invest Archives | Page 54 of 180

May

2024

How to Buy Treasury Bills, Bonds, and Notes

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

Investors can buy Treasury bills, bonds, and notes a few ways, including through TreasuryDirect, through a broker or bank, or even through an ETF or mutual fund. Treasury bills, bonds, and notes are stable, profitable, and less-risky investments that can be a key part of a diverse investment portfolio. Learning how to purchase Treasuries may be important, regardless of your experience level with fixed-income investments.

With the full faith and credit of the US government behind them, these government-issued securities are among the least-risky investment options out there. We’ll explore the principles of buying Treasury bills, bonds, and notes in this article.

Key Points

• Treasury bills, bonds, and notes can be purchased through TreasuryDirect, banks, or brokers.

• These securities are backed by the full faith and credit of the U.S. government, making them low-risk investments.

• Investors can also buy Treasury securities indirectly through ETFs or mutual funds.

• TreasuryDirect allows direct purchases without a broker, saving on transaction costs.

• Investing in Treasury securities through ETFs and mutual funds offers ease and diversification.

How Can You Buy US Treasuries?

Both individual and institutional investors can invest in U.S. Treasury bonds through a variety of methods. Getting them straight from the US Department of the Treasury through their web portal, TreasuryDirect, is one of the easiest ways to do so.

With the use of this platform, investors can purchase Treasury bills, bonds, and notes straight from the government. Alternatively, investors can purchase Treasuries via a financial institution or brokerage house. Treasury securities are accessible through a number of brokerages, which also offer a variety of services and choices to help investors make purchases.

Investors can also purchase Treasury assets indirectly through mutual funds, exchange-traded funds (ETFs), or investment vehicles dedicated to Treasury securities. This allows investors to have diversified exposure to Treasuries in a single investment instrument.

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

1. Direct through TreasuryDirect

The U.S. Department of the Treasury offers an online platform called TreasuryDirect for investors who want direct access to U.S. Treasury securities. People can take part in Treasury auctions, which are public sales of recently issued securities, through TreasuryDirect.

Pros

• Buying Treasury securities directly from TreasuryDirect can save transaction costs by eliminating the need for a brokerage middleman.

• With capabilities like managing maturing securities and reinvesting interest, investors can easily manage their Treasury holdings through the site.

Cons

• A less user-friendly interface than an online broker.

• Less customer service in comparison to brokerage firms.

Purchasing Limits

Purchase restrictions may apply, limiting the quantity of Treasury securities that a person can acquire in a given period of time. The minimum amount that you can purchase of any given Treasury Bill, Note, Bond, TIPS, or FRNs is $100. Additional amounts must be in multiples of $100. The maximum amount of Treasury bills that you can buy in a single auction is $10 million if the bids are noncompetitive, or 35% of the offering amount for competitive bids.

2. Broker or Bank

Investors can buy U.S. Treasury bonds through banks or brokerage houses, which provide access to secondary market transactions as well as primary market Treasury auctions.

Pros

• Banks and brokers offer extra support and services, such as financial advice, research tools, and customer help.

• Certain brokerage houses give investors access to the primary and secondary markets, giving them a wide selection of Treasury securities and investing choices.

Cons

• Transaction fees and costs associated with utilizing a bank or broker may increase the total cost of investing in Treasuries.

Purchasing Limits

Purchasing restrictions may apply, depending on the bank’s or brokerage company’s specific policies.

3. ETFs and Mutual Funds

Investments in mutual funds or ETFs with a Treasury concentration are an option for investors who want exposure to U.S. Treasuries without having to buy individual securities directly. These investment vehicles combine money from many individual investors and use it to buy a variety of Treasury securities.

Pros

• The ease of use and accessibility of ETFs and mutual funds, which provide investors with a diverse portfolio of Treasuries with a single investment, is one of their main benefits.

• These funds usually offer expert supervision and management.

• Mutual funds and ETFs also provide liquidity, enabling investors to purchase and sell shares on the secondary market at any time during the trading day.

Cons

• Particularly for long-term investors, expense ratios and management fees associated with mutual funds and ETFs can gradually reduce returns.

• The costs of purchasing and selling securities inside the fund, such as brokerage commissions and bid-ask gaps, are also indirectly paid for by investors.

• While mutual funds and ETFs provide diversification and relatively low risk, they carry some risk of market volatility and possible losses.

Purchasing Limits

ETFs usually have no minimum investment limits, making them widely accessible. There may be minimum initial investment restrictions for mutual funds, which could prevent certain individuals from participating. Ongoing mutual fund contributions, however, are frequently flexible, enabling investors to gradually make lower installments.

💡 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.

Portfolio Considerations When Buying Treasuries

When incorporating U.S. Treasuries into a portfolio, investors should consider several key factors to optimize their investment strategy. Due to their low correlation with other asset classes, treasuries are essential for offering stability and diversification within a portfolio. They are frequently seen as a safe haven investment, especially in volatile markets or uncertain economic times – though it’s important to remember that no investment is completely safe.

Using Treasury bill (T-bill) and Treasury bond (T-bond) ladders is one way to optimize the returns on Treasuries. Buying Treasury bills with staggered maturities — typically a few weeks to a year — is known as a T-bill ladder. Because T-bills mature on a regular basis, this strategy offers investors a consistent flow of income and liquidity, allowing them to reinvest the proceeds or access cash as needed. T-bond ladders, on the other hand, are a way to spread out interest rate risk and keep exposure to longer-term rates by buying Treasury bonds with different maturities.

Investing in a group of Treasury-focused ETFs with staggered durations is known as an ETF ladder. ETF ladders enable investors to manage interest rate risk and take advantage of a variety of yields.

Whichever strategy is chosen, adding Treasuries to a portfolio can offer a good balance between risk and return, especially for investors who prioritize income generation and capital protection.

The Takeaway

Investment funds, brokers, and TreasuryDirect are a few of the ways to buy U.S. Treasury securities. Additionally, by combining ETF ladders with effective portfolio management techniques like T-bond and T-bill ladders, investors can maximize the contribution of Treasuries to their investment portfolios.

Investors wanting to optimize returns on their investments might reduce risk by diversifying across a range of Treasury securities and maturities. Securities are a low risk investment that can be a great way to diversify one’s portfolio.

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

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

FAQ

How do I buy Treasury notes and bonds?

A few of the most common ways that investors can buy Treasuries is through TreasuryDirect.gov, a bank, broker, or dealer.

Do you pay taxes on T-Bills?

Interest from Treasury bills (T-bills) is subject to federal income taxes, but not state or local taxes.

What happens when a T-Bill matures?

When a Treasury bill matures, you are paid its face value. You can hold a bill until it matures or sell it before it matures.

Photo credit: iStock/kate_sept2004

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May

2024

An Introduction to Secondary Offerings

By Laurel Tincher | Financial Independence, Growing Wealth, invest, Investing | Comments Off

You may be familiar with the phrase “initial public offering,” or IPO, when a new company makes its shares available on a public exchange. The term secondary offering can refer to a couple of things: One is when investors sell their IPO shares on the secondary market to other investors. Another is when companies seek to raise more cash in a follow-on offering some time after the IPO.

When companies seek to raise additional capital after an IPO through a secondary offering, there are two types: dilutive and non-dilutive. Secondary offerings can have a significant impact on stock prices, so it’s beneficial for investors to understand how they work. Let’s dive into the details.

Key Points

• Secondary offerings occur when a company or its shareholders sell additional shares after an initial public offering (IPO).

• These offerings can be dilutive, issuing new shares, or non-dilutive, selling existing shares.

• Dilutive offerings decrease existing shareholders’ ownership percentage, potentially lowering the stock’s value.

• Non-dilutive offerings involve shareholders selling their shares, not affecting the company’s share count.

• Understanding the type of secondary offering is crucial for investors assessing potential impacts on stock value.

What Are Offerings In Stock?

When a company begins selling shares of stocks, bonds, or other securities to the public, it’s called an offering.

Usually people talk about buying stocks during initial public offerings, or IPOs, but there are other types of offerings companies can make to raise cash.

A company may have later offerings, post-IPO, which are called seasoned offerings or follow-on public offerings (FPO) in which the company sells new shares on the market or by issuing a convertible note offering. These are low-interest notes that can be converted into shares, often within five to 10 years.

Any of these can also be called a secondary offering or secondary stock offering.

Companies may make these offerings if they need cash, are looking to expand their business, want to acquire another company — or their stock is performing well and they want to stoke investor demand with a limited additional supply of new shares.

Primary vs Secondary Offerings

The difference between primary and secondary offerings is pretty straightforward, but there are different types of secondary offerings.

A primary offering is to raise capital. Companies issue new shares to investors in exchange for cash that’s used to fund business operations, make acquisitions, and other corporate aims.

In a secondary stock offering, investors who own those IPO shares can buy and sell their shares directly from and to each other. Or a company may decide to issue new shares. Here’s what that can look like.

What Is a Secondary Offering, What Are the Different Types?

There are a couple of different types of secondary offerings, so it’s important to distinguish between them.

The main definition of a secondary offering refers to investors who buy and sell IPO shares amongst each other. In this case, the cash is exchanged between investors, as noted above.

Sometimes a company needs to raise more capital and may hold what’s known as a follow-on, or seasoned equity offering. This is referred to as a type of secondary offering as well.

Sometimes, in this type of secondary offering, shareholders such as the CEO and founders sell a portion of their shares on the secondary market for private or personal reasons. If the shares are sold by individuals, the money goes to those sellers.

If the shares come from the company, the money raised from the sale goes to the company. There are two types of shares that can be offered here: dilutive and non-dilutive.

💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

Types of Secondary Offerings

It’s important for investors to understand the difference between dilutive and non-dilutive shares as they can have different impacts on the value of the stock.

Dilutive Secondary Offerings

A dilutive offering involves the creation of additional shares by the company, which in turn reduces the amount of ownership that preexisting shareholders have. As the name implies, the offering has a dilutive effect. Investors often have a negative sentiment toward dilutive offerings.

The company’s board of directors must approve of the increase in floating stock shares. The float of a stock is the number of shares available for trade.

Non-Dilutive Secondary Offerings

With non-dilutive offerings, no additional shares are created. A non-dilutive offering is often made by major shareholders selling their existing shares. This doesn’t have any effect on the company itself, except perhaps the investor’s perception about why the shareholders are selling.

This type of offering can also be beneficial because it allows more individuals and institutions to invest, which can increase the stock’s liquidity since there are more people buying and selling.

Examples of Secondary Offerings

Many companies make secondary offerings following their IPOs.

Google made a secondary offering in 2005 after its IPO in 2004. During the IPO, the company had a share price of $85 and raised $2 billion. During the secondary offering, the share price was $295 and the company raised $4 billion.

Then there’s Rocket Fuel, a company that made a secondary offering of 5 million shares in 2013. Existing shareholders sold 3 million shares and the company sold 2 million, all at a price of $34 per share. Just one month after the secondary offering, the value of the shares had gone up nearly 30%, to $44.

Why Make a Secondary Offering?

Similar to an IPO, a secondary offering helps companies raise money so they can expand their operations. This can be a quick way for companies to raise significant funds fairly efficiently.

Companies may also hold a second offering between their IPO and the end of their stock’s lock-up period, which is a time when large shareholders are not allowed to sell shares. After the lock-up period, a stock’s price often falls when these shareholders sell off some of their shares. By holding a secondary offering before the end of the lock-up period, additional investors can benefit from the success of an IPO.

It’s important for investors to look into why a company is making a secondary offering before deciding whether to invest, as this can affect the price of the stock in both the short and long term.

How to Trade Secondary Offerings

Most companies that file secondary offerings choose to do so soon after the end of the lock-up period after their IPO. When a company wants to make a secondary offering, they file it for approval with the SEC.

Investors can find out about the latest secondary offerings in a few ways. The SEC has a database of secondary offerings called the EDGAR database, where investors can find out about them. Investors can also look to the NASDAQ list of secondary offerings made by companies listed on the NASDAQ stock exchange. Companies filing secondary offerings tend to get covered in the media and also put out press releases with details about the offering.

How Do Stock Prices React to a Secondary Offering?

The basic concept of supply and demand dictates that if there is more of something available, its price will likely decrease. This is sometimes what occurs during a secondary offering, but not always.

If more shares are created, the price of the shares may fall — especially with dilutive offerings because they can decrease the earnings per share of the stock.

The price of stocks can also decrease during a secondary offering because the company issues the offered shares at a discounted price to incentivize investors to buy. The decrease in value can last a while because any investors who buy-in at the discounted price can sell at a slight increase and make a profit.

If a company creates new shares and sells them at market value with a discount to account for the amount of dilution, this generally results in the least amount of price volatility.

Although a secondary offering often results in a decline in stock price, that isn’t always the case. Non-dilutive offerings are viewed more positively, as they don’t affect the stock’s earnings per share or shareholders’ amount of ownership. Also, it can be seen as a good sign for the long-term value of the stock if a company is investing in growth and acquisitions.

Many secondary offerings don’t have any restrictions, but some may require a lock-up period similar to an IPO, during which investors aren’t allowed to sell their shares.

For Investors, Green or Experienced

Now the difference between a primary offering and the different types of secondary offerings makes more sense. A primary offering is when a new company goes public and makes its shares available on a public exchange — this is part of how companies raise capital.

A secondary offering is when IPO investors subsequently sell their shares on the secondary market to other investors. In this case the company doesn’t issue new shares, and they don’t raise more cash from this type of secondary stock offering. However, companies can seek to raise more cash in a follow-on offering some time after the IPO — which is also called a secondary offering. There are two types, dilutive and non-dilutive secondary offerings, which can impact the stock price overall.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.

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

Need help getting an account set up? SoFi has a team of professional advisors available to help at any time.

FAQ

Is a secondary offering good for stock?

A secondary stock offering can be good for the stock price, particularly if the shares offered are non-dilutive. Dilutive shares, which reduce the value of existing shares, may not be good for the stock price in the short-term — although prices may recover.

What is the difference between a primary and secondary offering?

A primary offering is to raise capital, typically during an IPO. In a secondary offering, investors with IPO shares can trade their shares directly with each other. Or a company may decide to issue new shares in a follow-on offering to raise more cash.

Can you sell a secondary offering stock?

Yes, you can sell stock from a secondary offering, whether you’ve bought it from an IPO investor selling their shares, or from the company during a follow-on offering.

How do you sell on secondary?

To sell stock on a secondary market, shareholders need to find a buyer through whatever method they deem most efficient (there are platforms that can facilitate this), come to an agreement regarding price, and execute a trade.

What is the purpose of a secondary listing?

In general, the purpose of a secondary listing is to raise more capital, and to expand a customer’s investor base.

What are the risks of buying from a secondary market?

Buying from a secondary market means that an investor is purchasing securities from any public stock exchange. As such, the risks of buying on the secondary market are the same as buying any stock – there’s market risks, credit risks, and numerous other risks baked into the securities.

What are the benefits of secondary markets to investors?

Secondary markets give investors access to publicly traded securities, and for shareholders, open up liquidity for their holdings, as there’s a market full of potential buyers. Overall, secondary markets facilitate trading and thus, create liquidity.

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May

2024

Everything You Need to Know About Taxes on Investment Income

By Anna Davies | Growing Wealth, invest, Investing | Comments Off

There are several ways investment income is taxed: You may be familiar with capital gains taxes — the taxes imposed when one sells an asset that has gained value — but it’s important to also understand the tax implications of dividends, interest, retirement account withdrawals, and more.

In some cases, for certain types of accounts, taxes are deferred until the money is withdrawn, but in general, tax rules apply to most investments in one way or another.

Being well aware of all the tax liabilities your investments hold can minimize headaches and help you avoid a surprise bill from the IRS. Being tax savvy can also help you plan ahead for different income streams in retirement, or for your estate.

Key Points

• Investment income is taxed through various forms including capital gains, dividends, and interest.

• Capital gains tax applies when assets are sold for a profit, with rates depending on the holding period.

• Dividends received from stocks are taxed either at ordinary income rates or qualified rates.

• Interest income from investments like bonds and savings accounts is taxed at ordinary income rates.

• The Net Investment Income Tax adds a 3.8% tax on investment income for high earners.

Types of Investment Income Tax

There are several types of investment income that can be taxed. These include:

• Dividends

• Capital Gains

• Interest Income

• Net Investment Income Tax (NIIT)

Taking a deeper look at each category can help you assess whether — and what — you may owe.

Tax on Dividends

Dividends are distributions that are sometimes paid to investors who hold a certain type of dividend-paying stock. Dividends are generally paid in cash, out of profits and earnings from a corporation.

• Most dividends are considered ordinary (or non-qualified) dividends by default, and these payouts are taxed at the investor’s income tax rate.

• Others, called qualified dividends because they meet certain IRS criteria, are typically taxed at a lower capital gains rate (more on that in the next section).

Generally, an investor should expect to receive form 1099-DIV from the corporation that paid them dividends, if the dividends amounted to more than $10 in a given tax year.

More About Capital Gains Tax

Capital gains are the profit an investor sees when an investment they hold gains value when they sell it. Capital gains taxes are the taxes levied on the net gain between purchase price and sell price.

For example, if you buy 100 shares of stock at $10 ($1,000 total) and the stock increases to $12 ($1,200), if you sell the stock and realize the $200 gain, you would owe taxes on that stock’s gain.

There are two types of capital gains taxes: Long-term capital gains and short-term capital gains. Short-term capital gains apply to investments held less than a year, and are taxed as ordinary income; long-term capital gains are held for longer than a year and are taxed at the capital-gains rate.

For 2023 and 2024, the long-term capital gains tax rates are typically no higher than 15% for most individuals. Some individuals may qualify for a 0% tax rate on capital gain — but only if their taxable income for the 2023 tax year is $89,250 or less (married filing jointly), or $44,625 or less for single filers and those who are married filing separately.

For the 2024 tax year, individuals may qualify for a 0% tax rate on long-term capital gains if their taxable income is $94,050 or less for those married and filing jointly, and $47,025 or less for single filers and those who are married and filing separately.

The opposite of capital gains are capital losses — when an asset loses value between purchase and sale. Sometimes, investors use losses as a way to offset tax on capital gains, a strategy known as tax-loss harvesting.

Capital losses can also be carried forward to future years, which is another strategy that can help lower an overall capital gains tax.

Capital gains and capital losses only become taxable once an investor has actually sold an asset. Until you actually trigger a sale, any movement in your portfolio is called unrealized gains and losses. Seeing unrealized gains in your portfolio may lead you to question when the right time is to sell, and what tax implications that sale might have. Talking through scenarios with a tax advisor may help spotlight potential avenues to mitigate tax burdens.

▶️ Watch the video: Unrealized Gains: Explained

Taxable Interest Income

Interest income on investments is taxable at an investor’s ordinary income level. This may be money generated as interest in brokerage accounts, or interest from assets such as CDs, bonds, Treasuries, and savings accounts.

One exception are investments in municipal (muni) bonds, which are exempted from federal taxes and may be exempt from state taxes if they are issued within the state you reside.

Interest income (including interest from your bank accounts) is reported on form 1099-INT from the IRS.

Tax-exempt accounts, such as a Roth IRA or 529 plan, and tax-deferred accounts, such as a 401(k) or traditional IRA, are not subject to interest taxes.

Net Investment Income Tax (NIIT)

The Net Investment Income Tax (NIIT), also sometimes referred to as the Medicare tax, is a 3.8% flat tax rate on investment income for taxpayers whose modified adjusted gross income (MAGI) is above a certain level — $200,000 for single filers; $250,000 for filers filing jointly. Per the IRS, this tax applies to investment income including, but not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and income from businesses involved in trading of financial instruments or commodities.

For taxpayers with a MAGI above the required thresholds, the tax is paid on the lesser of the taxpayer’s net investment income or the amount the taxpayer’s MAGI exceeds the MAGI threshold.

For example, if a taxpayer makes $150,000 in wages and earns $100,000 in investment income, including income from rental properties, their MAGI would be $250,000. This is $50,000 above the threshold, which means they would owe NIIT on $50,000. To calculate the exact amount the taxpayer would owe, one would take 3.8% of $50,000, or $1,900.

💡 Quick Tip: How long should you hold onto your investments? It can make a difference with your taxes. Profits from securities that you sell after a year or more are taxed at a lower capital gains rate. Learn more about investment taxes.

Tax-Efficient Investing

One way to mitigate the effects of investment income is to create a set of tax efficient investing strategies. These are strategies that may minimize the tax hit that you may experience from investments and may help you build your wealth. These strategies can include:

• Diversifying investments to include investments in both tax-deferred and tax-exempt accounts. An example of a tax-deferred account is a 401(k); an example of a tax-exempt account is a Roth IRA. Investing in both these vehicles may be a strategy for long-term growth as well as a way to ensure that you have taxable and non-taxable income in retirement.

Remember that accounts like traditional, SEP, and SIMPLE IRAs, as well as 401(k) plans and some other employer-sponsored accounts, are tax-deferred — meaning that you don’t pay taxes on your contributions the year you make them, but you almost always owe taxes whenever you withdraw these funds.

• Exploring tax-efficient investments. Some examples are municipal bonds, exchange-traded funds (ETFs), Treasury bonds, and stocks that don’t pay dividends.

• Considering tax implications of investment decisions. When selling assets, it can be helpful to keep taxes in mind. Some investors may choose to work with a tax professional to help offset taxes in the case of major capital gains or to assess different strategies that may have a lower tax hit.

The Takeaway

Investment gains, interest, dividends — almost any money you make from securities you sell — may be subject to tax. But the tax rules for different types of investment income vary, and you also need to consider the type of account the investments are in.

Underreporting or ignoring investment income can lead to tax headaches and may result in you underpaying your tax bill. That’s why it’s a good idea to keep track of your investment income, and be mindful of any profits, dividends, and interest that may need to be reported even if you didn’t sell any assets over the course of the year.

Some investors may find it helpful to work with a tax professional, who may help them see the full scope of their liabilities and become aware of potential investment strategies that might help them minimize their tax burden, especially in retirement. A tax professional should also be aware of any specific state tax rules regarding investment taxes.

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

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

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

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

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May

2024

Venture Capital: What Is It and How Does It Work?

By Brian O'Connell | Growing Wealth, invest, Investing | Comments Off

Venture capital is a type of financing that’s usually provided by wealthy individuals or investment banks. Venture capital often funds startups or other small businesses, and is a form of alternative investment – for those with the means.

Venture capital doesn’t gain much attention among the public, but it’s behind many of the brands most of us engage with daily. Any consumer who logs on to Facebook or listens to their favorite song on Spotify is engaging with a company that once received financial funding from a venture capital firm.

Key Points

• Venture capital is a form of private equity financing provided by high-net-worth investors and financial institutions to startups and small businesses with high growth potential.

• This type of investment often includes not just monetary support but also technical assistance and managerial expertise.

• Venture capital firms play a crucial role by connecting investors with high-potential companies, especially in environments where traditional banking support is limited.

• The funding process involves multiple stages, including seed, early, and late stages, each catering to different development phases of a company.

• Despite the high risks associated with venture capital investment, the potential for substantial returns makes it an attractive option for qualified investors.

What Is Venture Capital?

As noted, venture capital (VC) is a form of private equity financing typically provided by high-net-worth investors, investment banks, and other financial institutions. This type of funding is focused on startups and small businesses that demonstrate potential for significant long-term growth. In that sense, it’s a form of alternative investment.

VC can be monetary, but can also come in the form of technical assistance or managerial expertise. It is a great way to support businesses just starting out, offering them the potential to expand and succeed. In return, venture capitalists are offered ownership stakes in the company, creating a win-win partnership with the potential for both parties to benefit.

Venture capital (or VC, as it’s often called) is a huge force in the business funding market.

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What Is a Venture Capital Firm?

A venture capital firm is a company that looks for both interested investors and potential companies in which to invest. Venture capital can be critically important to startup firms, as traditional banks may be risk-averse in providing new business funding, given the relative high level of risk in picking winners in a highly competitive market environment.

The concept of venture capital firms dates back to the 1940’s, when a handful of fledgling private equity groups funded emerging companies. The VC sector accelerated in the 1970’s, in tandem with the dynamic growth of the US technology sector, and as government public policy made it easier for venture capital firms to develop and begin funding new businesses.

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What’s the Difference Between Venture Capitalists and Angel Investors?

Venture capitalists provide funding to startup enterprises on behalf of a risk capital firm, utilizing external funds. On the other hand, angel investors are affluent individuals. often referred to as “lone wolves,” who invest their own capital in entrepreneurial ventures.

How Does Venture Capital Work?

Venture capital starts with money — and lots of it.

A venture capital company will open a fund and start looking for qualified investors, otherwise known as limited partners. These partners, often banks, corporations or investment funds, agree to buy into the fund and invest in young companies with profit potential. In exchange for the funding, venture capital firms will give the limited partners minority equity in the company (i.e., below 50%), with the amount dependent upon how much money the partners have invested with the firm.

Once a financial commitment is obtained from enough limited partners, the venture capital firm sets out to identify promising companies. Typically, a VC funding campaign is thorough, with the venture capital firm taking a sharp look at the company’s business model, executive team, revenue history, product or service offered, and its long-term growth potential.

What Are the Stages of VC Funding?

If there’s mutual interest, the VC firm will likely offer the target company funding at different tiers, as follows:

Seed Stage

Seed stage money is usually offered to early-stage businesses with a limited amount of funding on the table.

The company, which needs cash to grow, can use the seed-stage venture capital funding for myriad uses, including research and development, product testing and development, or even to create a concrete business plan. In return, the venture capital company will likely require a stake in the company in the form of convertible notes, preferred stock options, or private equity. Funding amounts tend to vary widely.

Early Stage

With early-stage funding, VC firms will pour more cash into a company, typically once that company has a solid product or service in the pipeline and ready to roll.

VC firms usually fund early-stage companies in letter tiers, starting with Series A, then moving on to Series B, Series C, and Series D. The average early-stage funding amount also varies by company.

Late Stage

With late-stage funding, VC firms focus on more mature businesses that have a track record for growth and revenues, but need a big cash infusion to get to the next level. The funding level at the late stage is also rolled out in lettered tiers.

After the late-stage funding is complete, expectations are typically high that the company will flourish. That hopefully leads to a profitable acquisition or an initial public offering (IPO), where the company issues stocks, goes public, and lands on a stock market exchange.

While the time frame for exiting a company varies from VC firm to VC firm, generally the goal is to turn a significant profit via an IPO or acquisition and exit the funding position in a four-to-six year time frame.

Can I Invest in Venture Capital Funds?

The average investor may find it difficult to get involved in venture capital investing, as a requirement is that investors meet certain criteria – they must be an accredited investor, which means they have a high annual income and a high net worth (more than $1 million).

However, investors can invest in stocks that are involved in venture capital, or they can look at specific types of funds that open up venture capital to average investors. That can include interval funds, which are a type of alternative investment that may give investors exposure to off-market capital – they don’t trade on the secondary market, and as such, may be tricky to track down and add to your portfolio.

It may be a good idea to speak with a financial advisor or professional to get a sense of what other potential options may be open to you for investing in venture capital, too.

What Are the Risks Associated with Venture Capital Investing?

Venture capital investing can be particularly attractive because of the big potential rewards – but those are paired with significant risks, too.

As for those risks, venture capital entails significant market risk, as it involves investing in small businesses and startups that have a high chance of failure. Further, there’s operational risk (that those startups won’t be able to perform as hoped) and financial risks that are associated with small businesses, too. For investors, there’s also liquidity risks, as it can be difficult to get your money back or out once it’s been deployed.

But again, the rewards may make up for those risks for some investors. There’s high return potential if you back a successful startup, and being an early-stage investor can also open up personal and professional connections in the company and a specific industry. That, too, could lead to further investment opportunities.

Are VC Investments Regulated?

Venture capital and private equity are regulated by the SEC, and venture investments, specifically, are generally subject to many of the same investment regulations as other types of investments. For instance, there are reporting requirements that may be involved, “know-your-customer” (KYC) regulations, and rules regarding the Bank Secrecy Act – concerning fraud and money laundering issues – that venture firms need to abide by.

Are Venture Capital Firms Focused on Technology?

Many venture capital firms are focused on the tech sector, but not all. Over the past decade or two, technology has been a high-growth industry, which has, in turn, attracted a lot of investor attention, including VC attention. But venture capital firms can invest in just about anything, and just about anywhere.

In recent years, the number of VC investments and the proceeds have fallen as economic conditions have grown tighter, with higher interest rates and more risk aversion among investors and businesses. But the lion’s share of VC investments are still concentrated in the tech sector, along with sectors such as industrials, health care, financials, and more.

The Takeaway

Venture capital firms use money from qualified investors like banks, corporations, or investment funds to invest in promising startups or small businesses, with the goal of turning a profit within four to six years.

When the process goes according to plan, a venture capital deal can work out well for both the VC firm and the company receiving the funding. Start-up businesses gain the benefit of cash and experience while the VC firm gets a crack at a major financial return on its investment.

Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.

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An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.
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2024

Solo 401(k) vs SEP IRA: Key Differences and Considerations

Solo 401(k) vs SEP IRA: An In-Depth Comparison for Self-Employed Retirement Planning

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

Self-employment has its perks, but an employer-sponsored retirement plan isn’t one of them. Opening a solo 401(k) or a Simplified Employee Pension Individual Retirement Account (SEP IRA) allows the self-employed to save for retirement while enjoying some tax advantages.

So, which is better for you? The answer can depend largely on whether your business has employees or operates as a sole proprietorship and which plan yields more benefits, in terms of contribution limits and tax breaks.

Weighing the features of a solo 401(k) vs. SEP IRA can make it easier to decide which one is more suited to your retirement savings needs.

Key Points

• Solo 401(k) allows tax-deductible contributions, employer contributions, employee contributions, and offers the option for Roth contributions and catch-up contributions.

• SEP IRA allows tax-deductible contributions, employer contributions, but does not allow employee contributions, Roth contributions, catch-up contributions, or loans.

• Withdrawals from traditional solo 401(k) plans and SEP IRAs are taxed in retirement.

• Solo 401(k) plans allow loans, while SEP IRAs do not.

• Solo 401(k) plans offer more flexibility and options compared to SEP IRAs.

Understanding the Basics

A solo 401(k) is similar to a traditional 401(k), in terms of annual contribution limits and tax treatment. A SEP IRA follows the same tax rules as traditional IRAs. SEP IRAs, however, typically allow a higher annual contribution limit than a regular IRA.

What Is a Solo 401(k)?

A solo 401(k) covers a business owner who has no employees or employs only their spouse. Simply, a Solo 401(k) allows you to save money for retirement from your self-employment or business income on a tax-advantaged basis.

These plans follow the same IRS rules and requirements as any other 401(k). There are specific solo 401(k) contribution limits to follow, along with rules regarding withdrawals and taxation. Regulations also govern when you can take a loan from a solo 401(k) plan.

A number of online brokerages offer solo 401(k) plans for self-employed individuals, including those who freelance or perform gig work. You can open a retirement account online and start investing, no employer other than yourself needed.

If you use a solo 401(k) to save for retirement, you’ll also need to follow some reporting requirements. Generally, the IRS requires solo 401(k) plan owners to file a Form 5500-EZ if it has $250,000 or more in assets at the end of the year.

What Is a SEP IRA?

A SEP IRA is another option to consider if you’re looking for retirement plans for the self-employed. This tax-advantaged plan is available to any size business, including sole proprietorships with no employees. SEP IRAs work much like traditional IRAs, with regard to the tax treatment of withdrawals. They do, however, allow you to contribute more money toward retirement each year above the standard traditional IRA contribution limit. That means you could enjoy a bigger tax break when it’s time to deduct contributions.

If you have employees, you can make retirement plan contributions to a SEP IRA on their behalf. SEP IRA contribution limits are, for the most part, the same for both employers and employees. If you’re interested in a SEP, you can set up an IRA for yourself or for yourself and your employees through an online brokerage.

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Diving Deeper: Pros and Cons of Each Plan

As you debate between a solo 401(k) vs. a SEP IRA as ways to build wealth for retirement, it’s helpful to learn more about how these plans work, including their benefits and drawbacks.

Advantages of Solo 401(k)s

In terms of differences, there are some things that set solo 401(k) plans apart from SEP IRAs.

With a solo 401(k), you can choose a traditional or Roth. You can deduct your contributions in the year you make them with a traditional solo 401(k), but you’ll pay taxes on your distributions in retirement. With a Roth solo 401(k) you pay taxes on your contributions in the year you make them, and in retirement, your distributions are tax free. You can choose the plan that gives you the best tax advantage.

Another benefit of a solo 401(k) is that those age 50 and older can make catch-up contributions to this plan. In addition, you may be able to take a loan from a solo 401(k) if the plan permits it.

Advantages of SEP IRAs

One of the benefits of a SEP IRA is that contributions are tax deductible and you can make them at any time until your taxes are due in mid-April of the following year.

The plan is also easy to set up and maintain.

If you have employees, you can establish a SEP IRA for yourself as well as your eligible employees. You can then make retirement plan contributions to a SEP IRA on your employees’ behalf. (All contributions to a SEP are made by the employer only, though employees own their accounts.)

SEP IRA contribution limits are, for the most part, the same for both employers and employees. This means that you need to make the same percentage of contribution for each employee that you make for yourself. That means if you contribute 15% of your compensation for yourself, you must contribute 15% of each employee’s compensation (subject to contribution limits).

A SEP IRA also offers flexibility. You don’t have to contribute to it every year.

However, under SEP IRA rules, no catch-up contributions are allowed. There’s no Roth option with a SEP IRA either.

Eligibility and Contribution Limits

Here’s what you need to know about who is eligible for a SEP IRA vs. a Solo 401(k), along with the contribution limits for both plans for 2023.

Who Qualifies for a Solo 401(k) or SEP IRA?

Self-employed individuals and business owners with no employees (aside from their spouse) can open and contribute to a solo 401(k). There are no income restrictions on these plans.

SEP IRAs are available to self-employed individuals or business owners with employees. A SEP IRA might be best for those with just a few employees because IRS rules dictate that if you have one of these plans, you must contribute to a SEP IRA on behalf of your eligible employees (to be eligible, the employees must be 21 or older, they must have worked for you for three of the past five years, and they must have earned at least $750 in the tax year).

Plus, the amount you contribute to your employees’ plan must be the same percentage that you contribute to your own plan.

Contribution Comparison

With a solo 401(k), there are rules regarding contributions, including contribution limits. For 2023, you can contribute up to $66,000, plus an additional catch-up contribution of $7,500 for those age 50 and older. In 2024, you can contribute up to $69,000, plus an extra catch-up contribution of $7,500 for those age 50 and older.

For the purposes of a solo 401(k) you play two roles — employer and employee. As an employee, you can contribute the lesser of 100% of your compensation or up to $22,500 in 2023 and up to $23,000 in 2024. If you’re 50 or older, you can contribute the $7,500 catch-up contribution in 2023 and 2024 as well. As an employer, you can make an additional contribution of 25% of your compensation (up to $330,000 of compensation in 2023 and $345,000 in 2024) or net self-employment income.

The contribution limits for a SEP IRA are the lesser of 25% of your compensation or $66,000 in 2023 and $69,000 in 2024. As mentioned earlier, there are no catch-up contributions with this plan.

And remember, per the IRS, if you have a SEP IRA, you must contribute to the plan on behalf of your eligible employees. The amount you contribute to your employees’ plan must be the same percentage that you contribute to your own plan.

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Key Differences That Could Influence Your Decision

When you’re deciding between a solo 401(k) vs. a SEP IRA, consider the differences between the two plans carefully. These differences include:

Roth Options and Tax Benefits

With a solo 401(k), you can choose between a traditional and Roth solo 401(k), depending on which option’s tax benefits make the most sense for you. If you expect to be in a higher tax bracket when you retire, a Roth may be more advantageous since you can pay taxes on your contributions upfront and get distributions tax-free in retirement.

On the other hand, if you anticipate being in a lower tax bracket at retirement, a traditional solo 401(k) that lets you take deductions on your contributions now and pay tax on distributions in retirement could be your best option.

Loan Options and Investment Flexibility

You may also be able to take a loan from a solo 401(k) if your plan permits it. Solo 401(k) loans follow the same rules as traditional 401(k) loans.

If you need to take money from a SEP IRA before age 59 ½, however, you may pay an early withdrawal penalty and owe income tax on the withdrawal.

Both solo 401(k)s and SEP IRA offer more investment options than workplace 401(k)s. So you can choose the investment options that best suit your needs.

The Impact of Having Employees

Whether you have employees or not will help determine which type of plan is best for you.

A solo 401(k) is designed for business owners with no employees except for a spouse.

A SEP IRA is for those who are self-employed or small business owners. A SEP IRA may be best for those who have just a few employees since, as discussed above, you must contribute to a SEP IRA on behalf of all eligible employees and you must contribute the same percentage of compensation as you contribute for yourself.

The Financial Implications for Your Business

The plan you choose, solo 401(k) vs. SEP IRA, does have financial and tax implications that you’ll want to consider carefully. Here’s a quick comparison of the two plans.

Solo 401(k) vs SEP IRA at a Glance

Both solo 401(k) plans and SEP IRAs make it possible to save for retirement as a self-employed person or business owner when you don’t have access to an employer’s 401(k). And both can potentially offer a tax break if you’re able to deduct contributions each year.

Here’s a rundown of the main differences between a 401(k) vs. SEP IRA.

	Solo 401(k)	SEP IRA
Tax-Deductible Contributions	Yes, for traditional solo 401(k) plans	Yes
Employer Contributions Allowed	Yes	Yes
Employee Contributions Allowed	Yes	No
Withdrawals Taxed in Retirement	Yes, for traditional solo 401(k) plans	Yes
Roth Contributions Allowed	Yes	No
Catch-Up Contributions Allowed	Yes	No
Loans Allowed	Yes	No

How These Plans Affect Your Bottom Line

Both solo 401(k)s and SEP IRAs are tax-advantaged accounts that can help you save for retirement. With a SEP IRA, contributions are tax deductible, including contributions made on employees’ behalf, which offers a tax advantage. Solo 401(k)s give you the option of choosing a traditional or Roth option so that you can pay tax on your contributions upfront and not in retirement (traditional), or defer them until you retire (Roth).

Making the Choice Between SEP IRA and Solo 401(k): Which Is Right for You?

An important part of planning for your retirement is understanding your long-term goals. Whether you choose to open a solo 401(k) or make SEP IRA contributions can depend on how your business is structured, how much you want to save for retirement, and what kind of tax advantages you hope to enjoy along the way.

When to Choose a Solo 401(k)

If you’re self-employed and have no employees (or if your only employee is your spouse), you may want to consider a solo 401(k). A solo 401(k) could allow you to save more for retirement on a tax-advantaged basis compared to a SEP IRA. A solo 401(k) allows catch-up contributions if you are 50 or older, and you can also take loans from a solo 401(k).

Just be aware that a solo 401(k) can be more work to set up and maintain than a SEP IRA.

When to Choose a SEP IRA

If you’re looking for a plan that’s easy to set up and maintain, a SEP IRA may be right for you. And if you have a few employees, a SEP IRA can be used to cover them as well as your spouse. However, you will need to cover the same percentage of contribution for your employees as you do for yourself.

Remember that a SEP IRA does not allow catch-up contributions, nor can you take loans from it.

Step-by-Step Guide to Opening Your Account

You can typically set up a SEP IRA with any financial institution that offers other retirement plans, including an online bank or brokerage. The institution you choose will guide you through the set-up process and it’s generally quick and easy.

Once you establish and fund your account, you can choose the investment options that best suit your needs and those of any eligible employees you may have. You will need to set up an account for each of these employees.

To open a Solo 401(k), you’ll need an Employee Identification Number (EIN). You can get an EIN through the IRS website. Once you have an EIN, you can choose the financial institution you want to work with, typically a brokerage or online brokerage. Next, you’ll fill out the necessary paperwork, and once the account is open you’ll fund it. You can do this through direct deposit or a check. Then you can set up your contributions.

Additional Considerations for Retirement Planning

Besides choosing a SEP IRA or a solo 401(k), there are a few other factors to consider when planning for retirement. They include:

Rollover Process

At some point, you may want to roll over whichever retirement plan you choose — or roll assets from another retirement plan into your current plan. A SEP IRA allows for either option. You can generally roll a SEP IRA into another IRA or other qualified plan, although there may be some restrictions depending on the type of plan it is. You can also roll assets from another retirement plan you have into your SEP.

A solo 401(k) can also be set up to allow rollovers. You can roll other retirement accounts, including a traditional 401(k) or a SEP IRA, into your solo 401(k). You can also roll a solo 401(k) into a traditional 401(k), as long as that plan allows rollovers.

Can You have Both a SEP IRA and a Solo 401(k)?

It is possible to have both a SEP IRA and a solo 401(k). However, how much you can contribute to them depends on certain factors, including how your SEP was set up. In general, when you contribute to both plans at the same time, there is a limit to how much you can contribute. Generally, your total contributions to both are aggregated and cannot exceed more than $66,000 in 2023 and $69,000 in 2024.

Preparing for Retirement Beyond Plans

Choosing retirement plans is just one important step in laying the groundwork for your future. You should also figure out at what age you can retire, how much money you’ll need for retirement, and the typical retirement expenses you should be ready for.

Working on building your retirement savings is an important goal. In addition to opening and contributing to retirement plans, other smart strategies include creating a budget and sticking to it, paying down any debt you have, and simplifying your lifestyle and cutting unnecessary spending. You may even want to consider getting a side hustle to bring in extra income.

The Takeaway

Saving for retirement is something that you can’t afford to put off. And the sooner you start, the better so that your money has time to grow. Whether you choose a solo 401(k), SEP IRA, or another savings plan, it’s important to take the first step toward building retirement wealth.

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Venture Capital: What Is It and How Does It Work?

What Is Venture Capital?

Alternative investments, now for the rest of us.

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

What Is a Venture Capital Firm?

What’s the Difference Between Venture Capitalists and Angel Investors?

How Does Venture Capital Work?

What Are the Stages of VC Funding?

Seed Stage

Early Stage

Late Stage

Can I Invest in Venture Capital Funds?

What Are the Risks Associated with Venture Capital Investing?

Are VC Investments Regulated?

Are Venture Capital Firms Focused on Technology?

The Takeaway

Solo 401(k) vs SEP IRA: An In-Depth Comparison for Self-Employed Retirement Planning

Understanding the Basics

What Is a Solo 401(k)?

What Is a SEP IRA?

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Diving Deeper: Pros and Cons of Each Plan

Advantages of Solo 401(k)s

Advantages of SEP IRAs

Eligibility and Contribution Limits

Who Qualifies for a Solo 401(k) or SEP IRA?

Contribution Comparison

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