invest Archives | Page 34 of 181

Jan

2025

Roth IRA Conversion: Rules and Examples

By SoFi Editors | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

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.

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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.

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.

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Is Converting to a Roth IRA Right for You?

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

Reasons For

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

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

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

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

Reasons Against

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

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

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

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

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

The Takeaway

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

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

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FAQ

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

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

How many Roth iRA conversions are allowed per year?

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

When is the deadline for Roth IRA conversions?

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

Is there a loophole for Roth IRA conversions?

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

How do I avoid taxes on Roth conversion?

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

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

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

Do you have to pay taxes immediately on Roth conversion?

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

Should a 65 year old do a Roth conversion?

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

Does a Roth conversion affect my Social Security?

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

Does a Roth conversion affect Medicare premiums?

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

What is the best Roth conversion strategy?

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

Can you do Roth conversions after age 72?

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

How do I calculate my Roth conversion basis?

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

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

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

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Jan

2025

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

By AJ Smith | Growing Wealth, invest, Investing, Preparing for Retirement, Terminology | No Comments

Table of Contents

How Are IRAs and 401(k)s Different?
Other Key Differences Between IRAs and 401(k)s
A Closer Look at IRAs
A Closer Look at a 401(k)
When Should You Use a 401(k)?
When Should You Use an IRA?
When Should You Use Both an IRA and 401(k)?

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.

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.

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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.

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Jan

2025

SEP IRA Contribution Limits for 2024

By Rebecca Lake | invest, Investing, Preparing for Retirement | Comments Off

A SEP IRA, or Simplified Employee Pension IRA, is a tax-advantaged retirement plan for people who are self-employed or run a small business. SEP IRA contribution limits determine how much you can contribute to the account each year.

The IRS sets contribution limits for SEP IRAs and adjusts them annually for inflation. SEP IRA contribution rules permit employers to make contributions to their own or their employees’ SEP accounts; employees do not contribute to a SEP.

Key Points

• SEP IRAs offer a tax-advantaged way to save for retirement, beneficial for self-employed and small business owners.

• It’s possible to contribute as much as $69,000 to a SEP IRA in 2024, an increase from the previous year.

• For 2024, employers can contribute up to the lesser of 25% of an employee’s compensation or $69,000 to a SEP IRA.

• Contributions to SEP IRAs are tax-deductible and must be reported on IRS Form 5498.

• Since contributions to SEP IRAs are made with pre-tax dollars, qualified withdrawals are subject to ordinary income tax.

What Is a SEP IRA?

A SEP IRA is a tax-advantaged retirement account that allows employers to make contributions on behalf of employees. Businesses of any size can establish a SEP IRA, including self-employed individuals who have no employees.

SEP IRAs are subject to the same tax treatment as traditional IRAs. Specifically, that means:

• Contributions to a SEP IRA are tax-deductible for employers or self-employed individuals

• Qualified withdrawals are subject to ordinary income tax since SEP IRAs are funded with pre-tax dollars

• Early withdrawals before age 59 ½ may be subject to taxes and penalties

• Required minimum distributions (RMDs) are required at age 73 (assuming you turn 72 after Dec. 31, 2022).

The SECURE 2.0 Act permits employers to offer employees a Roth SEP IRA option, though they’re not required to. It’s also possible to convert a traditional SEP IRA to a Roth IRA, to get tax-free retirement withdrawals. However, the account owner would have to pay tax on earnings at the time of the conversion.

SEP IRA Contribution Limits for 2024

Once you open an IRA, it’s important to be aware that the IRS determines the maximum SEP IRA contribution limits each year. For 2024, it’s possible to contribute as much as $69,000, up from the maximum limit of $66,000 in 2023.

Unlike traditional or Roth IRAs, catch-up contributions are not allowed with SEP IRAs.

Here are the details on how the 2024 SEP IRA contribution limits work.

Maximum Contribution Amounts

The SEP IRA max contribution by employers for 2024 is the lesser of the following:

• 25% of an employee’s compensation

• $69,000

This limit applies to employers who make contributions on behalf of employees. As noted above, employees cannot make elective salary deferrals to a SEP IRA the way they can with a traditional or Roth 401(k) plan.

If you’re self-employed your SEP IRA contribution limits for 2024 are the lesser of:

• 25% of your net self-employment earnings (see how to calculate net self-employment earnings below)

• $69,000

Self-employed individuals may want to compare a solo 401(k) vs SEP IRA to decide which one offers the most benefits in terms of contribution levels and tax advantages.

Calculation Methods and Factors

Whether you’re an employer or a self-employed individual dictates how you calculate the amount you can contribute to a SEP IRA.

According to SEP IRA rules, employer contributions are based on each employee’s compensation. The IRS limits the amount of compensation employers can use to calculate the SEP IRA max contribution for the year.

For 2024, employers can base their calculations on the first $345,000 of compensation. As with the SEP IRA contribution limit, the IRS adjusts the compensation threshold annually.

In addition, contribution rates are required to be the same for all employees and the owner of the company. So if you’re a business owner who is contributing a certain amount to your own account, you must contribute funds at that same rate to your employees.

If you’re self-employed, you’ll need to calculate your net earnings from self-employment less the deductions for:

• One-half of self-employment tax

AND

• Contributions to your own SEP IRA

Net earnings from self-employment is the difference between your business income and business expenses. For 2024, the self-employment tax rate is 15.3% of net earnings, which consists of 12.4% for Social Security and 2.9% for Medicare.

Strategies for Maximizing SEP IRA Contributions

Maximizing SEP IRA contributions comes down to understanding the annual contribution limit and the deadline for making contributions.

The IRS releases updated SEP IRA contribution limits as soon as they’re finalized to allow employers and self-employed individuals sufficient time to plan. You’ll have until the annual income tax filing deadline each year to make contributions to a SEP IRA on behalf of your eligible employees or yourself, if you’re self-employed.

Once you open an investment account like a SEP IRA, you can make monthly contributions or contribute a lump sum to meet the max SEP IRA limit for the year. If you’re self-employed, you may find it helpful to contribute something monthly and then make one larger lump sum contribution just ahead of the tax filing deadline once you’ve had a chance to calculate your net earnings from self-employment.

This strategy could mean that you miss out on some earnings from compounding returns since you’re putting in less money throughout the year. However, it may prevent you from making excess contributions to your SEP IRA, which can result in a penalty.

Recommended: What is a Self-Directed IRA?

Potential Changes and Updates for Future Years

SEP IRA contribution limits don’t stay the same each year. The amount you contribute for 2024 increases for 2025. Staying on top of changes to the contribution limits can ensure that you don’t miss out on opportunities to maximize your SEP IRA.

Cost-of-Living Adjustments (COLAs)

Internal Revenue Code (IRC) Section 415 requires annual cost of living increases for retirement plans and IRAs. Cost-of-living adjustments are meant to help your savings rate keep pace with the inflation rate.

These COLA rules apply to:

• SEP IRAs

• SIMPLE IRAs

• Traditional and Roth IRAs

• 401(k) plans

• 403(b)plans

• 457 plans

• Profit-sharing plans

The IRC also applies COLAs to Social Security benefits to ensure that people who rely on them can maintain a similar level of purchasing power even as consumer prices rise.

Monitoring IRS Announcements

The IRS typically announces COLA limits and adjustments in November or December of the preceding year. For example, the IRS released the Internal Revenue Bulletin detailing SEP IRA contribution limits for 2025 and other COLA adjustments on November 1, 2024.

These bulletins are readily available on the IRS website. You can review the latest and past bulletins on the IRS bulletins page.

Compliance and Tax Implications

SEP IRAs are fairly easy to set up and maintain, but there are compliance rules you will need to follow. As an employer, you’re not required to make contributions to a SEP IRA for eligible employees every year, and if you are self-employed, you are not required to make yearly contributions to your own SEP. However, if you make contributions on behalf of one eligible employee, you have to make contributions on behalf of all eligible employees.

And remember, the contribution percentage you use to calculate the SEP IRA maximum for each employee, and for yourself as the business owner, must be the same.

Reporting SEP IRA Contributions

SEP IRA contributions must be reported on IRS Form 5498. If you’re using tax filing software to complete your return you should be prompted to enter your SEP IRA contributions when reporting your income. The software program will record contributions and calculate your deduction for you.

There’s one more thing to note. Contributions must be reported for the year in which they’re made to the account, regardless of which tax year the contributions are for.

Excess Contribution Penalties

The IRS treats excess SEP IRA contributions as gross income for the employee. If you make excess contributions, the employee would need to withdraw them, plus any related earnings, before the federal tax filing deadline.

If they fail to do so, the IRS can impose a 6% excise tax on excess SEP IRA contributions left in the employee’s account. The employer can also be hit with a 10% excise tax on excess nondeductible contributions.

The Takeaway

For small business owners and the self-employed, SEP IRAs can be a good way to save and invest for retirement. Just be aware that SEP IRA rules are more complicated than the rules for other types of IRAs when it comes to contributions and deductions. If you’re contributing to one of these plans for your employees, or for yourself as a self-employed business owner, it’s important to know how much you can contribute, what each year’s contribution limits are, and when contributions are due.

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

FAQ

What is the maximum SEP IRA contribution for 2024?

The SEP IRA contribution limit for 2024 tops out at $69,000. That’s the maximum amount you can contribute to a SEP account on behalf of an employee or to your own SEP IRA if you’re self-employed.

Can I contribute to both a SEP IRA and a 401(k)?

It’s possible to contribute to both a SEP IRA and a 401(k) if you’re employed by multiple businesses. The plans must be administered by separate companies, or you must work for a company that has a 401(k) and then contribute to a SEP IRA for yourself as a self-employed business owner.

Are SEP IRA contributions tax-deductible for employers?

Employers can deduct SEP IRA contributions made on behalf of employees. Contributions must be within the annual contribution limit to be deductible. Excess SEP IRA contributions are not eligible for a deduction.

Photo credit: iStock/Prostock-Studio

SoFi Invest®

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

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

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.

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

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

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Jan

2025

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

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

The Savings Incentive Match Plan for Employees 401(k), or SIMPLE 401(k), is a type of retirement account that can be offered by companies with 100 employees or less. SIMPLE plans were created so that small businesses could have a cost-efficient way to offer retirement plans to their workers.

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

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

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

How Does a SIMPLE 401(k) Work?

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

In 2024, the SIMPLE 401(k) limits are as follows: The maximum for employee elective deferrals is $16,000 per year, $16,500 for 2025. As with other types of retirement accounts, employees 50 and older can make an additional “catch-up” contribution of $3,500 to boost their savings. For those age 60, 61, 62, or 63 there is a “super catch-up” contibution allowed of up to $5,250 instead of $3,500.

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

There are other limits on how much an employer can contribute annually. The maximum compensation that could be used to figure out employer contributions and benefits is $345,000 for 2024, $350,000 for 2025. So if an employer offered a 2% nonelective contribution (e.g., funds an employer contributes regardless of whether the employee contributes to the account), and an employee earned $355,000 in 2024, the maximum contribution the employer could make would be 2% of $345,000, or $6,900.

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

Withdrawals made during retirement are subject to income tax.

💡 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.

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

Who Is Eligible for a SIMPLE 401(k)?

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

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

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

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

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

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

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

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

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

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

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

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

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

• Lower contribution limits: For 2024, a traditional 401(k) plan allows up to $23,000 per year from employees, and for 2025 it’s $23,500 — with an additional $7,500 catch-up contribution for those 50 and older. For 2025, those aged 60 to 63 only may contribute an additional $11,250 instead of $7,500, thanks to SECURE 2.0.

• The annual contribution limits for SIMPLE plans are lower: in 2024 the employee limit is $16,000 with an additional “catch-up” contribution of $3,500 for employees over age 50. Thanks to SECURE 2.0, for those aged 60, 61, 62, or 63 there is a “super catch-up” contribution allowed of up to $5,250 instead of $3,500.

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

SIMPLE 401(k) vs SIMPLE IRA

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

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

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

• Employers can only make contributions on up to $345,000 in employee compensation in 2024; up to $350,000 in 2025.

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

• Employer and employee contributions are fully vested immediately.

There are a few differences worth mentioning:

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

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

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

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

The Takeaway

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

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

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

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

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

Easily manage your retirement savings with a SoFi IRA.

FAQ

Who is a SIMPLE IRA best for?

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

What is the 2 year rule for SIMPLE IRAs?

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

Does money grow in a SIMPLE IRA?

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

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

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

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.

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.

SOIN0124059

Jan

2025

What Is a Non-Deductible IRA?

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

A non-deductible IRA is an IRA, or IRA contributions, that cannot be deducted from your income. While contributions to a traditional IRA are tax-deductible, non-deductible IRA contributions offer no immediate tax break.

In both cases, though, contributions grow tax free over time — and in the case of a non-deductible IRA, you wouldn’t owe taxes on the withdrawals in retirement.

Why would you open a non-deductible IRA? If you meet certain criteria, such as your income is too high to allow you to contribute to a traditional IRA or Roth IRA, a non-deductible IRA might help you increase your retirement savings.

It helps to understand how non-deductible contributions work, what the rules and restrictions are, as well as the potential advantages and drawbacks.

Who Is Eligible for a Non-Deductible IRA?

Several factors determine whether an individual is ineligible for a traditional IRA, and therefore if their contributions could fund a non-deductible IRA. These include an individual’s income level, tax-filing status, and access to employer-sponsored retirement plans (even if the individual or their spouse don’t participate in such a plan).

If you and your spouse do not have an employer plan like a 401(k) at work, there are no restrictions on fully funding a regular, aka deductible, IRA. You can contribute up to $7,000 in 2024; $8,000 if you’re 50 and older. In 2025, you can contribute up to $7,000; $8,000 if you’re 50 or older.

However, if you’re eligible to participate in an employer-sponsored plan, or if your spouse is, then the amount you can contribute to a deductible IRA phases out — in other words, the amount you can deduct gets smaller — based on your income:

• For single filers/head of household: the 2024 contribution amount is reduced if you earn more than $77,000 and less than $87,000. If you earn $87,000 and above, you can only contribute to a non-deductible IRA. For 2025, the phaseout begins when you earn more than $79,000 and less than $89,000. If you earn $89,000 or more, you can’t contribute to a traditional IRA.)

• For married, filing jointly:

◦ If you have access to a workplace plan, the phaseout for 2024 is when you earn more than $123,00 and less than $143,000. For 2025, the phaseout is when you earn more than $126,000, but less than $146,000.

◦ If your spouse has access to a workplace plan, the 2024 phaseout is when you earn more than $230,000 and less than $240,000. For 2025, the phaseout is when you earn more than $236,000 but less than $246,000.

💡 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.

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.

Non-Deductible IRA Withdrawal Rules

The other big difference between an ordinary, deductible IRA and a non-deductible IRA is how withdrawals are taxed after age 59 ½. (IRA withdrawals prior to that may be subject to an early withdrawal penalty.)

• Regular (deductible) IRA: Contributions are made pre-tax. Withdrawals after 59 ½ are taxed at the individual’s ordinary income rate.

• Non-deductible IRA: Contributions are after tax (meaning you’ve already paid tax on the money). Withdrawals are therefore not taxed, because the IRS can’t tax you twice.

To make sure of this, you must report non-deductible IRA contributions on your tax return, and you use Form 8606 to do so. Form 8606 officially documents that some or all of the money in your IRA has already been taxed and is therefore non-deductible. Later on, when you take distributions, a portion of those withdrawals will not be subject to income tax.

If you have one single non-deductible IRA, then the process is similar to a Roth IRA. You deposit money you’ve paid taxes on, and your withdrawals are tax free.

It gets more complicated when you mix both types of contributions — deductible and non-deductible — in a single IRA account.

Here’s an example of different IRA withdrawal rules:

Let’s say you qualified to make deductible IRA contributions for 10 years, and now you have $50,000 in a regular IRA account. Then, your situation changed — perhaps your income increased — and now only 50% of the money you deposit is deductible; the other half is non-deductible.

You contribute another $50,000 in the next 10 years, but only $25,000 is deductible; $25,000 is non-deductible. You diligently record the different types of contributions using Form 8606, so the IRS knows what’s what.

When you’re ready to retire, the total balance in the IRA is $100,000, but only $25,000 of that was non-deductible (meaning, you already paid tax on it). So when you withdraw money in retirement, you’ll owe taxes on three-quarters of that money, but you won’t owe taxes on one quarter.

Contribution Limits and RMDs

There are limits on the amount that you can contribute to an IRA each year, and deductible and non-deductible IRA account contributions have the same contribution caps. People under 50 years old can contribute up to $7,000 for 2024, and those over 50 can contribute $8,000 per year. People under 50 years old can contribute up to $7,000 for 2023, and those over 50 can contribute $8,000 per year.

IRA account owners are required to start taking required minimum distributions (RMDs), similar to a 401(k), from their account once they turn 73 years old. Prior to that, account holders can take money out of their account between ages 59 ½ and 73 without any early withdrawal penalty.

Individuals can continue to contribute to their IRA at any age as long as they still meet the requirements.

Benefits and Risks of Non-Deductible IRA

While there are benefits to putting money into a non-deductible IRA, there are some risks that individuals should be aware of as well.

Benefits

There are several reasons you might choose to open a non-deductible IRA. In some cases, you can’t make tax-deductible contributions to a traditional IRA, so you need another retirement savings account option. Though your contributions aren’t deductible in the tax year you make them, funds in the IRA that earn dividends or capital gains are not taxed, because the government doesn’t tax retirement savings twice.

Another reason people use non-deductible IRAs is as a stepping stone to a Roth IRA. Roth IRAs also have income limits, but they come with additional choices. High income earners can start by contributing funds to a non-deductible IRA, then convert that IRA into a Roth IRA. This is called a backdoor Roth IRA.

One thing to keep in mind with a backdoor Roth is that the conversion may not be entirely tax free. If an IRA account is made up of a combination of deductible and non-deductible contributions, when it gets converted into a Roth account some of those funds would be taxable.

Risks

The primary benefits of non-deductible IRAs come when used to later convert into a Roth IRA. It can be risky to keep a non-deductible IRA ongoing, especially if it’s made up of both deductible and non-deductible contributions, which can be tricky to keep track of for tax purposes. You can keep a blended IRA, it just takes more work to keep track of the amounts that are taxable.

As noted above, it requires dividing non-deductible contributions by the total contributions made to all IRAs one has in order to figure out the amount of after-tax contributions that have been made.

Non-Deductible IRA vs Roth IRA

With a non-deductible IRA, you contribute funds after you’ve paid taxes on that money, and therefore you’re not able to deduct the contributions from your income tax. The contributions that you make to the non-deductible IRA earn non-taxable interest while they are in the account. The money isn’t taxed when it is withdrawn later.

Roth IRA contributions are similarly made with after-tax money and one can’t get a tax deduction on them. Also, a Roth IRA allows an individual to take out tax-free distributions during retirement.

Unlike other types of retirement accounts, a Roth IRA doesn’t require the account holder to take out a minimum distribution amount.

There are income limits on Roth IRAs, so some high-income earners may not be able to open this type of account. The non-deductible IRA is one way to get around this rule, because an individual can start out with a non-deductible IRA and convert it into a Roth IRA.

How Can I Tell If a Non-Deductible IRA Is the Right Choice?

Non-deductible IRAs can be a way for high-income savers to make their way into a backdoor Roth account. This strategy can help them reduce the amount of taxes they owe on their savings. However, they may not be the best type of account for long-term savings or lower-income savers.

The Takeaway

For many people, contributing to an ordinary IRA is a clearcut proposition: You deposit pre-tax money, and the amount can be deducted from your income for that year. Things get more complicated, however, for higher earners who also have access (or their spouse has access) to an employer-sponsored plan like a 401(k) or 403(b). In that case, you may no longer qualify to deduct all your IRA contributions; some or all of that money may become non-deductible. That means you deposit funds post tax and you can’t deduct it from your income tax that year.

In either case, though, all the money in the IRA would grow tax free. And the upside, of course, is that with a non-deductible IRA the withdrawals are also tax free. With a regular IRA, because you haven’t paid taxes on your contributions, you owe tax when you withdraw money in retirement.

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.

Photo credit: iStock/Drazen Zigic

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

Roth IRA Conversion: Rules and Examples

What Is a Roth IRA Conversion?

How Does a Roth IRA Conversion Work?

Get a 1% IRA match on rollovers and contributions.

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

Roth IRA Conversion Rules

Taxes

Limits

Withdrawals

Backdoor Roth IRAs

5-Year Rule

Is Converting to a Roth IRA Right for You?

Reasons For

Reasons Against

The Takeaway

FAQ

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

How many Roth iRA conversions are allowed per year?

When is the deadline for Roth IRA conversions?

Is there a loophole for Roth IRA conversions?

How do I avoid taxes on Roth conversion?

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

Do you have to pay taxes immediately on Roth conversion?

Should a 65 year old do a Roth conversion?

Does a Roth conversion affect my Social Security?

Does a Roth conversion affect Medicare premiums?

What is the best Roth conversion strategy?

Can you do Roth conversions after age 72?

How do I calculate my Roth conversion basis?

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

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

How Are IRAs and 401(k)s Different?

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

Other Key Differences Between IRAs and 401(k)s

Who Can Set Up a 401(k)?

Who Can Set Up an IRA?

Understanding RMDs

A Closer Look at IRAs

Traditional IRA

What Are Roth Accounts?

A Closer Look at a 401(k)

When Should You Use a 401(k)?

1. If your employer matches your contributions

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

3. When your income is too high

When Should You Use an IRA?

1. When you leave your company

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

3. When you’re between jobs

4. If you can “double dip.”

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

The Takeaway

FAQ

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

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

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

Can you lose money in an IRA?

SEP IRA Contribution Limits for 2024

What Is a SEP IRA?

SEP IRA Contribution Limits for 2024

Maximum Contribution Amounts

Calculation Methods and Factors

Strategies for Maximizing SEP IRA Contributions

Potential Changes and Updates for Future Years

Cost-of-Living Adjustments (COLAs)

Monitoring IRS Announcements

Compliance and Tax Implications

Reporting SEP IRA Contributions

Excess Contribution Penalties

The Takeaway

FAQ

What is the maximum SEP IRA contribution for 2024?

Can I contribute to both a SEP IRA and a 401(k)?

Are SEP IRA contributions tax-deductible for employers?

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

How Does a SIMPLE 401(k) Work?

Get a 1% IRA match on rollovers and contributions.

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

Who Is Eligible for a SIMPLE 401(k)?

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

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

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

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

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