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May

2024

Guide to Direct Deposit

By Kelly Boyer Sagert | Budgeting & Goals, Financial Independence, money | Comments Off

If you’re like most Americans, your paycheck turns up in your bank account automatically, without any check to sign or wad of cash to pocket and then get to the bank.

With direct deposit, funds are electronically transferred out of one bank account and (ka-ching!) deposited into another. It’s a convenient way to automate one’s finances, and it’s not limited to paychecks. It can streamline other financial transactions as well.

Here, you’ll learn more about this process, the pros and cons of direct deposit, and ways you might want to put it to work for you.

Key Points

• Direct deposit is an electronic transfer of funds from one bank account to another, commonly used for payroll.

• It was introduced in 1972 with the formation of the first Automated Clearing House (ACH) network.

• Nearly 93% of employed Americans receive their salaries via direct deposit.

• The process involves employers sending an electronic file to the bank, which then distributes funds to employees’ accounts.

• Direct deposit is also utilized for government benefits, tax refunds, and other payments.

What Is Direct Deposit?

As mentioned above, direct deposit is a way of electronically transferring funds between bank accounts.

It was pioneered more than 50 years ago. In 1972, the first automated clearing house (ACH) network formed to manage electronic payments, with other networks quickly following. In 1975, the Social Security Administration (SSA) decided to test the system of direct deposit for payments they issued. Today, 99% of SSA’s payments are directly deposited.

Today, nearly 93% of employed people in the United States receive their salaries or wages this way.

What’s more, these automatic bank transfers are used today in ways beyond having paychecks directly deposited, including bill pay, retirement account contributions, and more.

💡 Quick Tip: Did you know online banking can help you get paid sooner? Feel the magic of payday up to two days earlier when you set up direct deposit with SoFi.

How Does Direct Deposit Work?

You’ve now learned a bit about what direct deposit is and how the ACH system facilitates direct deposit, allowing funds to flow seamlessly and quickly from one account to another.

Here, a bit more intel on how this process can be put to work for you and how to set up direct deposit.

Direct Deposit for Payroll

Let’s say that someone is ready to start a new job. The human resources department explains how the company either requires direct deposit or offers the option.

• If that employee wants to set up direct deposit, they would need to share bank information with their new employer, including the bank’s name, the routing number that identifies the financial institution, and the employee’s bank account number. Sometimes, a voided check is requested.

• This information would then be entered into the company’s payroll system and, whenever payroll rolls around, the company would send an electronic file to this employee’s financial institute. This file would share how much money should be transferred from the company’s (the “originator’s”) bank account to accounts for each of the employees whose direct deposit accounts are located at that particular financial institution.

• If, for example, three employees of a company all share Bank A, then let’s say this bank receives an electronic transfer of $4,345. Bank A would then distribute the money appropriately into the proper bank accounts, perhaps:

◦ $2,000 in Person A’s checking account and $500 into their savings account

◦ $1,350 in Person B’s account

◦ $445 in Person C’s checking account and $50 into their savings account.

• Then, if the employees (known as “receivers”) check their bank balances, they’ll see the deposits made through this direct deposit process. As noted in this example, money may be directly deposited to a checking account or into a savings account. Or some money can be put into a savings account with the rest in a checking account.

• How long does direct deposit take? Typically, the funds go through like clockwork and are there waiting on payday. Some banks may offer the ability to access your direct deposit up to two days sooner.

What Are the Uses of Direct Deposit?

There are several uses for direct deposit:

• Payroll. As noted, the vast majority of Americans get paid this way.

• Tax refund. This can be among the quickest ways to get your tax refund. The IRS can process a direct deposit refund for an electronically filed return in as little as seven to 10 days of receipt.

• Government benefits. Social Security and Supplemental Security Income benefits, VA, unemployment, and other benefits can be paid via direct deposit.

• Commissions, rental income, vendor payments and other earnings can be automated with direct deposit.

• Dividends. Shareholders may receive dividends by direct deposit.

• Child support. This may also be automated.

Benefits of Payroll Direct Deposits

Direct deposit has many benefits. Here’s a closer look:

• Convenience: With a direct deposit of their paycheck, employees can skip the step of physically depositing a paycheck into their accounts, which can be a timesaver.

This can be especially true if the employee telecommutes from home, is on vacation, or is otherwise out of the office when payday comes, because that employee doesn’t have to go into the office to retrieve the paper check.

• Speed: With direct deposit, the money is typically in an employee’s bank account at the start of the designated payment date, which gives them access to the funds that day. No waiting for checks to clear.

• Security: With paper checks, there’s always the possibility that they will get lost or stolen. So, payroll direct deposit can add a layer of security to the process.

Many times banks will waive fees for customers who have direct deposits set up.

• Savings: Many times banks will waive fees for customers who have direct deposits set up, although there may be a minimum deposit amount required for this to happen.

• Better money management: If an employee puts a percentage of each paycheck automatically into a savings account, this can get them into a regular savings habit.

Downsides of Payroll Direct Deposit

Now, for the other side of the coin, the cons of direct deposit:

• Inconvenience: When people receiving direct deposits decide to change banks, it may be a hassle. It may take workplaces a period of time to change where paychecks are sent, which means that the old account might need to be kept open longer to make sure all paychecks are received.

How long that period of time may be can vary. But, before you close your old account, ensure that all direct deposits are being put into the new account. Also make sure that all withdrawals and checks have cleared at your old bank and that any automated payments are coming out of the new bank.

• Scheduling: With direct deposit, it’s important to make sure the correct deposit dates and amounts are recorded. Otherwise, account holders could write checks beyond what’s available, which could trigger overdraft or non-sufficient fund (NSF) fees — which can be costly, especially when they add up.

• Lack of access: Not everybody in the United States has a bank account. If someone doesn’t but their employer requires direct deposit (more about that next), then employees without a bank account would likely receive their paychecks through a prepaid debit card. These can come with fees and, like paper checks, can be lost or stolen.

Here are the pros and cons in chart form:

Pros of Direct Deposit	Cons of Direct Deposit
Convenience receiving funds	Inconvenience if you change banks
Speed (no waiting for checks to clear)	Scheduling; must be sure funds arrive
Security (no carrying around cash or checks getting lost in the mail)	Lack of access for those who are unbanked
Savings; banks may offer discounts or bonuses if you receive qualifying direct deposits
Better money management

Employers Requiring Direct Deposit

Just as there are benefits to payroll direct deposit for employees, there are also benefits for employers. For instance, it’s cheaper to manage payroll payments this way, versus physical checks.

Plus, they have a record of accounts, which makes it easier for companies when they’re reviewing expenses — and they don’t have to reissue a check if an employee loses one.

And, after a person’s payroll information has been entered into the system, paying employees can be faster and easier with direct deposit.

Laws governing payroll direct deposit vary by state and, if a state has no specific laws on this subject, it defaults to federal regulations. Federal law states that employers must give each employee using direct deposit a summary of rights and liabilities and must get their signature on an authorization form along with relevant banking information.

Some states allow employers to actually require direct deposit for payroll, as long as the program is administered in a way that’s consistent with federal regulations. (In some cases, the rule only applies to public sector workers.) Most states, however, still give employees the choice between direct deposit and receiving a physical check.

A handful of states have laws that are unique to them, ones that don’t fit into any of the broad categories already described.

Automating Your Finances

The concept of electronic funds transfers is at the heart of payroll direct deposits, but goes beyond that. Here are additional ways to benefit from automating your finances.

• Automation is a tool that can also help people to build an emergency savings account. In general, traditional wisdom says this account should contain three to six months’ worth of living expenses.

That way, if an emergency arises (whether that’s a job loss, an unanticipated repair, or unexpected medical expenses), a financial cushion exists. By setting up a regular funds transfer to a savings account, this can make it easier to build up that emergency fund.

• Another way to streamline your financial life: paying bills through autopay. In some instances, lenders may offer a discounted interest rate for borrowers who use automated payments to pay their bills. Autopay can help borrowers make their payments on time, rather than forgetting them when life gets hectic. This can mean fewer or no late fees.

Autopay can help borrowers to make their payments on time, rather than forgetting them when life gets hectic.

• Because payment history plays a key role (35%) in a person’s FICO® Score, autopay can help you establish and maintain your credit score. By automating payments (as long as enough money is in their checking or savings account when the payment is due) you can optimize this aspect of your cash management.

• Autopay helps to reduce the number of paper bills that need to be sent out and the number of paper checks that may be written to pay those bills. This means that automated funds transfers can therefore be an eco-friendly choice to make.

• Whenever funds are electronically transferred, either in or out of a bank account, a digital record is automatically created. This can be helpful when balancing accounts, creating a budget, looking for tax deductible items, searching for ways to trim discretionary spending, and more.

• Autopay might also be a good strategy to use to contribute to a retirement account. Employers may automatically deduct an amount from employee paychecks to transfer it into a retirement account that’s set up by the company. That can make saving super easy.

Types of Accounts for Direct Deposits

For people who decide to use forms of automated funds transfers, here are some options to consider for receiving direct deposit:

• Checking accounts

• Savings accounts

• Money market account

• Investment accounts

• Some prepaid debit cards

• Some payment apps, such as PayPal or Cash App.

Getting Direct Deposit With SoFi

If you’re interested in opening a bank account to receive direct deposits, take a look at what SoFI offers and see if SoFi direct deposit is a good fit for you.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 4.00% APY on SoFi Checking and Savings.

FAQ

What is the meaning of direct deposit?

Direct deposit refers to the automated transfer of funds from one bank account to another. This means cash doesn’t need to change hands, nor does a check need to be written and then deposited.

How do you get direct deposit?

Typically, signing up for direct deposit involves sharing your bank account and routing number with, say, your employer or the government so they can direct deposit funds in your account. In some cases, you may be asked to share a voided check.

Is direct deposit only for paychecks?

Direct deposit is not only for paychecks. It can also be used for government benefits (such as Social Security), commissions, tax refunds, investment dividends, and other forms of payment.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2024 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.00% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.00% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.00% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 12/3/24. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

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.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

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.

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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May

2024

10 Online Banking Alerts to Turn On

By Emma Diehl | Budgeting & Goals, money | Comments Off

When it comes to managing your financial life, technology can be your friend. By toggling on banking alerts, you can stay on top of your bank accounts and possibly avoid such issues as overdraft, late fees, and unauthorized use of your banking details.

Setting up automated alerts can be quick and easy, but you may need help knowing which are the right ones to use to suit your needs. Here’s a guide to 10 of the most valuable online banking alerts that you may find useful.

Key Points

• Mobile banking alerts can enhance financial management and security by notifying users of important account activities.

• Alerts for low balances help avoid overdraft fees by notifying users when funds are low.

• Direct deposit alerts confirm when wages are deposited, aiding in financial planning and bill payments.

• Unusual activity alerts provide immediate notifications of atypical transactions, helping to prevent fraud.

• Large purchase alerts inform users of high-value transactions, offering a chance to block unrecognized purchases promptly.

What Are Mobile Banking Alerts?

Mobile banking alerts are typically alerts sent by email and/or text that keep you updated on the status of your accounts. They can share important information about your finances (such as, say, you are about to overdraft your account) or they can help protect your account by informing you of a new log-in.

In many cases, you can customize how you want to receive mobile banking alerts, whether by email, text message, and/or push notification. You can also personalize the alerts. For example, one person might want a low balance alert when their account balance falls under $200, while another person might want to be notified when their account gets down to $25.

💡 Quick Tip: Want to save more, spend smarter? Let your bank manage the basics. It’s surprisingly easy, and secure, when you open an online bank account.

What Are the Benefits of Online Banking Alerts?

benefits of turning on online banking alerts

These alerts can help keep your bank account safe online and protect your financial status in the following ways:

• Allow you to monitor your banking activity

• Help you avoid unauthorized activity

• Prevent scams and fraud

• Alert you to low balances so you can steer clear of overdraft and related fees

• Help you manage debit card purchase behavior

• Know when an important payment or debit is made

• Feel more in control and secure of your finances.

Mobile Banking Alerts You Should Turn On

10 mobile banking alerts to turn on

Here are 10 important mobile banking alerts. See which ones might suit your particular situation and needs.

1. Low Balance

Cars have gas lights to warn drivers when fuel is close to empty, so why shouldn’t bank accounts?

• A low balance alert lets you know when funds have dipped below a predetermined amount—it could be $20, $1,000, or any amount you set. This can help keep you from overspending and triggering expensive overdraft fees.

• When you receive an overdraft alert, you can then decide if you want to transfer money into your account or hold off on making a purchase until your next paycheck clears. You can potentially avoid having a negative bank balance.

2. Direct Deposit

Constantly checking your account to see if your paycheck has been deposited can be a nuisance, particularly if you only recently set up direct deposit (which can take one or two pay cycles to get going).

If you sign up for a direct deposit notification, however, you’ll know exactly when money sent electronically to your account has been deposited and is ready to use.

Being notified of direct deposits each pay cycle can also help you make sure that your employer is paying on time and that you have enough money in your account to cover bills and automatic expenses.

3. Unusual Activity Alert

Unfortunately, millions of people report fraud and identity theft to the Federal Trade Commission (FTC) each year.

Setting up an unusual activity mobile account alert can save account holders a lot of headaches, as well as time and money, should their accounts ever become compromised.

An unusual activity alert notifies consumers when there’s a change in their account status that’s outside the norm. For example, if a large amount of money gets transferred out of the account all at once and this is something that rarely occurs, you would receive an unusual activity alert.

Or, an alert might let you know if purchases are being made outside your typical travel area.

By alerting you the moment a potential fraud takes place, you can take action quickly, report the transaction, or even freeze your account.

4. New Log-In Alert

Another helpful way to protect your accounts against bank fraud and theft is to set up a new log-in account alert.

This alert lets you know when someone has logged into your account from a computer or device that has never been used to access your account before.

If you weren’t the one logging in, you can possibly stymie the fraudster by immediately changing your password and even freezing your account to prevent spending.

Some financial institutions also allow customers to set up multifactor authentication on their account (which requires users to provide multiple pieces of identifying information, not just a username and password to access an account), which can even further protect your money.

5. Large Purchase Alert

Some banks allow users to set up a customizable large purchase alert. With this kind of online banking alert, you will usually receive a message whenever a purchase over a certain dollar amount (which typically you determine) is about to be charged to your account.

If you see the alert and don’t recognize the purchase, you may then be able to block the transaction.

Having a large purchase alert set up can help prevent fraud, but also human error. If a restaurant server accidentally adds an extra zero to a dinner bill, a large purchase alert could go off. That could save you the hassle of reporting the purchase later and trying to have it reversed.

This mobile bank alert may be especially helpful if you are not in the habit of monitoring your bank account on a regular basis.

6. Overdraft Alert

If you overdraw your account using a check or debit card, your bank might allow the transaction, letting you spend more money than you actually have in your account.

Typically, this comes with a price — an overdraft or NSF fee (which can often exceed $35). And, if you don’t realize you’re overdrafting your account, you might continue to make purchases, and incur a fee on each one.

Depending on the bank, if your account remains in a negative balance for an extended number of days, your account could even be closed.

To avoid these problems, If you get an overdraft alert, you may want to:

• Add money to your account as quickly as possible to prevent any more overdrafts. If you move quickly, you might possibly be able to avoid the first overdraft fee (check if your bank has a deadline to deposit money that might help you avoid an overdraft fee).

• Some banks have no overdraft fees up to a certain dollar amount; check and see if yours offers this feature.

7. Profile Changes Alert

Profile change bank alerts notify you if someone has tried to change your password, username, or any personal information in your profile, such as contact information or opting out of bills through mail.

If you see something was changed and you didn’t make the changes, you’ll likely want to change your password ASAP and alert the bank to help protect your account.

8. Large ATM Withdrawal Alert

Setting an alert for withdrawals from an ATM or debit card lets a person know when cash has left their account.

This might be helpful in the event that there are multiple authorized users on the card (so you are aware of a change in the account balance) but also if the card has been stolen.

According to the FTC, the maximum loss for a person who reports their card as lost within two days of discovery is $50. That means even if a thief steals a debit or ATM card and wipes out the account’s balance, the account holder would not be out more than $50.

If a person doesn’t notice their ATM or debit card has gone missing, a withdrawal notification could be the first thing to alert them.

9. Debit Card Alert

This kind of alert clues you in to debit card transactions. It can tell you in real time about your debit card’s usage. It can be especially helpful as it can indicate when someone is using a debit card online that belongs to you.

If this is an unauthorized transaction, you can take action to contact your bank and freeze your account as needed. Remember, if you report misuse of your card number within two days of the event, you are not liable for more than $50, per the Electronic Funds Transfer Act. In this way, online banking activity alerts could help you avoid having to pay for fraudulent charges.

10. Upcoming Payment Alert

An upcoming payment alert can be a good way to stay posted on recurring or one-time scheduled payments. For instance, if you had scheduled a payment of a medical bill a couple of weeks ago to happen right now, the alert could nudge you to check your balance and make sure you’re in good shape to cover the expense.

Or an upcoming payment alert could remind you that you are paying for, say, a streaming channel you haven’t been watching and you might decide to cancel and save some money.

What to Do After Getting an Online Banking Alert or Bank Notification?

If you receive a mobile banking alert or bank notification, you may or may not need to take action.

• If the message tells you something you already knew or expected (say, that you received your paycheck or your mortgage was paid per your instructions), no action is needed.

• If you receive an alert that your bank account is low and/or you are tisk of overdraft, you can transfer funds to avoid problems and fees.

• If you are informed that a transaction or log-in occurred that you do not recognize, you can (and should) alert your bank’s customer service ASAP to avoid fraudulent activity and consequent issues, such as identity theft. In addition, you may want to change passwords or freeze your account.

The Takeaway

Online banking alerts can help you manage your financial life more conveniently. Automatic bank alerts can provide you with important and timely account information, such as when your account balance falls below a certain amount or when your paycheck has been electronically deposited.

This can help you keep track of your account and your spending, as well as avoid costly overdraft fees. They can also notify you right away if there’s unusual activity on your account, which can help you resolve any fraudulent activity on your account. Setting up alerts is a personal decision and can be changed as your needs evolve.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 4.00% APY on SoFi Checking and Savings.

FAQ

What types of bank accounts are eligible for account alerts?

Typically, a variety of bank accounts are eligible for alerts, including checking and savings accounts as well as certificates of deposit (CDs). You can also have alerts for your ATM and debit card.

Is it a good idea to set up mobile alerts on your checking account?

It can be a smart move to set up mobile alerts for your checking account since they can alert you to low balances, direct deposits, upcoming automated payments, and unusual activity. These can help protect your financial wellness.

How do you know if a bank alert is real?

Here are some ways to tell if a bank alert is real or if it’s phishing: Ask yourself if you have opted into this kind of message from your bank. Know that your bank will not ask for confidential information by text. Be aware that a sense of urgency or needing to send money to resolve a “problem with your account” right away can signal a scam. Also look for slight misspellings, such as Citiibank instead of Citibank. You can contact your bank directly to know if an alert is real.

How can you tell if someone is tracking your bank account?

If you are concerned that someone might be tracking your bank account, you can opt into online banking alerts that let you know when there are profile changes or new log-ins.

How do I get bank alerts on my phone?

The process may vary, but typically you get bank mobile alerts by logging into your account and going to your account or account services. Click on “manage alerts” or a similar tab and follow the instructions.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2024 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.00% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.00% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.00% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 12/3/24. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

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

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

SOBK0124071

May

2024

Mega Backdoor Roths, Explained

By Samuel Becker | Growing Wealth, invest, Investing, Terminology | Comments Off

For those who earn an income that makes them ineligible to contribute to a Roth IRA, a mega backdoor Roth IRA may be an effective tool to help them save for retirement, and also get a potential tax break in their golden years.

Only a certain type of individual will likely choose to employ a mega backdoor Roth IRA as a part of their financial plans. And there are a number of conditions that have to be met for mega backdoor Roth to be possible.

Read on to learn what mega backdoor Roth IRAs are, how they work, and the important details that investors need to know about them.

Key Points

• A mega backdoor Roth IRA allows high earners to save for retirement with potential tax benefits, despite income limits on traditional Roth IRAs.

• This strategy involves making after-tax contributions to a 401(k) and then transferring these to a Roth IRA.

• Eligibility for a mega backdoor Roth depends on specific 401(k) plan features, including the allowance of after-tax contributions and in-service distributions.

• Contribution limits for 401(k) plans in 2023 allow for significant after-tax contributions, enhancing the potential retirement savings.

• The process, while beneficial, can be complex and may require consultation with a financial professional to navigate potential hurdles.

What Is a Mega Backdoor Roth IRA?

The mega backdoor Roth IRA is a retirement savings strategy in which people who have 401(k) plans through their employer — along with the ability to make after-tax contributions to that plan — can roll over the after-tax contributions into a Roth IRA.

But first, it’s important to understand the basics of regular Roth IRAs. A Roth IRA is a retirement account for individuals. For tax year 2023, Roth account holders can contribute up to $6,500 per year (or $7,500 for those 50 and older) of their post-tax earnings. That is, income tax is being paid upfront on those earnings — the opposite of a traditional IRA. For 2024, they can contribute up to $7,000 (or $8,000 for those 50 and older).

Individuals can withdraw their contributions at any time, without paying taxes or penalties. For that reason, Roth IRAs are attractive and useful savings vehicles for many people.

But Roth IRAs have their limits — and one of them is that people can only contribute to one if their income is below a certain threshold.

In 2023 the limit is $138,000 for single people (people earning more than $138,000 but less than $153,000 can contribute a reduced amount); for married people who file taxes jointly, the limit is $218,000 (or between $218,000 to $228,000 to contribute a reduced amount).

In 2024 the limit is $146,000 for single people (people earning more than $146,000 but less than $161,000 can contribute a reduced amount); for married people who file taxes jointly, the limit is $230,000 (or between $230,000 to $240,000 to contribute a reduced amount).

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

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.

How Does a Mega Backdoor Roth Work?

When discussing a mega backdoor Roth, it’s helpful to understand how a regular backdoor Roth IRA works. Generally, individuals with income levels above the thresholds mentioned who wish to contribute to a Roth IRA are out of luck. However, there is a workaround: the backdoor Roth IRA, a strategy that allows high-earners to fund a Roth IRA account by converting funds in a traditional IRA (which has no limits on a contributors’ earnings) into a Roth IRA. This could be useful if an individual expects to be in a higher income bracket at retirement than they are currently.

Mega backdoor Roth IRAs involve 401(k) plans. People who have 401(k) plans through their employer — along with the ability to make after-tax contributions to that plan — can potentially roll over up to $46,000 in 2024, and $43,500 in 2023, in after-tax contributions into a Roth IRA. That mega Roth transfer limit has the potential to boost an individual’s retirement savings.

Example Scenario: How to Pull Off a Mega Backdoor Roth IRA

The mega backdoor Roth IRA process is pretty much the same as that of a backdoor Roth IRA. The key difference is that while the regular backdoor involves converting funds from a traditional IRA into a Roth IRA, the mega backdoor involves converting after-tax funds from a 401(k) into a Roth IRA.

Whether a mega backdoor Roth IRA is even an option will depend on an individual’s specific circumstances. These are the necessary conditions that need to be in place for someone to try a mega backdoor strategy:

• You have a 401(k) plan. People hoping to enact the mega backdoor strategy will need to be enrolled in their employer-sponsored 401(k) plan.

• You can make after-tax contributions to your 401(k). Determine whether an employer will allow for additional, after-tax contributions.

• The 401(k) plan allows for in-service distributions. A final piece of the puzzle is to determine whether a 401(k) plan allows non-hardship distributions to either a Roth IRA or Roth 401(k). If not, that money will remain in the 401(k) account until the owner leaves the company, with no chance of a mega backdoor Roth IRA move.

If these conditions exist, a mega backdoor strategy should be possible. Here’s how the process would work:

Open a Roth IRA — so there’s an account to transfer those additional funds to.

From there, pulling off the mega backdoor Roth IRA strategy may sound deceptively straightforward — max out 401(k) contributions and after-tax 401(k) contributions, and then transfer those after-tax contributions to the Roth IRA.

But be warned: There may be many unforeseen hurdles or expenses that arise during the process, and for that reason, consulting with a financial professional to help navigate may be advisable.

Who Is Eligible for a Mega Backdoor Roth

Whether you might be eligible for a mega backdoor Roth depends on your workplace 401(k) retirement plan. First, the plan would need to allow for after-tax contributions. Then the 401(k) plan must also allow for in-service distributions to a Roth IRA or Roth 401(k). If your 401(k) plan meets both these criteria, you should generally be eligible for a mega backdoor Roth IRA.

💡 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.

Contribution Limits

If your employer allows for additional, after-tax contributions to your 401(k), you’ll need to figure out what your maximum after-tax contribution is. The standard 401(k) contribution limit for all types of contributions to a 401(k) (meaning employee, employer, and after-tax contributions) in 2023 is $22,500 (or $30,000 for those 50 and older). For 2024, the limit is $23,000 (or $30,500 for those 50 and older).

The IRS allows up to $66,000, or $73,500 including catch-up contributions for those 50 and up, in total contributions to a 401(k) in 2023. For 2024, the total limits are $69,000, or 76,500 including catch-up contributions for those 50 and up.

So how much can you contribute in after-tax funds? Here’s an example. Say you are under age 50 and you contributed the max of $22,500 to your 401(k) in 2023, and your employer contributed $8,000, for a total of $30,500. That means you can contribute up to $35,500 in after-tax contributions to reach the total contribution level of $66,000.

Is a Mega Backdoor Roth Right For Me?

Given that this Roth IRA workaround has so many moving parts, it’s worth thinking carefully about whether a mega backdoor Roth IRA makes sense for you. These are the advantages and disadvantages.

Benefits

The main upside of a mega backdoor Roth is that it allows those who are earning too much to contribute to a Roth IRA a way to potentially take advantage of tax-free growth.

Plus, with a mega backdoor Roth IRA an individual can effectively supercharge retirement savings because more money can be stashed away. It may also offer a way to further diversify retirement savings.

Downsides

The mega backdoor Roth IRA is a complicated process, and there are a lot of factors at play that an individual needs to understand and stay on top of.

In addition, when executing a mega backdoor Roth IRA and converting a traditional IRA to a Roth IRA, it could result in significant taxes, as the IRS will apply income tax to contributions that were previously deducted.

The Future of Mega Backdoor Roths

Mega backdoor Roths are currently permitted as long as you have a 401(k) plan that meets all the criteria to make you eligible.

However, it’s possible that the mega backdoor Roth IRA could go away at some point. In prior years, there was some legislation introduced that would have eliminated the strategy, but that legislation was not enacted.

The Takeaway

Strategies like the mega backdoor Roth IRA may be used by some investors to help achieve their retirement goals — as long as specific conditions are met, including having a 401(k) plan that accepts after-tax contributions.

While retirement may feel like far off, especially if you’re early in your career or still relatively young, it’s generally wise to start thinking about it sooner rather than later.

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

Help grow your nest egg with a SoFi IRA.

FAQ

Are mega backdoor Roths still allowed in 2023?

Yes, mega backdoor Roths are still permissible in 2023.

Is a mega backdoor Roth worth it?

Whether a mega backdoor Roth is worth it depends on your specific situation. It may be worth it for you if you earn too much to otherwise be eligible for a Roth IRA and if you have a 401(k) plan that allows you to make after-tax contributions.

Is a mega backdoor Roth legal?

Yes, a mega backdoor Roth IRA is currently legal.

Are mega backdoor Roths popular among Fortune 500 companies?

A number of Fortune 500 companies allow the after-tax contributions to a 401(k) that are necessary for executing a mega backdoor Roth IRA.

What is a super backdoor Roth?

A super backdoor Roth IRA is the same thing as a mega backdoor Roth IRA. It is a strategy in which people who have 401(k) plans through their employer — along with the ability to make after-tax contributions to that plan — can roll over the after-tax contributions into a Roth IRA.

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

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

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

SoFi Invest®

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

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

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

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
SOIN0124016

May

2024

Margin Account: What It Is and How It Works

By Kate Ashford | Growing Wealth, invest, Investing | Comments Off

Margin accounts give investors the ability to borrow money from a brokerage to make bigger trades or investments than they would have been able to make otherwise. Just as you can borrow money against the equity in your home, you can also borrow money against the value of certain investments in your portfolio.

This is called margin lending, and it happens within a margin account, which is a type of account you can get at a brokerage. Most brokerages offer the option of making a taxable account a margin account. Tax-advantaged retirement accounts, such as traditional IRAs or Roth IRAs, generally are not eligible for margin trading.

Key Points

• A margin account allows investors to borrow money from a brokerage to make larger trades or investments.

• Margin extends purchasing power by allowing investors to buy securities worth more than the cash they have on hand.

• Margin accounts have rules and regulations set by regulatory bodies, including minimum margin requirements and maintenance margin thresholds.

• While margin accounts offer benefits like increased purchasing power and short-term cash access, they also come with risks, such as potential losses and margin calls.

• Opening a margin account requires signing a margin agreement with the brokerage, and it is generally recommended for experienced investors.

What Is a Margin Account?

As mentioned, a margin account is used for margin trading, which involves borrowing money from a brokerage to fund trades or investments.A margin account allows you to borrow from the brokerage to purchase securities that are worth more than the cash you have on hand. In this case, the cash or securities already in your account act as your collateral.

Margin accounts are generally considered to be more appropriate for experienced investors, since trading on margin means taking on additional costs and risks.

When defining a margin account, it helps to understand its counterpart — the cash account. With a cash brokerage account, you can only buy as many investments as you can cover with cash. If you have $10,000 in your account, you can buy $10,000 of stock.

Margin Account Rules and Regulations

When it comes to margin accounts, the Securities and Exchange Commission (SEC), FINRA, and other bodies have set some rules:

• Minimum margin: There is a minimum margin requirement before you can start trading on margin. FINRA requires that you deposit the lesser of $2,000 or 100% of the purchase price of the stocks you plan to purchase on margin.

• Initial margin: Your margin buying power has limits — generally you can borrow up to 50% of the cost of the securities you plan to buy. This means, for example, that if you have $10,000 in your margin account, you can effectively purchase up to $20,000 of securities on margin. You would spend $10,000 of your own money and borrow the other 50% from the brokerage. (You can also borrow much less than this.) Your buying power varies, depending on the value of your portfolio on any given day.

• Maintenance margin: Once you’ve bought investments on margin, regulators require that you keep a specific balance in your margin account. Under FINRA rules, your equity in the account must not fall below 25% of the current market value of the securities in the account. If your equity drops below this level, either because you withdrew money or because your investments have fallen in value, you may get a margin call from your brokerage.

Example of a Margin Account

An example of using a margin account could look like this: Say you have a margin account with $5,000 in cash in it. This allows you to use 50% more in margin, so you actually have $10,000 in purchasing power – you are able to actually make a trade for $10,000 in securities, using $5,000 in margin.

In effect, margin extends your purchasing power as an investor, and you’re not obligated to use it all.

💡 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.

Increase your buying power with a margin loan from SoFi.

Borrow against your current investments at just 12%* and start margin trading.

*For full margin details, see terms.

Benefits of a Margin Account

For an experienced investor who enjoys day trading, having a margin account and trading on margin can have some advantages:

• More purchase power. A margin account allows an investor to buy more investments than they could with cash. That might lead to higher returns, since they’re buying more securities and may be able to diversify their investments in different ways.

• A safety net. Just as an emergency fund offers access to cash when you need it, so does a margin account. If you need funds but you don’t want to sell investments at their current price point, you can take a margin loan for short-term cash needs.

• You can leave your losers alone. In another scenario, if you need cash but your investments aren’t doing so well, taking a margin loan allows you to keep your securities where they are instead of selling them right now at a loss.

• No loan repayment schedule. There is no repayment schedule for a margin loan, so you can repay it at any rate you please, as long as your equity in the account maintains the proper threshold. Monthly interest will accrue, however, and be added to your account.

• Potentially deductible interest. There may be tax situations in which the interest in a margin loan can be used to offset taxable income. A tax professional will tell you whether this is a move you can consider.

Drawbacks of a Margin Account

Despite the advantages, using a margin account has risks. Here are some things to consider before trading on margin:

• You could lose substantially. While it’s possible that trading on margin can help realize greater returns if an investment does well, you will also see greater losses if an investment takes a dive. And even if an investment you’ve purchased on margin loses all of its value, you’ll still owe the margin loan back to the brokerage — plus interest.

• There may be a margin call. If your investments tank, it’s possible that you’ll have to sell securities or deposit additional funds to bring your account back up to the required margin threshold. It’s also possible for a brokerage to sell securities from your account without alerting you.

How to Open a Margin Account

Opening a margin account is as simple as opening a cash account, but you’ll likely need to sign a margin agreement with your brokerage. You may also need to request margin for your account, depending on the brokerage.

But there are some other things to keep in mind.

If you’re a beginner investor, a cash account gives you an opportunity to learn how to trade and invest, and there’s a low level of risk. If you’re a more experienced investor and fully understand the risks of trading on margin, a margin account may offer the opportunity to expand and diversify your investments.

Some financial advisors suggest that clients open margin accounts in case they need cash in a hurry. For instance, if you need money quickly, it takes time to sell investments and for the money to be deposited in your account. If you have a margin account, you can take a margin loan while your securities are being sold. Typically, margin accounts don’t carry any additional fees as long as you aren’t borrowing on margin.

You also need a margin account for short selling. With short selling, you borrow a stock in your brokerage account and sell it for its current price. If the price of the stock falls — which you’re betting will happen — you repurchase shares of the stock and return it to the original owner, pocketing the difference in price.

Like trading on margin, short selling is a strategy for experienced investors and comes with a large amount of risk.

Things to Know About Margin Accounts

Here are a few other things to keep in mind about margin accounts.

Margin Calls

Margin calls are a risk. If the equity in your margin account drops below a certain threshold, you may get an alert from your brokerage, called a margin call. This is meant to spur you to either deposit more money into your account or sell some securities to bolster the equity that’s acting as collateral for your margin loan.

It’s worth noting that if your investment value drops quickly or significantly, you may find that your brokerage has sold some of your securities without notifying you. Commonly, investors are forced by a margin call to sell investments at an inopportune time — such as when the investment is priced at less than you paid for it. This is an inherent risk of trading on margin.

Margin Costs

Investors should also know about relevant margin costs. When you borrow money from the brokerage to buy securities, you are essentially taking out a loan, and the brokerage will charge interest. Margin interest rates are different from company to company, and may be somewhat higher than rates on other kinds of loans.

Consider interest costs when you’re thinking about your margin trading plan. If you use margin for long-term investing, interest costs can affect your returns. And holding investments on margin means the value of your securities must hold steady.

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

How to Manage Margin Account Risk

If you decide to open a margin account, there are steps you can take to try to minimize the amount of risk you’re taking by leveraging your trading:

• Skip the dodgy investments. Trading on margin works if you’re earning more than you’re paying in margin interest. Speculative investments can be a risky portfolio move, since a swift loss in value can result in a margin call.

• Watch your interest costs. Although there is no formal repayment schedule for a margin loan, you’re still accruing interest and you are responsible for paying it back over time. Regular payments on interest can help you stay on track.

• Maintain some emergency cash. Having a cushion of cash in your margin account gives you a little wiggle room to keep from facing a margin call.

The Takeaway

A margin account is an account that lets you borrow against the cash or securities you own, to invest in more securities. As with other lending vehicles, margin accounts do charge interest.

While margin accounts do come with risk — including the risk of losing more money than you originally had, plus interest on what you borrowed — they also offer benefits including more purchasing power and a safety net for short-term cash needs. If you’re unsure about using a margin account, it may be worthwhile to discuss it with a financial professional.

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

Is a margin account right for me?

A margin account may be a good tool for a specific investor if they’re comfortable taking on additional risks and investment costs, but also want to extend their purchasing power.

How much money do you need to open a margin account?

Before opening a trading account, investors will need a minimum of $2,000 in their brokerage account, per regulator rules.

Is a margin account taxable?

Any capital gains earned by using a margin account will be subject to capital gains tax, and the ultimate rate will depend on a few factors.

Should a beginner use a margin account?

It may be best for a beginner to stick to a cash account until they learn the ropes in the markets, as using a margin account can incur additional risks and costs.

Who qualifies for a margin account?

Most investors qualify for a margin account, granted they can reach the minimum margin requirements set forth by regulators, such as having $2,000 in their brokerage account.

What’s the difference between a cash account and a margin account?

A cash account only contains an investor’s funds, while a margin account offers investors additional purchasing power by giving them the ability to borrow money from their brokerage to make bigger trades.

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.

Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN0124037

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.

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?

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.

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