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Q: Is an unconfirmed LC safe?

Yes, it’s safe because there is guarantee or confirmation from one bank that payment will be made. Assuming that the issuing bank has a high credit rating, the seller can feel confident that the funds will be paid once all the conditions in the contract have been met. If the seller wants an additional layer of security, they may request a confirmed letter of credit — which means a second bank will guarantee payment if the first one fails to do so.

May

2024

Guide to a Confirmed Letter of Credit

By Sarah Li Cain | Budgeting & Goals, money | Comments Off

A confirmed letter of credit can be an important document to those who are launching or running a business, particularly those engaging in international trade. These letters are used to help protect both the buyer and the seller in a business-to-business transaction by adding an extra guarantee that the seller will get paid. They essentially mean that a second bank will pay the seller if the first bank fails to do so, which can inspire confidence and allow a deal to go through.

Here’s a closer look at what a confirmed letter of credit is, how it works, and its pros and cons.

What Is a Confirmed Letter of Credit?

Also known as a confirmed LC, a confirmed letter of credit is an additional guarantee for a payment by a secondary bank. It states that this additional bank will be responsible for a payment being on time and in full even if the buyer doesn’t meet their contractual obligations and the first bank (called the issuing bank) defaults on the payment. You might think of it as a kind of insurance policy or Plan B if the initial bank responsible for payment fails to do its job.

This type of document can be common in international trades, such as transactions between export and import businesses. In many cases, a guarantee may be required to conduct international transactions or when a vendor or seller has reason to doubt the first bank’s creditworthiness.

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How Confirmed Letters of Credit Work

Confirmed letters of credit are commonly used as negotiable instruments, which are signed documents that promise to pay a certain sum to a specified person. They can be especially valuable in international business transactions that involve a significant payment amount for goods or services. Since the letter acts as guaranteed payment, it may take the place of a request for advance payment.

To get a regular letter of credit, the buyer will likely need to submit required documents to the first bank, including proof that certain steps have been completed. Then the bank will send appropriate documents to the seller’s bank. This paperwork shares detailed instructions on the terms and conditions, as well as how payment should be made. Depending on the agreement between the buyer and the seller, payment may be made immediately or at an agreed-upon date.

Once the letter of credit has been issued, the buyer may need the backing of a second bank, or a confirmed letter of credit. Worth noting: A fee is likely to be involved. The exact amount of this fee may depend on how good (or questionable) the first bank’s credit is. This letter usually reflects the first letter of credit and uses the same terms.

A confirmed letter of credit can protect both parties because it decreases the risk of default for the vendor or seller. Additionally, it ensures that payment is only made if all the terms are met. It can be a step to building good credit when doing a deal with a new client. It can also be helpful for a business that is just starting out and making connections, building contacts, and monitoring its credit.

Parties Involved in a Confirmed Letter of Credit

Here’s a listing of all the parties typically involved in a confirmed letter of credit.

• Buyer or applicant: This is the party who is requesting the letter of credit and who will pay the seller.

• Beneficiary or seller: The party who is selling goods or services and is the one who receives payment.

• Issuing bank: This is usually a bank where the buyer already has a business bank account. It’s the one that issues the original letter of credit.

• Confirming bank: This is the second bank that will guarantee the funds to the seller once the terms in the letter of credit are met. In some cases, the confirming bank is from the seller’s home country (this may be called a correspondent bank) or is a bank the seller already works with.

Confirmed Letter of Credit Example

Let’s look at a fictional example of how a confirmed letter of credit could work. Say that Pauline’s Paper Goods receives an order for 100,000 pallets of customized notebooks from JessCo, a stationery company. Pauline’s Paper Goods has never worked with JessCo before and isn’t sure that this company has the means to pay for the goods. Maybe Pauline’s Paper Goods worries that JessCo doesn’t have what is considered good credit.

In order to prevent non-payment after the notebooks are produced and shipped off to the buyer, Pauline’s Paper Goods outlines an agreement that JessCo needs to pay with a confirmed letter of credit on the date the shipment leaves their warehouse.

If JessCo agrees, it would start applying for a letter of credit at its bank, where it has its checking account, in the U.S. If the bank requires it, the company needs to provide proof it has the funds available or it will apply for financing.

As soon as the issuing bank creates the letter of credit, JessCo then applies for a confirmed letter of credit with another bank, possibly the seller’s bank. When Pauline’s Paper Goods receives the completed confirmed letter, it manufactures and ships the customized notebooks. Once Pauline’s Paper Goods provides proof of when and how the goods were shipped, the guaranteed funds are released.

Confirmed vs Unconfirmed Letters of Credit

If you are conducting international business, you will probably hear the terms confirmed and unconfirmed letters of credit. An unconfirmed letter of credit is simply a letter of credit issued by a bank. A confirmed letter of credit, as we’ve described above, is backed by two banks. This can foster trust if, say, there’s reason to worry the payment won’t be made.

Here’s a look at some other differences between a confirmed vs. an unconfirmed letter or credit.

• Guaranteed payment: With a letter of credit, the issuing bank guarantees payment. With a confirmed letter of credit, however, two banks confirm payment.

• Cost: Unconfirmed letters of credit tend to cost less than confirmed letters of credit.

• Changes: The buyer is allowed to make changes to an unconfirmed letter of credit. With a confirmed letter of credit, both banks can modify the document.

• Issuance: The seller only has to approach one bank for an unconfirmed letter of credit, but needs to contact two with a confirmed letter of credit.

Recommended: Guide to a Commercial Letter of Credit

Advantages of Confirmed Letters of Credit

Confirmed letters of credit can have several benefits for sellers, particularly those doing business internationally and wanting to ensure smooth transactions. These advantages include:

• Protection for both the buyer and seller

• An extra layer of confidence for the seller

• A lower risk of default thanks to a reputable second bank (perhaps serving as a guarantor if the first bank has a low credit rating)

• Buyers can seem more creditworthy, which may increase the odds that a seller will do business with them

Disadvantages of Confirmed Letters of Credit

While confirmed letters of credit can be very valuable in business, there are a couple of downsides to recognize. Disadvantages of confirmed letters of credit include:

• It may take longer to get a confirmed letter of credit since an additional bank is involved

• Bank fees may be higher than with an unconfirmed letter of credit

The Takeaway

A confirmed letter of credit can be a valuable business tool, especially when conducting international business. For those importing or exporting, the letter will guarantee payment for goods a company is supplying if the buyer and the buyer’s bank can’t complete the deal. Getting a confirmed letter of credit may cost more and take longer compared to an unconfirmed letter of credit, but the effort may be worth it. It can secure a transaction and open doors to doing business with new customers in a way that communicates confidence.

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FAQ

What is an unconfirmed letter of credit?

An unconfirmed letter of credit is a letter of credit that’s only been issued by one bank, known as the issuing bank. In a transaction, the buyer requests an unconfirmed letter of credit to guarantee funds will be paid on time to the seller by the bank.

Is an unconfirmed LC safe?

Yes, an unconfirmed letter of credit is safe because there is a guarantee or confirmation from one bank that payment will be made. Assuming that the issuing bank has a high credit rating, the seller can feel confident that the funds will be paid once all the conditions in the contract have been met. If the seller wants an additional layer of security, they may request a confirmed letter of credit — which means a second bank will provide payment if the first one fails to do so.

What is the risk of an unconfirmed LC?

The risk of an unconfirmed letter of credit is that the issuing bank won’t have the funds to pay the seller. That means that even if the seller completes their end of the contract, they risk losing out on funds if the issuing bank doesn’t fulfill their promise.

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SOBK-Q224-1885527-V1

May

2024

Guide to Irrevocable Letters of Credit (ILOC)

By Rebecca Lake | Credit, money | Comments Off

An irrevocable letter of credit (or ILOC) is a written agreement between a buyer (often an importer) and a bank. As part of the agreement, the bank agrees to pay the seller (typically an exporter) as soon as certain conditions of the transaction are met. These letters help reduce a seller’s concern that an unknown buyer won’t pay for the goods they receive. It also helps eliminate a buyer’s concern that an unknown seller won’t send the goods the buyer has paid for.

Irrevocable letters of credit are often found in international trade, though they can be used in other types of financial arrangements to ensure that a seller will be paid, even if the buyer fails to uphold their end of the bargain.

Key Points

• An irrevocable letter of credit is a written agreement between a bank and a buyer to guarantee payment, ensuring that the seller will be paid even if the buyer fails to fulfill their obligations.

• Irrevocable letters of credit cannot be canceled or modified in any way without the explicit agreement of all parties involved.

• Irrevocable letters of credit are commonly used in international transactions but can be used in other situations as well.

• Alternatives to irrevocable letters of credit include trade credit insurance and standard letters of credit, which offer different levels of flexibility and protection.

What Is an Irrevocable Letter of Credit?

Simply defined, an irrevocable letter of credit represents an agreement between a bank and a buyer involved in a financial transaction. The bank guarantees payment will be made to the seller according to the terms of the agreement. Since the letter is irrevocable, that means it cannot be changed without the consent and agreement of all parties involved.

Irrevocable letters of credit can also be referred to as standby letters of credit. Once an irrevocable letter of credit is issued, all parties are contractually bound by it. This means that even if the buyer in a transaction doesn’t pay, the bank is obligated to make payment to the seller to satisfy the agreement.

Having an irrevocable letter of credit in place is a form of risk management. The seller is guaranteed payment from the bank, which can help to reduce concerns about the buyer failing to pay. And it ensures that the seller will follow through on their obligations by providing whatever is being purchased through the agreement. In simpler terms, a standby letter of credit or irrevocable letter of credit is a sign of good faith on the part of everyone involved in a transaction.

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How Does an Irrevocable Letter of Credit Work?

An irrevocable letter of credit establishes a contractual agreement between a buyer, a seller, and their respective banks. It effectively creates a safeguard for both the buyer and the seller, in that:

• Buyers are not required to forward payment until the seller provides the goods or services that have been purchased.

• Sellers can collect payment for goods and services, as long as the conditions outlined in the letter of credit are met.

The bank issuing the letter of credit acts as a go-between for both sides, guaranteeing payment to the seller even if the buyer doesn’t pay. Assuming the buyer does fulfill their obligations, they would then make payment back to the bank. In a sense, this allows the buyer to borrow from the bank without formally establishing credit in the form of a loan or credit line. (Check with your financial institution to learn what fees may be involved.)

Before an irrevocable letter of credit is issued, the bank will first verify the buyer’s creditworthiness. Assuming the bank is reassured that the buyer will, in fact, repay what’s owed to complete the purchase, it will then establish the irrevocable letter of credit to facilitate the transaction between the buyer and seller. Irrevocable letters of credit are communicated and sent through the SWIFT banking system.

Recommended: How Do Banks Make Money?

Irrevocable Letter of Credit Specifications

The exact details included in an irrevocable letter of credit can depend on the situation in which it’s being used. The conditions that are set for the completion of the transaction will also matter. But generally, you can expect an irrevocable letter of credit to include:

• Buyer’s name and banking information (that is, their bank account number and other details)

• Seller’s name and banking information

• Name of the intermediary bank issuing the letter of credit

• Amount of credit that’s being issued

• Date that the letter of credit is issued and the date it will expire

An irrevocable letter of credit will also detail the conditions that must be met by both the buyer and seller in order for the contract to be valid. For example, the seller may need to provide written verification that the goods or services referenced in the agreement have been provided before payment can be issued. The letter of credit must be signed by an authorized bank representative. It may need to be printed on bank letterhead to be valid.

Do I Need an Irrevocable Letter of Credit?

You may need an irrevocable letter of credit if you’re doing business with someone in a foreign country. You may also require one if you are conducting a transaction with a new company or individual (one with which you don’t yet have an established relationship).

Irrevocable letters of credit can help to mitigate some of the risk that goes along with international transactions. These letters ensure that if you’re the seller, you get paid for any products or services you’re providing. They also protect you if you’re the buyer, promising that products or services are delivered to you.

An irrevocable letter of credit could also come in handy if you’re still working on building credit for your business and you’re the buyer in a transaction. The bank will pay the money to the seller; you’ll then repay the bank. Payment may be required in a lump sum from your business bank account or another source. Or the bank may also offer the option of repaying it in installments over time. Repaying your obligation could help to raise your business’s creditworthiness in the bank’s eyes. This may make it easier to take out other loans or lines of credit later.

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Alternatives to Irrevocable Letters of Credit

An irrevocable letter of credit is not the only way to do business when engaging in international transactions. You may also consider trade credit insurance or another type of letter of credit instead.

Trade Credit Insurance

Trade credit insurance, also referred to as accounts receivable insurance or AR insurance, is used to insure businesses against financial losses resulting from unpaid debts. You can use trade credit insurance to cover all transactions or limit them to ones where you believe there may be a heightened risk of loss, such as transactions involving foreign businesses.

A trade credit insurance policy protects your business in the event that the other party to a financial agreement defaults. It can insulate your accounts receivable against losses if an unpaid account turns into a bad debt. Purchasing trade credit insurance may be an easier way to manage risk for your business overall, as it’s less involved than an irrevocable letter of credit.

Letters of Credit

A letter of credit guarantees payment from the buyer’s bank to the seller’s bank in a financial transaction. Like an irrevocable letter of credit, it establishes certain conditions that must be met in order for the transaction to be completed. But unlike an irrevocable letter of credit, a standard letter of credit can be revoked or modified.

You might opt for this kind of letter of credit if you’re doing business with someone you don’t know and you want reassurance that the transaction will be completed smoothly. A regular letter of credit may also be preferable if you’d like the option to modify or cancel the agreement.

The Takeaway

An irrevocable letter of credit is something you may need to use from time to time if you run a business and regularly deal with international transactions. It adds a layer of protection to buying and selling, as a bank is saying it will cover the transaction. An ILOC, as it’s sometimes known, can provide reassurance when working with a new business or establishing your company overseas. The letter cannot be changed, so you’re getting solid peace of mind.

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FAQ

What is the difference between a letter of credit and an irrevocable letter of credit?

A letter of credit and irrevocable letter of credit are largely the same, in terms of what they’re designed to and in what situations they can be used. The main difference is that unless a letter of credit specifies that it is irrevocable, it can be changed or modified by the parties involved.

What is the cost of an irrevocable letter of credit?

You generally need to pay a transaction fee for an irrevocable letter of credit. The fee is typically a small percentage of the transaction amount. The rate will vary from bank to bank.

Does an irrevocable letter of credit expire?

Yes, an irrevocable letter of credit will typically state the date by which the seller must submit the necessary paperwork in order to receive payment.

Photo credit: iStock/Photoevent

SOBK-Q224-1885505-V1

May

2024

What Is an IRA?

By Pam O’Brien | Growing Wealth, invest, Investing, Terminology | No Comments

Table of Contents

What Is an IRA?
What Are the Different Types of IRA Accounts?
How to Open an IRA
Benefits of Opening an IRA
Which Type of IRA Works for You?
How Much Should You Contribute to an IRA?
How Can You Use IRA Funds?
FAQ

What Is an IRA?

An individual retirement account, or IRA, is a retirement savings account that has certain tax advantages. Brian Walsh is a CFP® at SoFi — he says “The tax advantage part is important because it allows your money to grow a little bit more efficiently, especially over a long period of time.” An IRA allows individuals to save for retirement over the long-term.

There are different types of IRAs, but two of the most common are traditional and Roth IRAs. Both types generally let you contribute the same amount annually (more on that below). One key difference is the way the two accounts are taxed: With traditional IRAs, you deduct your contributions upfront and pay taxes on distributions when you retire. With Roth IRAs, contributions are not tax deductible, but you can withdraw money tax-free in retirement.

For those planning for their future, IRAs are worth learning more about—and potentially investing in. Read on to learn more about the different types of IRAs, which one might be right for you, and how to open an individual retirement account.

Key Points

• An IRA is a retirement savings account that offers tax advantages and allows individuals to save for retirement over the long-term.

• There are different types of IRAs, including traditional and Roth IRAs, each with its own tax treatment and contribution limits.

• Traditional IRAs allow for pre-tax contributions and tax-deferred growth, while Roth IRAs involve after-tax contributions and tax-free withdrawals in retirement.

• Other types of IRAs include SEP IRAs for small business owners and self-employed individuals, and SIMPLE IRAs for employees and employers of small businesses.

• Opening an IRA provides individuals with the opportunity to save for retirement, supplement existing retirement plans, and potentially benefit from tax advantages.

What Are the Different Types of IRA Accounts?

There are several types of IRAs, including traditional and Roth IRAs. Since it is possible to have multiple IRAs, an individual who works for themselves or owns a small business might also establish a SEP IRA (Simplified Employee Pension) or SIMPLE IRA (Savings Incentive Match Plan for Employees). Just be aware that you cannot exceed the total contribution limits across all the IRAs you hold.

Here is an overview of some different types of IRAs:

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.

Traditional IRA

A traditional IRA is a retirement account that allows individuals to make pre-tax contributions. Money inside a traditional IRA grows tax-deferred, and it’s subject to income tax when it’s withdrawn.

Contributions to a traditional IRA are typically tax-deductible because they can lower an individual’s taxable income in the year they contribute.

Traditional IRAs have contribution limits. In 2024, individuals can contribute up to $7,000 per year, with an additional catch-up contribution of $1,000 for those aged 50 and up. In 2023, the contribution limit was $6,500 annually or $7,500 for those 50 and older.

When individuals reach a certain age, they must start taking required minimum distributions (RMDs) from a traditional IRA. RMDs are generally calculated by taking the IRA account balance and dividing it by a life expectancy factor determined by the IRS.

Saving for retirement with an IRA means that an individual is, essentially, saving money until they reach at least age 59 ½. Withdrawals from a traditional IRA taken before that time are typically subject to income tax and a 10% early withdrawal penalty. There are some exemptions to this rule, however — such as using a set amount of IRA funds to buy a first house or pay a medical insurance premium after an individual loses their job.

Calculate your IRA contributions.

Discover how much you can put into an IRA in 2024 using SoFi’s IRA contribution calculator.

Roth IRA

Unlike a traditional IRA, contributions to a Roth IRA are made with after-tax dollars, and contributions are not tax-deductible. The money can grow tax-free in the Roth IRA account. Withdrawals made after age 59 ½ are tax-free, as long as the account has been open for at least five years.

Roth IRAs are subject to the same contribution limits as traditional IRAs, but the amount an individual can contribute may be limited based on their tax filing status and income levels.

For 2024, married couples filing jointly can contribute only a partial amount to a Roth if their modified adjusted gross income (MAGI) is $230,000 or more. If their MAGI is over $240,000, they cannot contribute to a Roth at all. For single filers, those whose MAGI is $146,000 or more can make a reduced contribution to a Roth, and those whose MAGI is more than $161,000 cannot contribute.

Individuals with Roth IRAs are not required to take RMDs. Additionally, Roth withdrawal rules are a bit more flexible than those for a traditional IRA. Individuals can withdraw contributions to their Roth IRAs at any time without having to pay income tax or a penalty fee. However, they may be subject to taxes and a 10% penalty on earnings they withdraw before age 59 ½.

SEP IRA

A simplified employee pension (SEP IRA) provides small business owners and self-employed people with a way to contribute to their employees’ or their own retirement plans. Contribution limits are significantly larger than those for traditional and Roth IRAs.

Only an employer (or self-employed person) can contribute to a SEP IRA. In 2024, employers can contribute up to 25% of their employees’ compensations or $69,000 a year, whichever is less. The amount of employee compensation that can be used to calculate the 25% is limited to $345,000 in 2024.

If an individual is the owner of the business and contributes a certain percentage of their compensation to their own SEP IRA —for example, 15%— the amount they contribute to their employees’ plans must be the same proportion of the employees’ salary (in other words, also 15% or whatever percentage they contributed).

When it comes to RMDs and early withdrawal penalties, SEP IRAs follow the same rules as traditional IRAs. However, in certain situations, the early withdrawal penalty may be waived.

SIMPLE IRA

A Savings Incentive Match Plan for employees, or SIMPLE IRA, is a traditional IRA that both employees and employers can contribute to. These plans are, typically, available to any small business with 100 employees or fewer.

Employers are required to contribute to the plan each year by making a 3% matching contribution, or a 2% nonelective contribution, which must be made even if the employee doesn’t contribute anything to the account. This 2% contribution is calculated on no more than $345,000 of an employee’s compensation in 2024.

Employees can contribute up to $16,000 to their SIMPLE IRA in 2024, and they can also make catch-up contributions of $3,500 at age 50 or older, if their plan allows it.

SIMPLE plans have RMDs, and early withdrawals are subject to income tax and a 10% penalty. The early withdrawal penalty increases to 25% for withdrawals made during the first two years of participation in a plan. (There are, however, certain exemptions recognized by the IRS.)

This article is part of SoFi’s Retirement Planning Guide, our coverage of all the steps you need to create a successful retirement plan.

How to Open an IRA

Benefits of Opening an IRA

The main advantage of opening an IRA is that you are saving money for your future. Investing in retirement is an important financial move at any age. Beyond that, here are some other benefits of opening an IRA:

• Anyone who earns income can open an IRA. It’s a good option if you don’t have access to an employee-sponsored plan, such as a 401(k) or a 403(b).

• An IRA can supplement an employee plan. You could open an IRA to supplement your retirement plan at work, especially if you’ve already contributed the annual maximum.

• An IRA might be a good rollover vehicle. If you’re leaving your job, you could roll over funds from a 401(k) or 403(b) into an IRA. That may give you access to more investment options—not to mention consolidating your accounts in one place.

• A SEP IRA might be helpful if you’re self-employed. A SEP IRA may allow you to contribute more each year than you could to a Roth or Traditional IRA, depending on how much you earn.

Which Type of IRA Works for You?

There are many different types of IRAs and deciding which one is better for your particular financial situation will depend on your individual circumstances and future plans. Here are some questions to ask yourself when deciding between different types of IRAs:

• Thinking ahead, what do you expect your tax income bracket to look like at retirement? If you think you’ll be in a lower bracket when you retire, it might make more sense to invest in a traditional IRA, since you’ll pay more in taxes today than you would when you withdraw the money later.

• Will you likely be in a higher tax bracket at retirement? That can easily happen as your career and income grow and if you experience lifestyle inflation. In that case, a Roth IRA might give you the opportunity to save on taxes in the long run.

• Do you prefer not to take RMDs starting at age 73? If so, a Roth IRA might be a better option for you.

• Is your income high enough to prevent you from contributing the full amount (or at all) to a Roth IRA? In that case, you may want to consider a traditional IRA.

How Much Should You Contribute to an IRA?

If you can afford it, you could contribute up to the maximum limit to your IRA every year (including catch-up contributions if you qualify). Otherwise, it generally makes sense to contribute as much as you can, on a regular basis, so that it becomes a habit.

Until you’re on track for retirement, many financial professionals recommend prioritizing IRA contributions over other big expenses, like saving for a down payment on a first or second home, or for your kids’ college education.

Any money you put into an IRA has the opportunity to grow over time. Of course, everyone’s circumstances are different, so for specifics unique to your situation, it might help to talk to a financial advisor and/or a tax advisor.

How Can You Use IRA Funds?

Early withdrawals of your IRA funds, prior to the age of 59 ½, can trigger a 10% penalty tax. However, there are exceptions that may allow an individual to use their IRA funds before hitting the age of eligibility and without facing the 10% penalty, according to IRS rules. Just keep in mind that early withdrawals are generally considered a last resort after all other options have been exhausted since you don’t want to dip into your retirement funds unless absolutely necessary.

IRA withdrawal exceptions include:

• Permanent disability

• Higher education expenses

• Certain out-of-pocket medical expenses totaling more than 10% of adjusted gross income

• Qualified first-time homebuyers up to $10,000

• Health insurance premiums while unemployed

• IRS levy of the plan

• Qualified military reservist called to active duty

• Death of the IRA’s owner

The Takeaway

IRAs offer individuals an opportunity to save money for retirement in a tax-advantaged plan. There are several different IRAs to choose from to help you find an account that suits your needs and goals.

There are multiple options for opening an IRA, including online brokers and robo-advisors. With an online broker, you choose the investment assets for your IRA. A robo-advisor is an automated investment platform that picks investments for you based on your financial goals, risk tolerance, and investing time frame. Whichever option you choose, you decide on a financial institution, pick the type of IRA you want, and set up your account.

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

Easily manage your retirement savings with a SoFi IRA.

FAQ

How is an IRA different from a 401(k)?

While IRAs and 401(k)s are both tax-advantaged ways to save money for retirement, a 401(k) is an employer-sponsored plan that is offered through the workplace, and an IRA is an account you can open on your own.

What’s the difference between a Roth IRA and a Traditional IRA?

The biggest difference between a traditional IRA vs. Roth IRA is how and when your money is taxed. With a traditional IRA, you get a tax deduction when you make contributions. Your contributions are made with pre-tax dollars, and when you withdraw money in retirement, the funds are taxed.

With a Roth IRA, you make contributions with after-tax dollars. You don’t get a tax deduction upfront when you contribute, but your money grows tax-free. When you withdraw the money in retirement, you won’t pay taxes on the withdrawals.

When should I make IRA contributions?

One simple way to fund your IRA is to set up automatic contributions at regular intervals that puts money from your bank account directly into your IRA. You could contribute monthly or several times a year—the frequency is up to you. Some people contribute once annually, after they receive a year-end bonus, for example.

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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May

2024

Growth Savings Accounts: What They Are and How They Work

By Jacqueline DeMarco | Financial Independence, invest, Life & Career | Comments Off

The term “growth savings account” or “grow savings account” generally refers to a savings account that earns more than the average interest rate for a savings account. This allows your money to grow faster, just for sitting in the bank.

But are these accounts always a good bet? Important points to consider are:

• What is a growth savings account?

• How do growth savings accounts work?

• The pros and cons of a growth savings account

• How to open a growth savings account.

What Is a Growth Savings Account?

Growth savings accounts are similar to regular savings accounts, except that they tend to pay a higher annual percentage yield (APY), which represents how much an account holder will earn in interest over the course of a year.

More commonly referred to as a high-yield savings account, these accounts can pay 10 to 20 times more than the average APY for a savings account, while keeping those funds safe and accessible.

You may get the best interest rate on a growth savings account at an online bank or credit union versus a traditional, brick-and-mortar, bank. However, even at their best, the APYs on these savings accounts generally lag behind what you could earn by investing in the market over time. That makes growth savings accounts best suited for your emergency fund and money you’re saving for a short-term goal, like a vacation or large purchase.

How Do Growth Savings Accounts Work?

Growth savings accounts work in the same way as regular savings accounts. You open the account at a bank or credit union, deposit money into the account, and begin to earn interest on your balance. You can continue adding money to the account, either by making a deposit at a branch or ATM, transferring money from a linked account, or via mobile check deposit or direct deposit.

Savings accounts are typically insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC) at banks and the National Credit Union Administration (NCUA) at credit unions. So you can’t lose your money (up to certain limits) even if the bank were to go out of business.

Savings accounts allow easy access to your money when you need it, though some institutions may limit the number of withdrawals or transfers you can make to six or nine per month.

Recommended: How High-Yield Savings Accounts Work

Pros of a Growth Savings Account

Here’s a look at some of the advantages that come with opening a growth or high-yield savings account.

Higher Interest Rates

Because these savings accounts can offer higher interest rates, the money held in the account tends to grow faster than money held in traditional savings accounts. When determining what is a good interest rate, it’s a good idea to also look into minimum balance requirements. You may see that you need to keep your balance above a certain threshold to earn the highest available rate.

Accessible Form of Growth

Putting money in a savings account can be a great way to earn interest while keeping that money liquid, meaning you can access it as soon as you need it. You don’t need to sell off investments or wait until a particular maturity date to withdraw the money.

Recommended: CDs vs Savings Accounts Compared

Good Way to Build an Emergency Fund

Because these funds are fairly accessible, a growth savings account can be a great place to build an emergency fund. That way, the emergency fund can continue to grow until it might be needed.

Cons of a Growth Savings Account

There are also some downsides to growth savings accounts worth keeping in mind before opening one.

Limited Growth Opportunity

Yes, growth savings accounts typically earn more interest than traditional savings accounts. However, when considering your long-term savings options, there may be more strategic investments that can enhance growth over time. If, for instance, you’re saving for retirement, which is a few decades away, you might take a look at the stock market for growth.

Withdrawal Limits

Growth savings accounts generally provide easier access to funds than keeping money in investments. That said, you may only be able to make a certain number of withdrawals or transfers per month (such as six or nine) or risk running into fees. While the Federal Reserve withdrew this rule during the pandemic, banks are allowed to continue imposing those limits, so it’s a good idea to check.

Earnings Are Taxable Income

The interest earned in a growth savings account can count as taxable income. By contrast, the money you put into a Roth Individual Retirement Account (IRA) grows tax-free.

Pros of Growth Savings Accounts	Cons of Growth Savings Accounts
Higher interest rates	Accessible form of growth
Good way to build an emergency fund	Limited growth opportunity
Possible withdrawal limits	Earnings are taxable income

Choosing a Growth Savings Account

When you’re looking for ways to earn more interest on your money, a growth or high-yield savings account might be a good option. It’s a good idea to shop around to find the best fit for your needs. Here are a few factors to keep in mind when looking for a new savings account:

• APYs

• Minimum balance requirements

• Fees

• Account features

• Mobile app

• Other product and service offerings

How to Open a Growth Savings Account

While each banking institution will have its own process, opening a growth savings account typically includes the following steps:

• Fill out the application. When filling out a savings account application, you’ll usually provide details like your name, Social Security number, proof of address (say, from a utility bill), and government-issued photo ID.

• Choose the account type. There may be different savings account types, such as an individual account or a joint account (to share with a spouse or family member). Select the kind that’s right for your needs.

• Designate beneficiaries. It’s important to choose a beneficiary for your growth savings account, just as you might select a beneficiary for a 401(k) plan. This is the person who would receive the account’s funds if you were to become incapacitated or pass away.

• Deposit funds. Some banks require a minimum initial deposit, so you may need to make that deposit to open the account.

• Create login information. To set up your online account, you’ll need to create login information such as a username and password. Be sure to create a unique and complex password with at least one capital letter, number, and symbol.

While there may be another step or two in some situations, that’s how to open a bank account.

The Takeaway

Growth savings accounts generally offer higher interest rates than traditional savings accounts, which can help your money grow faster. In some cases, however, these accounts may come with monthly fees and/or require you to maintain a certain minimum balance to earn the higher rate, so it pays to shop around.

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

How do growth savings accounts work?

Growth savings accounts function similarly to traditional savings accounts. The only difference between these account types is that growth savings accounts tend to have higher interest rates.

What does “growth account” mean?

A growth account — also known as a high-yield account — typically offers a higher interest rate than a traditional savings account. This higher interest rate leads to more growth on deposited funds.

How much interest does a growth savings account earn?

These days, a growth or high-yield savings account can earn as much as 5% APY.

Photo credit: iStock/Eoneren

SOBK-Q224-1885549-V1

May

2024

Charge Card vs Credit Card: What’s the Difference?

Charge Card vs. Credit Card: Understanding the Key Differences

By Kim Franke-Folstad | Credit, Family Finances, money | Comments Off

Though the terms may be used interchangeably, there are major differences: With a credit card, you can either pay your full monthly bill or a portion of it. With a charge card, no matter how much you owe, you’re expected to pay the monthly bill in full.

That’s not the only thing that sets these cards apart. The two also vary in their accessibility, flexibility, spending limits, and costs. If you’re wondering if a charge card vs. a credit card is a better fit for you, read on to understand their key differences, which can help you decide.

How Charge Cards Work

In some ways, a charge card is much like a regular credit card. When you use it to make a purchase, you’re borrowing money from the card issuer. And when you pay your bill, you’re paying the card issuer back.

But there are several things about the way charge cards work that make them very different from traditional credit cards. And because of the way they work, there are benefits and risks of charge cards to consider.

As mentioned above, a charge card holder’s obligation to pay the bill in full each month is probably the most important distinction. Because you don’t have the option of carrying forward a balance, you won’t pay any interest. But if you don’t pay the balance in full by the due date, you could be subject to a late fee and restrictions on your future card use.

Another thing that makes a charge card unique is that there’s no pre-set credit limit. This offers charge card holders some added flexibility, but it doesn’t mean you can go out and spend as much as you want any time you want — even if you’ve stayed current with your charge card payments.

A transaction still may be declined if it exceeds the amount the card issuer determines you can manage based on your spending habits, account history, credit record, and other financial factors. To avoid any confusion, card holders can contact their charge card issuer before making a major purchase to ask if the amount will be approved.

Recommended: When Are Credit Card Payments Due

How Credit Cards Work

Because they’re more common, you may be more familiar with how credit cards work than you are with charge cards. With a traditional credit card, card holders are given a preset credit limit that’s based on their income, debt-to-income ratio, credit history, and other factors.

Once your account application is approved and you receive a card with a unique credit card number, you can use your card as much or as little as you like — as long as you stay within that limit.

Each month when you receive your billing statement, you can decide if you want to repay the full amount you owe or make a partial payment, but you must make at least the minimum payment that’s due. And if you carry forward a balance, you can be charged interest on that amount. (Similar to your spending limit, interest rates are typically based on a cardholder’s creditworthiness.)

A credit card is classified as “revolving credit” because there’s no set date for when all the money you’ve borrowed must be repaid. As long as you make at least your minimum payments on time and stay within your credit limit, the account remains open, and you can use the available credit over and over again.

Differences Between a Charge Card and Credit Card

Here’s a side-by-side look at some key differences between charge cards and credit cards:

Charge Card vs. Credit Card
Charge Cards	Credit Cards
Full payment required every billing cycle	Can carry a balance, but must make minimum monthly payment
Can be difficult to find and qualify for	Many options available, even for those with not-so-great credit
Accepted by most U.S. vendors (but less so overseas)	Widely accepted in the U.S. and worldwide
No interest charged, but can expect a high annual fee	May avoid annual fee, but interest accrues on unpaid balance
Known for prestigious rewards programs	Many cards offer rewards, often without an annual fee
No hard spending limit	Hard pre-set spending limit

Payment Obligations

With a charge card, you’re required to pay what you owe in full when you receive your monthly billing statement. With a credit card, on the other hand, you can make a full or partial payment, but you’re only required to make a minimum monthly payment.

Even if you’re waiting for a refund that hasn’t yet shown up as a credit on your statement, you’ll be expected to pay the full amount of your charge card bill. With a credit card refund, you’ll just have to make sure you pay at least the minimum amount on your current bill.

Availability

If you’re looking for a new card, you’ll find there are far more credit cards available than true charge cards these days. Even American Express, the only major card issuer that still offers charge cards, has gone with a more hybrid approach.

American Express still offers cards that don’t have a preset spending limit. But those cards now come with a feature that — for a fixed fee — allows a card holder to split up eligible large purchases into monthly installments.

There also are some fuel cards, typically geared toward businesses, that are true charge cards.

Credit cards also are generally easier to qualify for than the charge cards that are available. Even if you have a poor or limited credit history, you may be able to find a secured or unsecured credit card that suits your needs.

Acceptance

Whether you shop local most of the time or hope to use your card as you travel the world, you may want to look at the acceptance rates of charge cards vs. credit cards.

Your card may not do you much good if you can’t use it where you like. American Express says its cards can now be accepted by 99% of the vendors in the U.S. that accept credit cards. If you aren’t sure your favorite local boutique or grocer will accept a particular card, you may want to ask or look for the card’s network logo in the store window.

If you plan to use your card overseas, you may want to check ahead on the acceptance rate in that country and also find out if you’ll have to pay a foreign transaction fee. Charge cards tend to have a lower rate of acceptance overseas.

Costs

If you’re trying to decide between a charge card vs. a credit card, how much a credit card costs compared to a charge card — both in interest charges and fees — could be an important consideration.

Interest

You can find a full explanation of how your card issuer calculates interest in your card’s terms and conditions. But as noted above, if you carry forward a balance on your credit card, you can expect to pay interest on the outstanding amount.

According to the Federal Reserve, the average credit card’s annual percentage rate (APR) is currently around 22.8%. Your rate may be higher or lower, depending on your creditworthiness.

You may not have just one interest rate associated with your account either. Your account may have a different APR for purchases, for example, than for credit card cash advances or balance transfers. Or you might have a lower, introductory APR for the first few months after you get a new card. If, over time, you miss payments or make late payments, the card issuer also could decide to raise your APR.

Because you don’t carry a balance with a charge card, you don’t pay interest. But if you pay off your credit card balance by the due date every month, you also won’t have to worry about accruing interest on a credit card account.

Annual Fees

You won’t pay interest with a charge card, but you may end up paying a significant annual fee just to own the card. (The annual membership fee for an American Express Platinum Card, for example, is currently $695.)

Some credit cards also charge annual fees, but you can find many that don’t.

Rewards and Perks

You may decide it’s worth paying a higher annual fee to enjoy the extra benefits some charge cards offer. American Express, for example, has a reputation for offering its card holders prestigious perks, including travel and retail purchase protections, early access to tickets for concerts and other entertainment events, and special offers from partner merchants.

However, plenty of credit cards also come with special benefits, such as cash back rewards, travel rewards, retail discounts, and more. And many of those card issuers don’t charge an annual fee.

Both charge card and credit card issuers also occasionally offer generous welcome or sign-up bonuses to new card holders, so that might be another benefit worth looking at when you’re searching for a new card.

Before you sign up for any card to get the perks it offers, though, it can be a good idea to step back and assess whether it’s worth paying a higher annual fee (or accruing interest on a balance you can’t pay off) to reap those rewards.

Spending Limit

With a credit card vs. a charge card, you’ll know exactly how much you can spend, because your credit card will come with a pre-set limit. You can go online or use an app to check your credit card account at any time to see how much available credit you have.

Charge cards don’t have hard spending limits. But that doesn’t necessarily mean you can use your card to buy a car or take a trip around the world. Your card issuer may decline a charge if you’re spending more than it thinks you can afford.

How Card Choice Can Impact Your Credit Score

When it comes to what a charge vs. credit card can do for (or to) your credit score, there are few things you should know.

Inquiries

Whether you’re applying for a charge card or credit card, you can expect the card company to run a hard inquiry on your credit. This could temporarily lower your credit score, but usually only by about five points.

Payments

Whether you use a charge card or a credit card, paying your monthly bill on time is critical to building and maintaining a good credit record.

Payment history makes up 35% of your FICO® credit score, so consistency is key. If your payment is 30 days or more past due and your card issuer reports it to the credit bureaus, that negative news could remain on your credit report for up to seven years. And it could come back to haunt you when you try to borrow money to buy a car or house.

Utilization

Credit utilization (the percentage of your available credit that you’re currently using) makes up 30% of your FICO score, so it’s important to keep your credit card balances well under the assigned limit.

To maintain or positively impact your credit score, the general rule is that you should try not to exceed a 30% credit card utilization rate. If you’re using up a big chunk of the pre-set limit on your credit card, it could have a negative effect on your score.

Because charge cards don’t have a pre-set credit limit, it can be difficult to determine if a card holder is at risk of overspending — so neither FICO or VantageScore include charge card information when calculating a person’s utilization rate.

This can have both pros and cons for charge card holders. The advantage, of course, is that you don’t have to worry about negative consequences for your credit score if you spend a lot in one month using your charge card. On the flip side, though, if you have a large amount of available credit that you aren’t using, it won’t do anything to help your score.

Choosing Between Credit Cards and Charge Cards

Deciding whether to apply for a credit card vs. a charge card may come down to evaluating the benefits you’re hoping to get from the card and assessing your own spending behavior. Here are some questions you might want to ask:

• Does the card offer unique, valuable perks you think you’ll use?

• If there’s a high annual fee for the card, does it fit your budget and are the card’s perks worth the cost?

• Do you have enough money, discipline, and organization to ensure your bill is paid in full every month? Or could there be times when you’ll want to make a partial or minimum payment and carry forward a balance?

• Is your credit score good or excellent? If not, you may have more options and a better chance of qualifying if you apply for a credit card instead of a charge card.

• If you think you’ll pay off your card’s balance every month, would a credit card still be a better fit because of the rewards, low or no fees, and wider acceptance from vendors?

Also keep in mind that you don’t necessarily have to choose. In fact, you could benefit from owning both a charge card and a credit card. You may find there are reasons to have both types of cards in your wallet.

The Takeaway

The terms charge card and credit card are often used interchangeably, but they are not the same thing. A charge card must be paid off every month, so there’s no interest to worry about — but there may be a high annual fee to pay. A credit card allows the user to make a minimum monthly payment and carry forward a balance, but the interest on that balance can add up quickly.

Each individual user must decide which is the better fit for their needs. And a card’s benefits vs. its costs may be a deciding factor.

Whether you're looking to build credit, apply for a new credit card, or save money with the cards you have, it's important to understand the options that are best for you. Learn more about credit cards by exploring this credit card guide.

FAQ

Is a credit card easier to get than a charge card?

Because these days there are more companies issuing credit cards, it may be easier to find one that suits your needs and has qualifications you can meet — even if you have a poor or limited credit history. There are very few charge cards available anymore.

Does a charge card build credit better than a credit card?

Both a credit card and a charge card can help or hurt your credit score, depending on how you use it.

When do credit cards charge interest?

Most credit cards come with a grace period, which means the credit card issuer won’t charge you interest on purchases if you pay your entire balance by the due date each month. If you fail to pay the entire amount on your statement balance, however, or if you make your payment after the due date, interest charges will likely appear on your next monthly statement.

Photo credit: iStock/9dreamstudio

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.

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 .

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Guide to a Confirmed Letter of Credit

What Is a Confirmed Letter of Credit?

How Confirmed Letters of Credit Work

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Parties Involved in a Confirmed Letter of Credit

Confirmed Letter of Credit Example

Confirmed vs Unconfirmed Letters of Credit

Advantages of Confirmed Letters of Credit

Disadvantages of Confirmed Letters of Credit

The Takeaway

FAQ

What is an unconfirmed letter of credit?

Is an unconfirmed LC safe?

What is the risk of an unconfirmed LC?

Guide to Irrevocable Letters of Credit (ILOC)

What Is an Irrevocable Letter of Credit?

How Does an Irrevocable Letter of Credit Work?

Irrevocable Letter of Credit Specifications

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Do I Need an Irrevocable Letter of Credit?

Alternatives to Irrevocable Letters of Credit

Trade Credit Insurance

Letters of Credit

The Takeaway

FAQ

What is the difference between a letter of credit and an irrevocable letter of credit?

What is the cost of an irrevocable letter of credit?

Does an irrevocable letter of credit expire?

What Is an IRA?

What Is an IRA?

What Are the Different Types of IRA Accounts?

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

Traditional IRA

Roth IRA

SEP IRA

SIMPLE IRA

How to Open an IRA

Benefits of Opening an IRA

Which Type of IRA Works for You?

How Much Should You Contribute to an IRA?

How Can You Use IRA Funds?

The Takeaway

FAQ

How is an IRA different from a 401(k)?

What’s the difference between a Roth IRA and a Traditional IRA?

When should I make IRA contributions?

Growth Savings Accounts: What They Are and How They Work

What Is a Growth Savings Account?

How Do Growth Savings Accounts Work?

Pros of a Growth Savings Account

Higher Interest Rates

Get up to $300 when you bank with SoFi.

Accessible Form of Growth

Good Way to Build an Emergency Fund

Cons of a Growth Savings Account

Limited Growth Opportunity

Withdrawal Limits

Earnings Are Taxable Income

Choosing a Growth Savings Account

How to Open a Growth Savings Account

The Takeaway

FAQ

How do growth savings accounts work?

What does “growth account” mean?

How much interest does a growth savings account earn?

Charge Card vs. Credit Card: Understanding the Key Differences

How Charge Cards Work

How Credit Cards Work

Differences Between a Charge Card and Credit Card

Payment Obligations

Availability

Acceptance

Costs

Interest

Annual Fees

Rewards and Perks

Spending Limit

How Card Choice Can Impact Your Credit Score

Inquiries

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