in 2024, you aren’t eligible to contribute to a Roth. For 2023, you can’t contribute to a Roth if your income is over $153,000 (for single filers) or over $228,000 (for married filing jointly). And while a traditional IRA doesn’t have income limits, the picture changes if you’re covered by a workplace plan like a 401(k).

If you’re covered by a workplace retirement plan and your income is too high for a Roth, you likely wouldn’t be eligible to open a traditional, tax-deductible IRA either. You could however open a nondeductible IRA. To understand the difference, you may want to consult with a professional.

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Contributing to a Taxable Account

Of course, when you’re weighing what to do with bonus money, you don’t want to leave out this important option: Opening a taxable account.

While employer-sponsored retirement accounts typically have some restrictions on what you can invest in, taxable brokerage accounts allow you to invest in a wider range of investments.

So if your 401(k) is maxed out, and an IRA isn’t an option for you, you can use your bonus to invest in stocks, bonds, exchange-traded funds (ETFs), mutual funds, and more in a taxable account.

Deferred Compensation

You also may be able to save some of your bonus from taxes by deferring compensation. This is when an employee’s compensation is withheld for distribution at a later date in order to provide future tax benefits.

In this scenario, you could set aside some of your compensation or bonus to be paid in the future. When you defer income, you still need to pay taxes later, at the time you receive your deferred income.

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

Your Bonus and 401(k) Tax Breaks

Wondering what to do with a bonus? It’s a smart question to ask. In order to maximize the value of your bonus, you want to make sure you reduce your taxes where you can.

One method that’s frequently used to reduce income taxes on a bonus is adding some of it into a tax-deferred retirement account like a 401(k) or traditional IRA. The amount of money you put into these accounts typically reduces your taxable income in the year that you deposit it.

Here’s how it works. The amount you contribute to a 401(k) or traditional IRA is tax deductible, meaning you can deduct the amount you save from your taxable income, often lowering your tax bill. (The same is not true for a Roth IRA or a Roth 401(k), where you make contributions on an after-tax basis.)

The annual contribution limits for each of these retirement accounts noted above may vary from year to year. Depending on the size of your bonus and how much you’ve already contributed to your retirement account for a particular year, you may be able to either put some or all of your bonus in a tax-deferred retirement account.

It’s important to keep track of how much you have already contributed to your retirement accounts because you don’t want to put in too much of your bonus and exceed the contribution limit. In the case where you have reached the contribution limit, you can put some of your bonus into other tax deferred accounts including a traditional IRA or a Roth IRA.

How Investing Your Bonus Can Help Over Time

Investing your bonus may help increase its value over the long-run. As your money potentially grows in value over time, it can be used in many ways: You can stow part of it away for retirement, as an emergency fund, a down payment for a home, to pay outstanding debts, or another financial goal.

While it can be helpful to have some of your bonus in cash, your money is typically better in a savings or investment account where it has the potential to work for you. If you start investing your bonus each year in either a tax-deferred retirement account or non-retirement account, this could help you save for the future.

Investing for Retirement With SoFi

The yearly question of what to do with a bonus is a common one. Just having that windfall allows for many financial opportunities, such as saving for immediate needs — or purchasing things you need now. But it may be wisest to use your bonus to boost your retirement nest egg — for the simple reason that you may stand to gain more financially down the road, while also potentially enjoying tax benefits in the present.

The fact is, most people don’t max out their 401(k) contributions each year, so if you’re in that boat it might make sense to take some or all of your bonus and max it out. If you have maxed out your 401(k), you still have options to save for the future via traditional or Roth IRAs, deferred compensation, or investing in a taxable account.

Keeping in mind the tax implications of where you invest can also help you allocate this extra money where it fits best with your 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).

Help grow your nest egg with a SoFi IRA.

FAQ

Is it good to put your bonus into a 401(k)?

The short answer is yes. It might be wise to put some or all of your bonus in your 401(k), depending on how much you’ve contributed to your workplace account already. You want to make sure you don’t exceed the 401(k) contribution limit.

How can I avoid paying tax on my bonus?

Your bonus will be taxed, but you can lower the amount of your taxable income by depositing some or all of it in a tax-deferred retirement account such as a 401(k) or IRA. However, this does not mean you will avoid paying taxes completely. Once you withdraw the money from these accounts in retirement, it will be subject to ordinary income tax.

Can I put all of my bonus into a 401(k)?

Possibly. You can put all of your bonus in your 401(k) if you haven’t reached the contribution limit for that particular year, and if you won’t surpass it by adding all of your bonus. For 2023, the contribution limit for a 401(k) is $22,500 if you’re younger than 50 years old; those 50 and over can contribute an additional $7,500 for a total of $30,000. In 2024, the contribution limit for a 401(k) is $23,000 if you’re under age 50, and those 50 and up can contribute an additional $7,500 for a total of $30,500.

You may also be interested in:

How Much Should I Contribute to My 401k?

Guide to Maxing Out Your 401(k)

The Average 401(k) Balance by Age

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May

2024

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

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

By LeeMarie Kennedy | Growing Wealth, invest, Preparing for Retirement | Comments Off

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.

• Contribution limits for 401(k)s in 2024 are $23,000, or $30,500 for those 50 and older, with higher total limits including employer contributions.

• 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
Contributions	No more than $275,000 in 2024 or 100% of employee’s average compensation for the highest 3 consecutive years	$23,000 ($30,500 for those 50 and up) for 2024. Contributions from employee and employer cannot exceed $69,000 (or $76,500 for those 50 and up) in 2024
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, 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 $265,000 for tax year 2023 and $275,000 for 2024.

• 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.

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.

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 2023, annual employee contributions can’t exceed $22,500 for workers under 50, and $30,000 for workers 50 and older (this includes a $7,500 catch-up contribution). The total annual contribution paid by employer and employee in 2023 is capped at $66,000 for workers under 50, and $73,500 for workers 50 and over.

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

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

May

2024

The Strategic Guide to Early Retirement

By AJ Smith | Budgeting & Goals, invest, Life & Career, Preparing for Retirement | No Comments

An early retirement used to be considered a bit of a dream, but for many people it’s a reality — especially those who are willing to budget, save, and invest with this goal in mind.

If you’d like to retire early, there are concrete steps you can take to help reach your goal. Here’s what you need to know about how to retire early.

Key Points

• Early retirement requires significant savings, often guided by the Rule of 25, which suggests saving 25 times annual expenses.

• The FIRE movement encourages saving 50-75% of income to retire early.

• Effective budgeting and reducing expenses are crucial for accumulating necessary retirement funds.

• Investment strategies should balance growth and risk, adjusting as retirement nears.

• Health insurance planning is essential when retiring before qualifying for Medicare at age 65.

Understanding Early Retirement

Early retirement typically refers to retiring before the age of 65, which is when eligibility for Medicare benefits begins. Some people may want to retire just a few years earlier, at age 60, for instance. But others dream of retiring in their 40s or 50s or even younger.

Clarifying Early Retirement Age and Goals

You’re probably wondering, how can I retire early? That’s an important question to ask. First, though, you have to decide at what age to retire.

Schedule a few check-ins with yourself, and/or a partner or loved ones, to discuss what “early retirement” means. Is it age 50? Age 55? And what might your early retirement look like? Will you stop working completely? Work part-time? Or maybe you want to switch to a different field or start a business? Perhaps you dream of going back to school, volunteering, or traveling.

Early retirement is different for everyone. So the clearer you can get about the details now, the smarter you can be about how much money you need to make your plan work.

Also, consider why you want to retire at a specific age. Is it because you’re financially prepared to take that step? Or are you feeling ready to spend more time with family and friends? Determining what’s motivating you can help you better prepare and plan for your retirement.

Reasons for Retiring

In a recent SoFi survey, respondents cite the following as the top factors influencing their reasons to retire:

• Financial readiness: 54%

• Enjoying more time with family and friends and pursuing hobbies: 50%

• Health considerations: 46%

• More travel and leisure: 43%

• Eligibility for Social Security benefits: 41%

Source: SoFi Retirement Survey, April 2024

Insights into the Financial Independence, Retire Early (FIRE) Movement

There’s a movement of people who want to retire early. It’s called the FIRE movement, which stands for “financially independent, retire early.” FIRE has become a worldwide trend that’s inspiring people to work toward retiring in their 50s, 40s, and even their 30s. In the 2024 SoFi Retirement Survey, 12% of respondents say the retirement age they’re aiming for is 49 or younger.

Here’s how FIRE works: In order to retire at a young age, people who follow the movement allocate 50% to 75% of their income to savings. However, that can be challenging because it means they have to sacrifice certain lifestyle pleasures such as eating out or traveling. Of the SoFi survey respondents who said they want to retire at age 49, 18% are not using any strategies that might help them retire early.

Once they retire, FIRE proponents tend to use investments that pay dividends as passive income sources to help support themselves. However, dividend payments depend on company performance and they’re not guaranteed. So a FIRE adherent would likely need other sources of income in retirement as well.

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Financial Planning for Early Retirement

In order to start planning to retire early, first ask yourself how confident you are about pulling it off. In the SoFi Retirement Survey, 68% of respondents say they are very or somewhat confident in their ability to retire at their target age, while 15% are very or somewhat doubtful they can do it.

Once you’ve assessed your confidence level, the next step is to calculate how much money you’ll need to live on once you stop working. How much would you have to save and invest to arrive at an amount that would allow you to retire early? Here’s how to help figure that out.

Many people wonder: How much do I need to retire early? There isn’t one answer to that question. The right answer for you is one that you must arrive at based on your unique needs and circumstances. That said, to learn whether you’re on track for retirement it helps to begin somewhere, and the Rule of 25 may provide a good ballpark estimate.

The Rule of 25 recommends saving 25 times your annual expenses in order to retire. Why? Because according to one rule of thumb, you should only spend 4% of your total nest egg every year. By limiting your spending to a small percentage of your savings, the logic goes, your money is more likely to last.

Here’s an example: if you spend $75,000 a year, you’ll need a nest egg of $1,875,000 in order to retire.

$75,000 x 25 = $1,875,000

With that amount saved, and assuming an annual withdrawal rate of 4%, you would have $75,000 per year in income.

Obviously, this is just an example. You might need less income in retirement or more — perhaps a lot less or a lot more, depending on your situation. If your desired income is $50,000, for example, you’d need to save $1,250,000.

The Benefits of Social Security

Once you reach the age of 62, which some consider a traditional retirement age, you are then able to claim Social Security benefits. (Age 67 is considered “full retirement” age for those born in 1960 and later, and you can wait to claim benefits until age 70.)

The longer you wait to claim Social Security, the higher your monthly payments will be. You could add those Social Security benefits to your income or consider reinvesting the money, depending on your circumstances as you get older.

Effective Savings Strategies

How do you save the amount of money you’d need for your early retirement plan?

Having a budget you can live with is critical to making this plan a success. The essential word here isn’t budget, it’s the whole phrase: a budget you can live with.

There are countless ways to manage how you budget. There’s the 50-30-20 plan, the envelope method, the zero-based budget, and so on. You could test a couple of them for a couple of months each in order to find one you can live with.

Another strategy for saving more is to get a side hustle to bring in some extra income. You can put that money toward your early retirement goal.

Adjusting Your Financial Habits

As you consider how to retire early, one of the first things you’ll need to do is cut your expenses now so that you can save more money. These strategies can help you get started.

Lifestyle Changes to Accelerate Savings

Take a look at your current spending and expenses and determine where you could cut back. Maybe instead of a $4,000 vacation, you plan a $2,000 trip instead, and then save or invest the other $2,000 for retirement.

You may be able to live more of a minimalist lifestyle overall. Rather than buying new clothes, for instance, search through your closets for items you can wear. Eat out less and cook at home more. Cut back on some of the streaming services you use. Scrutinize all areas of your spending to see what you can eliminate or pare back.

Debt Management Before Retirement

Obviously, it’s very difficult to achieve a big goal like saving for an early retirement if you’re also trying to pay down debt. It’s wise to work to pay off any and all debts you might have (credit card, student loan, personal loan, car loan, etc.).

That’s not only because being debt-free feels better — it also saves you money. For example, the interest rate you’re paying on credit card or store cards can be quite high, often above 15% or even 20%. If you owe $6,000 on a credit card at 17% interest, for example, when you pay that off, you’re essentially saving the interest that debt was costing you each year.

Health Care Planning: A Critical Component of Early Retirement

When you retire early, you need to think about health insurance since you’ll no longer be getting it through your employer. Medicare doesn’t begin until age 65, so start researching the private insurance market now to understand the different plans available and what you might need.

It’s critical to have the right health insurance in place, so make sure you devote proper time and attention to this task.

Investment Management for Future Retirees

Next up, you’ll need to decide what to invest in and how much to invest in order to grow your savings without putting it at risk.

Understanding Your Investment Options

How do you invest to retire early? You can invest in stocks, bonds, mutual funds, exchange-traded funds (ETFs), target date funds, and more.

One major factor to consider is how aggressively you want to invest. That means: Are you ready to invest more in equities, say, taking on the potential for greater risk in order to possibly reap potential gains? Or would you feel more at ease if you invested using a more conservative strategy, with less exposure to risk (but potentially less reward)?

Whichever strategy you choose, you may want to invest on a regular cadence. This approach, called dollar-cost averaging, is one way to maximize potential market returns and mitigate the risk of loss.

Balancing Growth and Risk in Your Investment Portfolio

Because you have less time to save for retirement, you will likely want your investments to grow. But you also need to consider your risk tolerance, as mentioned above. Think about a balanced, diversified portfolio that has the potential to give you long-term growth without taking on more risk than you are comfortable with.

As you get closer to your early retirement date, you can move some of your savings into safer, more liquid assets so that you have enough money on hand for your living, housing, and healthcare expenses.

Retirement Accounts: 401(k)s, IRAs, and HSAs

If your employer offers a retirement plan like a 401(k) or 403(b), that’s the first thing you want to take advantage of — especially if your employer matches a percentage of your savings.

The other reason to save and invest in an employer-sponsored plan is that in most cases the money you save the plan reduces your taxable income. These accounts are considered tax deferred because the amount you save is deducted from your gross income. So the more you save, the less you might pay in taxes. You do pay ordinary income tax on the withdrawals in retirement, however.

The caveat here is that you can’t access those funds before you’re 59½ without paying a penalty. So if you plan to retire early at 50, you will need to tap other savings for roughly the first decade to avoid the withdrawal penalties you’d incur if you tapped your 401(k) or Individual Retirement Account (IRA) early.

Be sure to find out from HR if there are any other employee benefits you might qualify for, such as stock options or a pension, for instance.

Additionally, if your employer offers a Health Savings Account as part of your employee benefits, you might consider opening one.

A Health Savings Account allows you to save additional money: For tax year 2024, the HSA contribution caps are $4,150 for individuals and $8,300 for family coverage.

Your contributions are considered pre-tax, similar to 401(k) or IRA contributions, and the money you withdraw for qualified medical expenses is tax free (although you’ll pay taxes on money spent on non-medical expenses).

Finally, consider opening a Roth IRA. The advantage of saving in a Roth IRA vs. a regular IRA is that you’re contributing after-tax money that can be withdrawn penalty- and tax-free at any time.

To withdraw your earnings without paying taxes or a penalty, though, you must have had the account for at least five years (as per the Roth IRA 5-Year Rule), and you must be over 59 ½.

Recommended: How to Open an IRA in 5 Steps

The Pillars of Early Retirement

Retiring early means you’ll need to have income coming in to help support you. You may have a pension, which can also help. Once you’ve identified the income you’ll be generating, you’ll need to withdraw it in a manner that will help it last over the years of your retirement.

Establishing Multiple Income Streams

Having different streams of income is important so that you’re not just relying on one type of money coming in. For instance, your investments can be a source of potential income and growth, as mentioned. In addition, you may want to get a second job now in addition to your full-time job — perhaps a side hustle on evenings and weekends — to generate more money that you can put toward your retirement savings.

The Role of Social Security and Pensions in Early Retirement

Social Security can help supplement your retirement income. However, as covered above, the earliest you can collect it is at age 62. And if you take your benefits that early they will be reduced by as much as 30%. On the other hand, if you wait until full retirement age to collect them, you’ll receive full benefits. If you were born in 1960 or later, your full retirement age is 67. You can find out more information at ssa.gov.

If your employer offers a pension, you should be able to collect that as another income stream for your retirement years. Generally, you need to be fully vested in the plan to collect the entire pension. The amount you are eligible for is typically based on what you earned, how long you worked for the company, and when you stop working there. Check with your HR department to learn more.

The Significance of Withdrawal Strategies: Rules of 55 and 4%

When it comes to withdrawing money from your investments after retirement, there are some rules and guidelines to be aware of. According to the Rule of 55, the IRS allows certain workers who leave their jobs to take penalty-free distributions from their current employer’s workplace retirement account, such as a 401(k) or 403(b), the year they turn 55.

The 4% rule is a general rule of thumb that recommends that you take 4% of your total retirement savings per year to cover your expenses.

To figure out what you would need, start with your desired yearly retirement income, subtract the annual amount of any pension or additional revenue stream you might have, and divide that number by 0.4. The resulting amount will be 4%, and you can aim to withdraw no more than that amount every year. The rest of your money would stay in your retirement portfolio.

Monitoring Your Progress Towards Early Retirement

To stay on course to reach your goal of early retirement, keep tabs on your progress at regular intervals. For instance, you may want to do a monthly or bi-monthly financial check-in to see where you’re at. Are you saving as much as you planned? If not, what could you do to save more?

Using an online retirement calculator can help you keep track of your goals. From there you can make any adjustments as needed to help make your dreams of early retirement come true.

How to Manage Early Retirement When You Get There

The budget you make in order to save for an early retirement is probably a good blueprint for how you should think about your spending habits after you retire. Unless your expenses will drop significantly after you retire (for instance, if you move or need one car instead of two, etc.), you can expect your spending to be about the same.

That said, you may be spending on different things. Whatever your retirement looks like, though, it’s wise to keep your spending as steady as you can, to keep your nest egg intact.

The Takeaway

An early retirement may appeal to many people, but it takes a real commitment to actually embrace it as your goal. These days, many people are using movements like FIRE (financial independence, retire early) to help them take the steps necessary to retire in their 30s, 40s, and 50s.

You can also make progress toward an early retirement by determining how much money you’ll need for post-work life, budgeting, and cutting back on expenses . And by saving and investing wisely, you may be able to make your goal a reality.

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).

Help grow your nest egg with a SoFi IRA.

FAQs

How much do you need to save for early retirement?

There isn’t one right answer to the question of how much you need to save for early retirement. It depends on your specific needs and circumstances. However, as a starting point, the Rule of 25 may give you an estimate. This guideline recommends saving 25 times your annual expenses in order to retire, and then following the 4% rule, and withdrawing no more than 4% a year in retirement to cover your expenses.

Is early retirement a practical goal?

For some people, early retirement can be a practical goal if they plan properly. You’ll need to decide at what age you want to retire, and how much money you’ll need for your retirement years. Then, you will need to map out a budget and a concrete strategy to save enough. It will likely require adjusting your lifestyle now to cut back on spending and expenses to help save for the future, which can be challenging.

SoFi Invest®

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

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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.

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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.

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.

SOIN0224019

May

2024

6 Investing Tips and Strategies for Retirees

By Michael Flannelly | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

A lot of personal finance advice is about saving for retirement. But the need for saving and investing doesn’t stop once you’re done working; seniors also need to maintain a sound investment strategy during retirement.

Retirees face several challenges that make investing after 65 necessary, including maintaining safe income streams, outpacing inflation, and avoiding the risk of running out of money. Here are some tips seniors may consider as they choose the right path for investing after retirement.

Key Points

• Assessing income sources and budgeting is crucial for retirees to manage financial changes without a steady paycheck.

• Tracking down forgotten 401(k)s can recover significant unclaimed funds.

• Understanding the time horizon and risk tolerance is essential for choosing suitable investments.

• Diversification across various asset classes helps mitigate risks associated with specific investments.

• Regular portfolio rebalancing ensures alignment with changing financial goals and market conditions.

1. Assess Income Sources and Budget

Once in retirement, seniors likely don’t have an income stream from a steady paycheck. Instead, retirees utilize a mix of sources to pay the bills, such as Social Security, withdrawals from retirement and savings accounts, and perhaps passive sources of income such as rental properties. This change, going from relying on a regular salary to relying on savings and investments to fund a particular lifestyle, can be daunting.

Retirees should first understand where their income is coming from and how much is coming in to help navigate this financial change. This initial step can help establish a budget that allows them to comfortably cover typical retirement expenses and map out discretionary spending or new investments in their golden years.

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2. Track Down Forgotten 401(k)s and Other Lost Money

If you changed jobs during your career, it’s possible that you left an old 401(k) behind. As of May 2023, there were 29.2 million forgotten or left-behind 401(k) accounts, according to estimates by Capitalize, a company that helps with 401(k) rollovers. These forgotten accounts hold about $1.65 trillion in assets.

To determine if you have a forgotten 401(k), make a list of every company you worked for and where you participated in a 401(k) plan. Contact them to see if they still have an account in your name. If a company no longer exists, or if it merged with another company, check with the U.S. Department of Labor (DOL). Visit the DOL website, where you can track down your former company’s Form 5500, which is required to be filed annually for employee benefit plans. That should give you contact information you can reach out to or at least tell you who your 401(k) plan’s administrator was.

If you still can’t find a forgotten 401(k), you could try the National Registry of Unclaimed Retirement Benefits. Be aware that you’ll need to supply your Social Security number to search on their website. Another option is to check the website for the National Association of Unclaimed Property Administrators, which may be able to help you find unclaimed funds, including an old 401(k). Check under every state that you’ve lived and worked in.

If and when you find an old 401(k), you can roll it over into an IRA. If you don’t yet have an IRA, you can set one up online. From there, you can invest the money as you see fit.

3. Understand Time Horizon and Risk

Retirees must consider time horizon and risk in post-retirement investment plans. Time horizon is the amount of time an individual has to invest before reaching a financial goal or needing the investment earnings for living expenses.

Time horizon significantly affects risk tolerance, which is the balance an individual is willing to strike between risk and reward. Generally speaking, seniors with a time horizon of a decade or more might choose to invest in riskier assets, such as stocks, because they feel they may have time to ride out any short-term downturns in the market. Individuals with a short time horizon of just a few years may stick to more conservative investments, such as bonds, where they can benefit from capital preservation and interest income.

4. Consider Diversification

Diversification involves spreading out investment across different asset classes, such as stocks, bonds, real estate, and cash. Diversification also involves spreading investments out among factors such as sector, size, and geography within each asset class.

It is important to consider diversification when investing after retirement. Diversification may help investors protect their portfolios from the risk and volatility unique to a specific type of investment, although there is still risk involved. Retirees do not want to concentrate a portfolio with any one asset, which may increase volatility during a period when they want a low risk tolerance.

5. Rebalance Regularly

A retiree’s financial goals, risk tolerance, and time horizon generally affect the desired asset allocation in an investment portfolio. However, those initial goals and risk considerations can change during a retiree’s golden years.

Additionally, the market is constantly in flux, shifting the proportions of assets a person holds. It may make sense to rebalance the assets inside a portfolio regularly.

Rebalancing a portfolio can be thought of like the routine upkeep of your investments. For example, if a portfolio has an asset allocation of 70% bonds and 30% stocks and the stocks do well during a year, they might make up a higher percentage of a portfolio than planned. By the end of the year, the asset allocation may be 65% bonds and 35% stocks. The investor may want to rebalance by selling stock and buying more conservative assets, such as bonds, to ensure the portfolio’s asset allocation is in line with their goals. Alternatively, they may use other income to make new bond investments.

6. Keep an Eye on Inflation

Retirees living on a fixed income may be negatively affected by rising inflation. As prices increase, the fixed income that an individual relies on will be worth less the following year. For example, if an individual receives $1,000 a month in a fixed income and inflation rises by a 4% annual rate, then that $1,000 monthly income will be worth $960 in today’s money.

Investments that pay out a fixed interest rate, such as bonds, are most vulnerable to inflation risk as inflation may outpace the earned interest rate. Some other assets may outpace inflation, such as stocks, real estate investment trusts (REITs), or inflation-protected securities.

Boost your retirement contributions with a 1% match.

SoFi IRAs now get a 1% match on every dollar you deposit, up to the annual contribution limits. Open an account today and get started.

Only offers made via ACH are eligible for the match. ACATs, wires, and rollovers are not included.

Smart, Safer Investment Options for Retirees

Retirees have a lot of choices when it comes to making new investments. But their financial goals, age, and risk tolerance can impact which investments they choose to make. Here are a few investments for seniors in retirement with those factors in mind.

Cash

Cash is the most stable way to hold money, and it is a necessary part of a retiree’s financial portfolio. Keeping cash on hand can help cover necessities like housing, utilities, food, and clothes.

Retirees can put a portion of their cash in a money market account or a high-yield savings account to earn interest while having easy access to their cash. However, the interest paid out in typical savings or checking accounts tends to be very low and may not beat the inflation rate. That means the money in these accounts may slowly lose its value over time.

By comparison, some high-yield savings accounts pay nearly 5% interest, compared to the 0.47% national average rate.

Bonds

Bonds generally don’t offer the same potential for high returns as stocks and other assets, but they may have advantages for investing after retirement. Bonds typically pay interest regularly, such as twice a year, which may provide investors with a predictable income desired in retirement. Also, if investors hold a bond to maturity, they typically get back their entire principal, which can help preserve their savings while investing.

However, it’s important to be aware that while bonds are considered by investors to be a less risky investment, it’s still possible to lose money investing in them. For instance, a bond issuer may fail to make interest payments and default on the bond. Retirees should be aware of the risks involved when considering bonds.

Various types of bonds may help investors preserve capital and realize interest income during retirement, including relatively safe U.S. Treasuries. Additionally, Treasury-Inflation Protected Securities (TIPS) are bonds that hedge against inflation, which can be helpful for retirees worried about rising prices.

Stocks

Stocks are considered a risky investment; they tend to be more volatile than more conservative assets like bonds or certificates of deposit. Though investing in stocks can potentially lead to significant returns, it also means there is the potential for big losses that many retirees may not be able to stomach. However, there may be value in investing in stocks for seniors.

Stock investments may help ensure a portfolio experiences capital gains that outpace inflation and have enough income in the later decades of their retirement. It may not make sense for older investors to chase returns from higher risk stocks like tech start-ups. Instead, retirees may look for proven companies whose stocks offer steady growth. Retirees may consider investing in companies that provide stable dividend payouts that generate a regular income source.

Certificates of Deposit

Certificates of deposit, otherwise known as CDs, are low-risk investments that may offer higher interest rates than typical savings accounts. Investors put their money in a CD and choose a term, or length of time, that the bank will hold their money. The term length is generally anywhere from one month to 20 years, and during this period, the investor can’t touch the money until the term is up. Once the term is over, the investor gets the principal back, plus interest. Typically, the longer the investor’s money is in the account, the more interest the bank will pay.

Fixed Annuities

Fixed annuities may provide retirees with a regular income, bolster the gains from other investments, and supplement savings. In short, an annuity is a contract with an insurance company. The buyer pays into the annuity for a certain number of years, and the insurance company pays back the money in monthly payments. Essentially, an individual is paying the insurance company to take on the risk of outliving their retirement savings.

The Takeaway

Investing for retirement should begin as soon as possible, ideally through a tax-advantaged retirement account. But the need for a sound investing strategy doesn’t stop once you hit retirement. You need to ensure that your savings and investments are working for you throughout your golden years.

Another step that can help you manage your retirement savings is doing a 401(k) rollover, where you move funds from an old account to a rollover IRA. You can even search for a lost or forgotten 401(k) to roll over into an IRA.

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).

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