Jan
24
2024
top view working on desk with flowers

25 Tax Deductions for Freelancers

By | Budgeting & Goals, Financial Independence, money | Comments Off on 25 Tax Deductions for Freelancers

Are you a freelancer? If so, you are in good company. Last year, almost 40% of the U.S. population did freelance work.

As the gig economy surges and more people participate, it’s important to be aware of the taxes you owe and the deductions you can take. Those deductions can help lower the amount of taxes you owe and help you keep more of your hard-earned money, so you’ll want to claim what’s due to you.

Taxes for those who are self-employed can get complex, and tax laws can change frequently. It’s therefore wise to do your research or hire a tax professional who focuses on freelance taxes.

But whether you choose to work with a tax pro, or go it on your own, it can be very helpful to know about the self-employed tax deductions that are usually allowed. To help you get up to speed, read on for 25 tax deductions that many freelancers can take.

Self-Employed Tax Deductions You Won’t Want to Miss

When considering whether an expense is deductible or not, you may want this rule of thumb in mind: The Internal Revenue Service (IRS) guideline for freelancer tax deductions is that expenses must be ordinary and necessary.

If you purchase an item or incur an expense even if you weren’t running your freelance business, it likely would not qualify for a deduction.

Below are some key deductions you may be able to qualify for. Knowing and noting them can help you with financial planning for freelancers.

1. Home Office

Are you earning money from home? If so, one of the most common deductions for freelancers is claiming a home office on your taxes. To take this deduction, the designated space must be used regularly and exclusively for business operations, and must be the principal location where business is conducted.

You can take this deduction whether your own or rent. You can use the simplified method, which has a rate of $5 per square foot for business use of the home, with a maximum deduction of $1,500 (or 300 square feet), according to the IRS .

Or, you can use the regular method, which divides expenses of operating the home (including mortgage/rent, real estate taxes, utilities, home insurance) between personal and business use.

Calculating Home Office Tax Deductions

To maximize your deduction for a home office you may want to calculate both the simplified and the regular techniques to see which is higher.

•   As mentioned above, the simplified method involves calculating your home office’s square footage (up to a cap of 300 square feet), and multiplying that by five.

•   For the regular method, you would use IRS Form 8829 to figure out the number. While this is a more involved calculation, it might yield a higher number.

💡 Quick Tip: Tired of paying pointless bank fees? When you open a bank account online you often avoid excess charges.

2. Office Supplies

Looking for more tax deductions for freelancers? The materials you purchase to work in your home office, such as paper, pens, pencils, pads, printer ink, staples, paper clips, etc, can typically be deducted at full cost as long as the items are used for business.

3. Hardware and Equipment

If you require specific hardware, such as a laptop, personal computer, tablet, or other types of equipment to run your business, these purchases may count as deductions.

Or maybe you earn money from a side hustle like photography or jewelry making, which requires specialized equipment.

You may want to talk to your accountant about the best way to deduct these expenses, as some bigger purchases that will be used beyond one year may need to be depreciated over a set number of years, rather than deducted in full.

4. Web Hosting and Online Tools

If you have a website and pay fees for web hosting, these expenses can likely be deducted from your taxes. If you use other online tools for your business (such as Dropbox or Zoom), fees you pay for these services can also usually be deducted.

5. Phone And Internet Service

If you use the internet, a landline phone, or a cell phone for business at least some of the time, these services may qualify for a deduction.

You may want to keep in mind, however, that you can generally only deduct a portion based on your business usage.

6. Start-Up Costs

Here’s another freelance tax deduction: You may be able to deduct up to $5,000 of initial purchases and investments made to get your business up and running in its first year. Purchases that exceed that amount can often be deducted over time.

7. Employee Salaries

The cost of paying employees to work within a business can usually be deducted. These costs generally include both wages and benefits.

8. Self-Employment Tax

Are you a 1099 worker? Self-employment taxes cover freelancer contributions toward Social Security and Medicare. You can generally deduct the employer-equivalent portion of your self-employment tax, which is half the total self-employment tax.

💡 Quick Tip: Your money deserves a higher rate. You earned it! Consider opening a high-yield checking account online and earn 0.50% APY.

9. Your Car

The entire cost of ownership and maintenance of any vehicle used strictly for business purposes can typically be deducted from business income (subject to some limits). For 2023, the standard mileage rate per the IRS for business-related driving you do is 65.5 cents/mile.

Cars driven for both business and personal use can also be deducted, but only for costs incurred while conducting business. It’s wise to set up a system to keep track of when you are driving for personal vs. professional purposes.

10. Unpaid Invoices

Also known as bad debt, unpaid invoices (meaning your business is owed money that it has no hope of reclaiming) may be deductible.

However, in order for the deduction to be allowed, it must be clear to both parties that the transaction was not a gift.

11. Business License

Depending on the industry, certain state and federal licenses may be required for a business to operate. However, there may be an amortization schedule to be aware of, meaning you would deduct percentages of the cost over time.

The fees paid annually to state or local governments for obtaining those licenses can generally be deducted.

It’s wise to look further into the tax code to be sure you understand how to properly take these deductions.

12. Qualified Business Income

This is a newer self-employment deduction. If you earn $182,100 or less as a single filer (or $364,200 as a joint filer) in 2023, you may qualify for a 20% deduction on your taxable business income via the QBI, or qualified business income deduction.

13. Product Supplies and Storage Units

For freelancers who sell products, the supplies purchased in order to make those products can usually be a freelance tax deduction.

The costs of keeping business supplies and assets in a storage unit can generally also be deducted, since storage is an expense factored into the overall cost of the goods sold.

Get up to $300 when you bank with SoFi.

No account or overdraft fees. No minimum balance.

Up to 4.00% APY on savings balances.

Up to 2-day-early paycheck.

Up to $2M of additional
FDIC insurance.


14. Business Loan Interest

If you’ve taken out a loan to help fund your business, you may be able to deduct the interest you incur from it as a business expense.

For this to be deductible, however, a freelancer must be legally liable for that debt. In addition, both the freelancer and the lender must intend that the debt be repaid and have a true debtor-creditor relationship.

15. Meals

Sorry, buying takeout and eating it at your desk isn’t tax-deductible. But if you are traveling for business, at a conference, or dining with a client, then you can deduct 50% of the cost if you have the receipt. If you don’t have the receipt, you can take off 50% of the standard meal allowance.

16. Transaction Fees

If part of your business involves processing credit card orders, you may have an additional freelancer deduction. The processing costs a freelancer may incur by accepting credit cards payments is usually deductible as a qualified business expense.

17. Attorney & Accountant Fees

The fees charged by attorneys and accountants that are related to operating your business are typically considered tax-deductible business expenses.

That includes tax preparation fees, as well as any additional tax resolution expenses that pertain to your business.

18. Education Costs

Freelancer deductions can include the cost of education that helps you maintain or improve skills needed in your present work. This tax deduction also typically includes costs for books, supplies and even transportation.

19. Industry Events

Fees for attending conferences or conventions that are business related can typically be deducted.

Not only are the admission or registration fees often deductible, but all reasonable travel expenses accrued in order to attend the event may be deductible as well.

20. Promotional Materials

Tools used for marketing, advertising, and the general promotion of a business are considered deductible expenses. That includes advertising your product or service on social media or elsewhere.

Any expenses incurred in order to influence legislation (such as lobbying), however, are not deductible.

21. Business Membership Fees

While you generally can’t deduct dues or fees paid for memberships in clubs organized for recreational or social purposes, dues paid to join organizations that align with your specific business industry are usually considered deductible.

This includes organizations, such as boards of trade, chambers of commerce, and professional organizations (like bar associations and medical associations).

22. Business Travel Expenses

Travel costs that are associated with conducting business are considered valid income tax deductions, as long as they are ordinary and necessary and last more than one workday.

This can include flights, hotel stays, meals, getting around locally via bus/train/ride sharing services, even dry cleaning or laundry expenses while you’re away from home.

You may want to keep in mind that lavish and extravagant travel conditions generally do not qualify for deduction.

Also, day-to-day commuter expenses between home and business are not typically deductible.

23. Business Gifts

If you give a gift to a client or vendor as a thank you for conducting business with you, the cost of the gift is generally deductible up to $25 per person per year.

Extra costs such as engraving, packing, or shipping aren’t included in the $25 limit if they don’t add significant value to the gift.

24. Health Insurance

Self-employed individuals with qualifying policies are typically allowed to deduct premiums for health, dental, and long-term care for themselves and their families.

25. Retirement Plan Contributions

Just because you don’t work for a large company doesn’t mean you can’t benefit from a tax-advantaged retirement plan. Indeed, freelancers often have even more options for saving this way.

Two self-employed retirement options you may want to consider: a traditional IRA (which allows you to contribute up to $6,500 per year in pre-tax dollars if you’re under 50, and up to $7,500 if you’re older) and a SEP IRA (which allows you to contribute up to 25% of your income for a maximum of $66,000 per year for tax year 2023).

Claiming Tax Deductions

Why is it important to claim tax deductions? They will help lower how much you pay in taxes and increase how much you keep to spend and save.

If, say, you earn $120,000 in a given year and can claim $25,000 in tax deductions, then you would only be paying taxes on $95,000. That can make a big difference in your daily financial life as well as your ability to build wealth and hit your financial goals.

Tips for Freelancer Tax Deductions

If you are a freelancer, there are a couple of smart guidelines to follow as you move through the tax year.

Keeping Records of Everything

As you earn, spend, and save as a freelancer, it’s important to make a budget and track where your money is going. Keeping records of how much you are paid from different clients or customers, what you are spending on your business, and when and where those expenses are incurred (and even how they are paid) can make a big difference when tax preparation time rolls around.

Also, if you ever need that information if audited, you will be glad you have those files.

Keeping Your Personal and Business Finances Separate

As you have learned, it’s important to keep your business and personal finances separate when you are self-employed. This means your workspace, your transportation and meal expenses, and the like.

This will have important implications at tax time. For instance, you may have to parse how much of your rent or mortgage and your utilities actually go towards your home-based business vs. personal use.

•   Opening a separate bank account for your business. It can be a smart move to keep your business finances separate from your personal to clarify your professional earning and spending. Many financial institutions offer business accounts to meet these needs. If you are just launching a side hustle or have a small, part-time gig, you might simply open up an additional checking and savings account to start.

Working With a Tax Professional

It’s not always easy to decipher the tax code as a freelancer or know which expenses qualify and to what expense.

Sometimes, working with a qualified tax professional can help. They are trained to know the ins and outs of the law and can guide you on correct tax filing.

The IRS offers guidelines for choosing a reputable tax professional that can be worth reading.

The Takeaway

As a freelancer, you can often lower your tax liability by deducting expenses that were incurred to operate your business.

There are a wide range of deductions you may be able to take, including some or all of your expenses for a home office, supplies for that home office, business events, advertising, self-employment taxes, and more.

In addition to managing your business income, you’ll also want to consider the full breadth of financial services you need, and compare which banking partner is best for your needs, whether personal or professional.

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

Do freelancers need to declare income?

Yes, if you are a freelancer, you need to declare your income and pay taxes on it. It is wise to pay quarterly estimated taxes to avoid a large tax bill and potential penalties at tax time.

How is income tax calculated for freelancers?

In addition to regular income tax, freelancers typically need to pay a self-employment tax of 15.3% to cover Social Security and Medicare taxes. Typically, employees and their employers split that bill. But self-employed people pay the whole thing.

What happens if you don’t file freelance taxes?

Not filing freelance taxes doesn’t mean you don’t owe them. Not paying taxes can mean you are still liable for the amount you owe, plus interest and penalties.

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.

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.

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

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

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

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.

SOBK0324003

Read more
Dec
09
2023
Guide to Student Loan Transfers_780x440: Student loan transfers are one way to take matters into your own hands.

Guide to Student Loan Transfers

By | Debt Payoff, Student Loans, student_loan | Comments Off on Guide to Student Loan Transfers

Sometimes, student loan debt can start to feel like it’s slowing you down. Maybe the interest rate is too high, you’re not happy with your loan terms, or you’re frustrated with the lender’s customer service. If so, you have the right to look for a new lender and transfer your debt to a different company.

However, you can’t simply ask a new lender to take on your debt with the same terms. To transfer your student loan, you generally need to take out a new loan with a new lender or servicer. The process of switching will be different depending on whether your student loans are private or federal, and may involve consolidating the loan or refinancing.

If you’re thinking about a loan transfer, keep in mind that there’s no guarantee you’ll end up in a more favorable situation just by switching lenders. Here’s what you need to know about student loan transfers.

How Do I Transfer Student Loans to Another Private Lender?

If you have private student loans, the main way to transfer your debt to another lender is to refinance. This involves taking out a new loan with a different lender and using it to pay off your current student loan(s). Moving forward, you only make payments on your new loan to your new lender.

If you have multiple private student loans, refinancing can simplify repayment by giving you only one monthly payment to manage. And, if your financial picture has improved since you took out your original private student loan(s), you may be able to qualify for a lower interest rate. Another perk of refinancing is the ability to lengthen your repayment timeline to reduce your monthly payment amount. Keep in mind, though, that a longer repayment will generally end up costing you more in the long run.

You’ll need to meet certain criteria to be eligible for private student loan transfer via refinancing. Most lenders have a minimum income threshold as well as a minimum credit score (often in the upper 600s). If you don’t meet the income or credit requirements, you may be able to qualify by adding a cosigner.

Many lenders offer prequalification, which lets you see what type of rates and terms you may be able to qualify for without impacting your credit score. To find the loan with the best rate, it can be a good idea to shop around and compare lenders through prequalifying. Once you find a lender you want to work with, you’ll need to officially apply for the student loan refinance.


💡 Quick Tip: Ready to refinance your student loan? With SoFi’s no-fee loans, you could save thousands.

Can I Transfer My Sallie Mae Loans to Another Lender?

Currently, Sallie Mae only offers private student loans. Prior to 2014, however, the lender serviced federal student loans. If you want to refinance a Sallie Mae loan you took out before 2014, you’ll need to check whether it’s federal or private before moving forward.

If you took out a Sallie Mae loan after 2014, it’s a private student loan, and you can refinance the loan with another private lender. This might be a good idea if you can qualify for a lower interest rate.

What’s the Difference between a Lender and a Loan Servicer?

While the terms lender and loan servicer are often used interchangeably, they are not the same thing. Here’s a look at how they differ.

Student Loan Lender

A lender is an institution or company that originates and funds the student loan. In other words, they’re the one lending you the money. For example, if you apply for a federal student loan, the federal government is your lender. If you apply for a private student loan, you can choose between a number of private lenders.

A Student Loan Servicer

A federal student loan servicer is the middleman between you and the federal government (the lender). Servicers collect your student loan bills and keep track of whether you pay them on time. They will help you if you’re having trouble with your repayment plan or need to change your address or other personal information. You do not get to pick your servicer.

During the course of your federal student loan, your servicer might change a few times. For example, if you had a loan with Great Lakes, it was likely transferred to Nelnet some time between March 2022 and June 2023. You’ll typically get notified of a student loan transfer two two weeks prior to your transfer date.

If you have a federal student loan and you’re not sure who your servicer is, you can log in to studentaid.gov to find out.

Can I Change My Student Loan Servicer?

You can’t change your federal student loan servicer directly. However, if you’re willing to do some legwork, there are two main ways to move your federal student debt to a new servicer or lender.

If you want to keep your federal loan status but switch to a different loan servicer, you can transfer your loans through consolidation. If your main objective is to save on interest, you may want to look into refinancing your student loans with a private lender. Read below to learn more about each scenario.

What about Consolidating My Student Loans?

One way to switch loan servicers is to consolidate your federal student loan(s). This allows you to transfer the debt to a different servicer but keep your federal student loan status, since the lender will still be the federal government.

The consolidation process lets you combine several federal student loans into a single, easier-to-manage Direct Consolidation Loan. While it does not reduce your interest rate, it can lower your payment by extending the term. The downside is that the extended term will mean you pay more in interest over time.

Since not all federal loans have the same interest rate, the interest rate on a new Direct Consolidation Loan will be a weighted average based on your current loan amounts and interest rates. Any unpaid interest is added to your principal balance. The combined amount will be your new loan’s principal balance. You’ll then pay interest on the new principal balance.

Consolidation can be a good option if you are unhappy with your servicer or have several servicers and want to simplify your student debt by having only one payment.

If you have Federal Family Education Program or parent PLUS loans, you need to consolidate to be eligible for income-driven repayment, public service loan forgiveness, and other relief programs.

You can complete a consolidation loan application at studentaid.gov.

What About Student Loan Refinancing?

Another way to change your federal student loan servicer is to refinance your federal student loans with a private lender. If you also have private student loans, you can refinance them together with federal loans, giving you a single loan payment each month.

Generally, refinancing federal student loans only makes sense if you can qualify for a lower interest rate. If you have higher-interest federal student loans, such as graduate PLUS loans or Direct Unsubsidized Loans, you may be able to get a lower rate by refinancing. To qualify for the best rates on a private student refinance, you generally need to have strong financials (or can recruit a cosigner who does).

It’s important to note that refinancing federal student loans with a private lender means losing federal protections, such as income-driven repayment plans, federal deferment and forbearance programs, and loan forgiveness options like Public Service Loan Forgiveness (PSLF).

If you’re interested in refinancing your federal loans, it’s a good idea to review offers from multiple lenders to find the best deal. Many private lenders will allow you to prequalify via a soft credit check so you can see your likely new interest rate without negatively impacting your credit score.


💡 Quick Tip: It might be beneficial to look for a refinancing lender that offers extras. SoFi members, for instance, can qualify for rate discounts and have access to financial advisors, networking events, and more — at no extra cost.

What About Transferring My Student Loan Balance to a Credit Card?

You generally can’t pay federal student loans with a credit card. If you have private loans, however, another option for student loan transfer is to move the balance onto a credit card and pay your monthly bills there. Some credit card issuers allow student transfers, but not all.

Generally speaking, this tactic only makes sense if you can qualify for a card with a 0% introductory rate and can pay off the entire balance before that promotional period expires (often 15-21 months). Otherwise, you could be left paying even more in interest than you would with the original loan.

To see if you can manage this repayment schedule, simply divide your loan balance by the number of months you would need to pay it off before interest applies. Also check to make sure the credit card offers a high enough credit limit to accommodate your loan, and find out if there are any transfer fees.

If you decide it’s a good deal and are confident you can make it work, you would apply for the credit card and, once approved, give your credit card account details to your loan servicer. Your credit card issuer would then pay off your private student loan debt and move the balance to your credit card account. Moving forward, you only make payments to the credit card issuer.

Is It Possible to Transfer Student Loans From Parent to Student?

The federal government does not offer a way to transfer Parent PLUS loans to the child. However, if you’re looking to have your Parent PLUS loans transferred to your child, refinancing the loans with a private lender allows you to do that.

To make this type of loan transfer, you’ll first need to identify Parent PLUS refinance lenders that allow loan transfers. After that, your child may want to prequalify with a few of these lenders to see where they can get the best rate.

If your child meets the lender’s qualifications on their own, you can fully transfer the loan to them. If they don’t, you can serve as a cosigner on the refinanced loan and work with them to meet the lender’s cosigner release requirements. Many lenders allow cosigner release after a set number of successful payments.

The Takeaway

If you’re interested in transferring your student loans to a new servicer or lender, you have some options. If you have federal student loans, you can consolidate your loans to get a different servicer. If you have federal, private, or a mix of both types of student loans, another option for loan transfer is to refinance your loans with a private lender.

Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.


With SoFi, refinancing is fast, easy, and all online. We offer competitive fixed and variable rates.


SoFi Student Loan Refinance
SoFi Student Loans are originated by SoFi Bank, N.A. Member FDIC. NMLS #696891. (www.nmlsconsumeraccess.org). SoFi Student Loan Refinance Loans are private loans and do not have the same repayment options that the federal loan program offers, or may become available, such as Public Service Loan Forgiveness, Income-Based Repayment, Income-Contingent Repayment, PAYE or SAVE. Additional terms and conditions apply. Lowest rates reserved for the most creditworthy borrowers. For additional product-specific legal and licensing information, see SoFi.com/legal.


SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

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.

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

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

SOSL1123019

Read more
Dec
04
2023
Solo 401(k): The Retirement Plan Built for the Self-Employed

Navigating Solo 401(k) Plans: A Complete Guide for the Self-Employed

By | invest, Investing, Preparing for Retirement | Comments Off on Navigating Solo 401(k) Plans: A Complete Guide for the Self-Employed

Being self-employed offers many perks, including freedom and flexibility. What it doesn’t offer is an employer-sponsored retirement plan. But when you don’t have access to a 401(k) at work, opening a solo 401(k) can make it easier to stay on track with retirement planning.

Before you establish a solo 401(k) for yourself, it’s important to understand how these plans work and the pros and cons involved.

What Is a Solo 401(k)?

A solo 401(k) is a type of 401(k) that’s designed specifically with self-employed individuals in mind. This retirement savings option follows many of the same rules as workplace 401(k) plans in terms of annual contribution limits, tax treatment, and withdrawals. But it’s tailored to individuals who run a business solo or only employ their spouses.

It’s one of several self-employed retirement options you might consider when planning a long-term financial strategy.

Definition and Overview

A solo 401(k) is a tax-advantaged retirement account that’s for self-employed individuals and business owners who have zero employees, or no employees other than their spouse. This type of 401(k) plan is also known by a few other names:

•   Solo-k

•   Uni-k

•   One-participant plan

Traditional solo 401(k) contributions are made using pre-tax dollars. However, it’s possible to open a Roth solo 401(k) instead. In the case of a Roth solo 401(k), you’d make contributions using after-tax dollars and be able to withdraw the money tax-free in retirement.

A self-employed 401(k) plan works much the same as a regular 401(k). For instance, you may be able to take loans from your savings if needed. Catch-up contributions are also allowed. The biggest difference is that there is no matching contribution from an outside employer.

You can start investing in a solo 401(k) for yourself through an online brokerage. There’s some paperwork you’ll need to fill out to get the process started, but once your account is open you can make contributions year-round.

At the end of the year, the IRS requires solo 401(k) plan owners to file a Form 5500-EZ if the account has $250,000 or more in assets.


💡 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.

Contribution Limits in Solo 401(k) Plans

Much like workplace 401(k)s, there are annual contribution limits that apply to solo 401(k) plans.

The IRS caps total contributions to a solo 401(k) account at $66,000 for 2023 and $69,000 for 2024. That doesn’t include catch-up contributions for those age 50 and over, which are an additional $7,500 for each year.

As both the employee and employer of your own business, you can contribute both elective salary deferrals and employer nonelective contributions (you are both the employer and the employee in this scenario). Each has different contribution caps.

Annual Contribution Limits

As an employee, you can contribute up to 100% of your earned income up to the annual contribution limit: $22,500 in 2023 and $23,000 in 2024, plus an additional $7,500 for those age 50+ in elective salary deferrals.
In addition, you can make employer nonelective contributions. These come directly from the “employer” (aka you) and are not deducted from the employee’s (your) salary. As an employer, you can contribute up to 25% of your self-employment income (business income – ½ self-employment tax and elective salary deferrals), in pre-tax dollars.

Setting Up a Solo 401(k) Plan

If you’re interested in setting up a solo 401(k) for yourself, you can do so through an online brokerage. Here’s a step-by-step guide for how to open a solo 401(k).

Steps to Establish Your Plan

1. Choose a Plan Administrator

A plan administrator is the person responsible for managing your solo 401(k). It’s their job to make sure the plan is meeting reporting and other requirements established by the IRS. If you’re self-employed, you can act as your own plan administrator or you could choose your accountant instead.

2. Choose a Brokerage

Once you know who’s going to manage the plan, the next step is deciding where to open it. A number of brokerages offer solo 401(k) plans so you may want to spend some time comparing things like:

•   Account setup process

•   Investment options

•   Fees

You may be able to start the solo 401(k) account setup process online, though some brokerages require you to call and speak to a representative first. And you may need to finalize your account opening by mailing or faxing in any supporting documents the brokerage needs to complete the application.

3. Fill Out a Solo 401(k) Application

Before you can start a 401(k) account for yourself, you’ll need to give your brokerage some information about your business. A typical solo 401(k) application may ask for your:

•   First and last name

•   Employer Identification Number (EIN)

•   Plan administrator’s name and contact information

•   Social Security number

•   Mailing address

•   Citizenship status

•   Income information

You’ll also need to disclose any professional associations or affiliations that might result in a conflict of interest with the brokerage. In completing the application, you’ll be asked to name one or more beneficiaries. You may also be asked to provide bank account information that will be used to make your initial contribution to the plan.

4. Choose Your Investments

Once you’ve returned your solo 401(k) account application and it’s been approved, you can choose your investments. The type of investments offered can depend on the brokerage and the plan. But typically, you may be able to choose from:

•   Target-date funds

•   Index funds

•   Actively managed funds

•   Exchange-traded funds (ETFs)

Whether you have access to individual stocks, bonds, CDs, or alternative investments such as commodities can depend on the platform that’s offering the plan.

5. Decide How Much to Contribute

You may choose to schedule automatic investments or make them manually according to a schedule that works for you.

Choosing Between Traditional and Roth Solo 401(k)s

You can opt for a traditional solo 401(k), which is made with pre-tax dollars, or a Roth solo 401(k), which is made with after-tax dollars. Which plan is better for you may depend on what you expect your income to be in retirement.

If you believe your income will be higher in retirement than it is now, in general, a Roth could be a better choice since you can take the distributions tax-free at that time. But if you think your income may be less in retirement than it is now, you might be better off with a traditional solo 401(k), which allows you to take the tax deduction now and have your distributions taxed in retirement.

Advantages and Disadvantages of Solo 401(k) Plans

When considering retirement account options, it can be helpful to look at the pros and cons to determine what works best for your personal situation.

Benefits of Having a Solo 401(k)

There are different reasons why opening a 401(k) for self employed individuals could make sense.

•   Bigger contributions. Compared to other types of self-employed retirement plans, such as a SEP IRA or SIMPLE IRA, solo 401(k) contribution limits tend to be more generous. Neither a SEP IRA or SIMPLE IRA, for instance, allows for catch-up contributions.

•   Roth contributions. You also have the option to open a Roth solo 401(k). If you anticipate being in a higher tax bracket when you retire, you may prefer being able to withdraw contributions tax-free with a Roth.

•   Flexible withdrawal rules. A solo 401(k) can also offer more flexibility with regard to early withdrawals than a SEP IRA, SIMPLE IRA, traditional IRA, or Roth IRA. If your solo 401(k) plan allows it, you could take out a loan in place of an early withdrawal. This could help you to avoid early withdrawal penalties and taxes. An IRA-based plan wouldn’t allow for loans.

Considerations and Potential Drawbacks

There are also a few potential downsides of investing in a solo 401(k).

•   Eligibility restrictions. If you run a small business and you have at least one employee other than a spouse, you won’t be able to open a solo 401(k) at all.

•   Complicated reporting. Calculating contributions and filing can be more complicated with a solo 401(k) vs. a SEP IRA or SIMPLE IRA. If your plan has more than $250,000 in assets you’ll need to file Form 5500-EZ with the IRS each year.

•   Administrative costs. Depending on where you open a solo 401(k) plan, the cost of maintaining it year to year may be higher compared to other self employed retirement plans. And an early 401(k) withdrawal can trigger taxes and penalties.

It’s important to consider the range of investment options offered through a solo 401(k). What you can invest in at one brokerage may be very different from another. The individual cost of those investments can also vary if some mutual funds or exchange-traded funds offered come with higher expense ratios than others.


💡 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.

Withdrawals and Loan Provisions

There are certain requirements for withdrawals and/or loans from a solo 401(k).

Rules for Withdrawing Funds

You can make withdrawals from a solo 401(k) without penalty at age 59 ½ or older. Distributions may be allowed before that time in the case of certain “triggering events,” such as a disability, but you may owe a 10% penalty as well as income taxes on the withdrawal.

Loan Options and Conditions

Some solo 401(k) plans may be set up to allow loans. If yours does, you could take out a loan in place of an early withdrawal. This could help you to avoid early withdrawal penalties and taxes. Just be sure to find out the loan terms and conditions, which can vary by plan.

Testing and Compliance for Solo 401(k)s

Unlike workplace 401(k)s, solo 401(k)s have no testing compliance requirements involved.

Alternatives to Solo 401(k) Plans

Instead of a solo 401(k), self employed individuals can consider another type of retirement account. Here’s how different options stack up.

Comparing a Solo 401(k) to a SEP IRA and Other Retirement Options

A SEP IRA is designed for small businesses. However, unlike a solo 401(k), a SEP IRA allows no catch-up contributions and there is no Roth version of the plan.

A SIMPLE IRA is for businesses with no more than 100 employees. It has much lower contribution limits than a solo 401(k) and once again, there is no Roth option.

Pros and Cons of a Solo 401(k)

A solo 401(k) has advantages and disadvantages. Here’s a side-by-side comparison of the benefits and drawbacks.

Solo 401(k) Pros

 Solo 401(k) Cons
Catch-up contributions may allow older investors to save more for retirement versus a SEP IRA or SIMPLE IRA. Only self-employed individuals who have no employees or just employee their spouses can contribute.
It’s possible to choose between a traditional solo 401(k) or Roth solo 401(k), based on your investing goals and tax situation. Annual reporting requirements may be more complicated for a solo 401(k) compared to other self employed retirement plans.
Solo 401(k) plans may allow for loans, similar to workplace plans. Early withdrawals from a solo 401(k) are subject to taxes and penalties.

The Takeaway

A solo 401(k) can be a worthwhile investment vehicle for self-employed people who want to save for retirement. It has more generous contribution limits than some other retirement options. In addition, there is a Roth version of the plan, and a solo 401(k) plan may also offer flexibility in terms of early withdrawals. For individuals who are self-employed, opening a solo 401(k) is one potential way to start saving for their golden years.

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

Easily manage your retirement savings with a SoFi IRA.

FAQ

Can I contribute 100% of my salary to a solo 401(k)?

As an employee, you can contribute up to 100% of your earned income to a solo 401(k) up to the annual contribution limit, which is $22,500 in 2023, and $23,000 in 2024, plus an additional $7,500 for those age 50 and up in elective salary deferrals.

Is a solo 401(k) taxable income?

You will pay taxes with a solo 401(k), but the type of plan you open determines when you’ll pay those taxes. If you have a traditional 401(k), your contributions are tax-deferred, and they reduce your taxable income for the year in which you make them. However, you will pay taxes on distributions when you take them in retirement. If you have a Roth 401(k), you pay taxes on your contributions when you make them, but your distributions in retirement are tax-free.

What is the average return on a solo 401(k)?

The return on a solo 401(k) depends on the investments in your portfolio. However, in general, a solo 401(k) invested in a mix of bonds, stocks, and cash assets can have an average rate of return ranging between 3% and 8%. But again, it depends on what your investments are, and how much you allocate to those different assets. You may want to compare your plan’s performance to plans with similar funds to get a general sense of what the average return might be.

Who qualifies for a solo 401(k)?

To be eligible for a solo 401(k), you must be self-employed or a small business owner with no employees other than a spouse. To open a solo 401(k) you will need an Employee Identification Number (EIN), which is available from the IRS.

Photo credit: iStock/visualspace

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.

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.

SOIN1023177

Read more
Nov
22
2023
IRA Withdrawal Rules: All You Need to Know

Guide to IRA Withdrawal Rules

By | invest, Investing, Preparing for Retirement | Comments Off on Guide to IRA Withdrawal Rules

The purpose of Individual Retirement Accounts (IRAs) is to allow you to save for your golden years, so there are strict IRA withdrawal rules meant to make it harder to access that money for other reasons.

Ideally you sock away money consistently and your investment grows over time. You also get the benefit of tax breaks. But it’s important to keep the IRA rules for withdrawals in mind to make the most of your accounts.

Key Points

•   Traditional and Roth IRAs have specific withdrawal rules and penalties to protect retirement savings.

•   Roth IRA withdrawal rules include the five-year rule for penalty-free withdrawals, and required minimum distributions for inherited IRAs.

•   Traditional IRA withdrawals before age 59 ½ incur regular income taxes and a 10% penalty.

•   There are exceptions to the penalty, such as using funds for medical expenses, health insurance, disability, education, and first-time home purchases.

•   Many experts recommend that early IRA withdrawals should be a last resort due to the potential impact on retirement savings and tax implications.

Roth IRA Withdrawal Rules

When can you withdraw from a Roth IRA? The rules for IRA withdrawals are different for Roth IRAs and traditional IRAs. For instance, qualified withdrawals from a Roth IRA are tax free, since you make contributions with after-tax funds. And there are some other rules about Roth IRAs to keep in mind as well.

The Five-year Rule

If you have a Roth IRA, you may face a Roth IRA withdrawal penalty if you withdraw funds you deposited less than five years ago. This is known as the “five-year rule“. These Roth IRA withdrawal rules also apply to the funds in a Roth rolled over from a traditional IRA. In those cases, if you make a withdrawal from a Roth IRA account that you’ve owned for less than five years, you’ll owe a 10% tax penalty on the account’s gains.

For inherited Roth IRAs, the five-year rule applies to the age of the account, so if your benefactor opened the account more than five years ago, you can access the funds penalty-free. If you tap into the money before that, you’ll owe taxes on the gains.

Required Minimum Distributions (RMDs) on Inherited Roth IRAs

If you’re wondering about Roth IRA distribution rules, in most cases, you do not have to pay required minimum distributions on money in a Roth IRA account. However, for inherited Roths, IRA withdrawal rules mandate that you take required minimum distributions.

There are two ways to do that without penalty:

•   Withdraw funds by December 31 of the fifth year after the original holder died. You can do this in either partial distributions or a lump sum. If the account is not emptied by that date, you could owe a 50% penalty on whatever is left.

•   Take withdrawals each year, based on your life expectancy.

Get a 1% IRA match on rollovers and contributions.

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

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.

💡 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.

Traditional IRA Withdrawal Rules

If you take funds out of a traditional IRA before you turn 59 ½, you’ll owe regular income taxes on the contributions and the gains, per IRA tax deduction rules, plus a 10% penalty. Brian Walsh, CFP® at SoFi specifies, “When you make contributions to a traditional retirement account, that money is going to grow without paying any taxes. But when you take that money out—say 30 or 40 years from now—you’re going to pay taxes on all of the money you take out.”

RMDs on a Traditional IRA

The rules for withdrawing from an IRA mean that required minimum distributions kick in the year you turn 73. After that, you have to take distributions each year, based on your life expectancy. If you don’t take the RMD, you’ll owe a 50% penalty on the amount that you did not withdraw.

When Can You Withdraw from an IRA Without Penalties?

You can make withdrawals from an IRA once you reach age 59 ½ without penalties.

In addition, there are other situations in which you may be able to make withdrawals without having to pay a penalty. These include having medical expenses that aren’t covered by health insurance (as long as you meet certain qualifications), having a permanent disability that means you can no longer work, and paying for qualified education expenses for a child, spouse, or yourself.

Read more about these and other penalty-free exceptions below.

9 Exceptions to the 10% Early-Withdrawal Penalty on IRAs

Whether you’re withdrawing from a Roth within the first five years or you want to take money out of a traditional IRA before you turn 59 ½, there are some instances where you don’t have to pay the 10% penalty on your IRA withdrawals.

1. Medical Expenses

You can avoid the early withdrawal penalty if you use the funds to pay for unreimbursed medical expenses that total more than 7.5% of your adjusted gross income (AGI).

2. Health Insurance

If you’re unemployed for at least 12 weeks, IRA withdrawal rules allow you to use funds from an IRA penalty-free to pay health insurance premiums for yourself, your spouse, or your dependents.

3. Disability

If you’re permanently disabled and can no longer work, you can withdraw IRA funds without penalty. In this case, your plan administrator may require you to provide proof of the disability before signing off on a penalty-free withdrawal.

4. Higher Education

IRA withdrawal rules allow you to use IRA funds to pay for qualified education expenses, such as tuition and books for yourself, your spouse, or your child without penalty.

5. Inherited IRAs

IRA withdrawal rules state that you don’t have to pay the 10% penalty on withdrawals from an IRA, unless you’re the sole beneficiary of a spouse’s account and roll it into your own, non-inherited IRA. In that case, the IRS treats the IRA as if it were yours from the start, meaning that early withdrawal penalties apply.

Recommended: Inherited IRA Distribution Rules Explained

6. IRS Levy

If you owe taxes to the IRS, the agency may take it directly out of your IRA account. In that case, the IRS will not assess the 10% penalty. If you take the money out of the account yourself, however, to pay taxes, you’d also have to pay the 10% penalty.

7. Active Duty

If you’re a qualified reservist, you can take distributions without owing the 10% penalty. This goes for a military reservist or National Guard member called to active duty for at least 180 days after September 11, 2001.

8. Buying a House

While you can’t take out IRA loans, you can use up to $10,000 from your traditional IRA toward the purchase of your first home — and if you’re purchasing with a spouse, that goes for each of you. The IRS defines first-time homebuyers as someone who hasn’t owned a principal residence in the last two years. You can also withdraw money to help with a first home purchase for a child or your spouse’s child, grandchild, or parent.

In order to qualify for the penalty-free withdrawals, you’ll need to use the money within 120 days of the distribution.

9. Substantially Equal Periodic Payments

Another way to avoid penalties under IRA withdrawal rules, is by starting a series of distributions from your IRA, spread equally over your life expectancy. To make this work, you must take at least one distribution each year and you can’t alter the distribution schedule until five years have passed or you’ve reached age 59 ½, whichever is later.

The amount of the distributions must use an IRS-approved calculation that involves your life expectancy, your account balance, and interest rates.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

Is Early IRA Withdrawal Worth It?

While there may be cases where it makes sense to take an early withdrawal, most advisors agree that it should be a last resort. These are disadvantages and advantages to consider.

Pros of IRA Early Withdrawal

•   If you have a major expense and there are no other options, taking an early withdrawal from an IRA could help you cover the cost.

•   An early withdrawal may help you avoid taking out a loan you would then have to repay with interest.

Cons of IRA Early Withdrawal

•   By taking money out of an IRA account early, you’re robbing your own nest egg not only of the current value of the money but also future years of compound growth.

•   Money taken out of a retirement account now can have a big impact on your financial security in the future when you retire.

•   You may owe taxes and penalties, depending on the specific situation.

Opening an IRA With SoFi

Like 401(k)s, IRAs are powerful, tax-advantaged accounts you can use to save for retirement. However, it is possible to take money out of an IRA if you need it before retirement age. Just remember, even if you’re able to do so without an immediate tax penalty, the withdrawals could leave you with less money for retirement 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).

Easily manage your retirement savings with a SoFi IRA.

FAQ

Can you withdraw money from a Roth IRA without penalty?

You can withdraw your own contributions to a Roth IRA without penalty no matter what your age. However, you cannot withdraw the earnings on your contributions before age 59 ½, or before the account has been open for at least five years, without incurring a penalty.

What are the rules for withdrawing from a Roth IRA?

You can withdraw your own contributions to a Roth IRA at any time penalty-free. But to avoid taxes and penalties on your earnings, withdrawals from a Roth IRA must be taken after age 59 ½ and once the account has been open for at least five years.

However, there are a number of exceptions in which you typically don’t have to pay a penalty for an early withdrawal, including: some medical expenses that aren’t covered by health insurance, being permanently disabled and unable to work, or if you’re on qualified active military duty.

What are the 5 year rules for Roth IRA withdrawal?

Under the 5-year rule, if you make a withdrawal from a Roth IRA that’s been open for less than five years, you’ll owe a 10% penalty on the account’s earnings. If your Roth IRA was inherited, the 5-year rule applies to the age of the account. So if you inherited the Roth IRA from a parent, for instance, and they opened the account more than five years ago, you can withdraw the funds penalty-free. If the account has been opened for less than five years, however, you’ll owe taxes on the gains.

Photo credit: iStock/Fly View Productions

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.

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.

SOIN0723096

Read more
Nov
22
2023

What Is the Average Rate of Return on a 401(k)?

By | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off on What Is the Average Rate of Return on a 401(k)?

The average rate of return on 401(k)s is typically between 5% and 8%, depending on specific market conditions in a given year. Keep in mind that returns will vary depending on the individual investor’s portfolio, and that those numbers are a general benchmark.

While not everyone has access to a 401(k) plan, those who do may wonder if it’s an effective investment vehicle that can help them reach their goals. The answer is, generally, yes, but there are a lot of things to take into consideration. There are also alternatives out there, too.

Key Points

•   The average rate of return on 401(k)s is typically between 5% and 8%, depending on market conditions and individual portfolios.

•   401(k) plans offer benefits such as potential employer matches, tax advantages, and federal protections under ERISA.

•   Fees, vesting schedules, and early withdrawal penalties are important considerations for 401(k) investors.

•   401(k) plans offer limited investment options, typically focused on stocks, bonds, and mutual funds.

•   Asset allocation and individual risk tolerance play a significant role in determining 401(k) returns and investment strategies.

Some 401(k) Basics

To understand what a 401(k) has to offer, it helps to know exactly what it is. The IRS defines a 401(k) as “a feature of a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts.”

In other words, employees can choose to delegate a portion of their pay to an investment account set up through their employer. Because participants put the money from their paychecks into their 401(k) account on a pre-tax basis, those contributions reduce their annual taxable income.

Taxes on the contributions and their growth in a 401(k) account are deferred until the money is withdrawn (unless it’s an after-tax Roth 401(k)).

A 401(k) is a “defined-contribution” plan, which means the participant’s balance is determined by regular contributions made to the plan and by the performance of the investments the participant chooses.

This is different from a “defined-benefit” plan, or pension. A defined-benefit plan guarantees the employee a defined monthly income in retirement, putting any investment risk on the plan provider rather than the employee.

Benefits of a 401(k)

There are a lot of benefits that come with a 401(k) account, and some good reasons to consider using one to save for retirement.

Potential Employer Match

Employers aren’t required to make contributions to employee 401(k) plans, but many do. Typically, an employer might offer to match a certain percentage of an employee’s contributions.

Tax Advantages

As mentioned, most 401(k)s are tax-deferred. This means that the full amount of the contributions can be invested until you’re ready to withdraw funds. And you may be in a lower tax bracket when you do start withdrawing and have to pay taxes on your withdrawals.

Federal Protections

One of the less-talked about benefits of 401(k) plans is that they’re protected by federal law. The Employee Retirement Security Act of 1974 (ERISA) sets minimum standards for any employers that set up retirement plans and for the administrators who manage them.

Those protections include a claims and appeals process to make sure employees get the benefits they have coming. Those include the right to sue for benefits and breaches of fiduciary duty if the plan is mismanaged, that certain benefits are paid if the participant becomes unemployed, and that plan features and funding are properly disclosed. ERISA-qualified accounts are also protected from creditors.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

Get a 1% IRA match on rollovers and contributions.

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

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.

401(k) Fees, Vesting, and Penalties

There can be some downsides for some 401(k) investors as well. It’s a good idea to be aware of them before you decide whether to open an account.

Fees

The typical 401(k) plan charges a fee of around 1% of assets under management. That means an investor who has $100,000 in a 401(k) could pay $1,000 or more. And as that participant’s savings grow over the years, the fees could add up to thousands of dollars.

Fees eat into your returns and make saving harder — and there are companies that don’t charge management fees on their investment accounts. If you’re unsure about what you’re paying, you should be able to find out from your plan provider or your employer’s HR department, or you can do your own research on various 401(k) plans.

Vesting

Although any contributions you make belong to you 100% from the get-go, that may not be true for your employer’s contributions. In some cases, a vesting schedule may dictate the degree of ownership you have of the money your employer puts in your account.

Early Withdrawal Penalties

Don’t forget, when you start withdrawing retirement funds, some of the money in your tax-deferred retirement account will finally go toward taxes. That means it’s in Uncle Sam’s interest to keep your 401(k) savings growing.

So, if you decide to take money out of a 401(k) account before age 59 ½, in addition to any other taxes due when there’s a withdrawal, you’ll usually have to pay a 10% penalty. (Although there are some exceptions.) And at age 73, you’re required to take minimum distributions from your tax-deferred retirement accounts.

Potentially Limited Investment Options

One more thing to consider when you think about signing up for a 401(k) is what kind of investing you’d like to do. Employers are required to offer at least three basic options: a stock investment option, a bond option, and cash or stable value option. Many offer more than that minimum, but they stick mostly to mutual funds. That’s meant to streamline the decision-making. But if you’re looking to diversify outside the basic asset classes, it can be limiting.

How Do 401(k) Returns Hold Up?

Life might be easier if we could know the average rate of return to expect from a 401(k). But the unsatisfying answer is that it depends.

Several factors contribute to overall performance, including the investments your particular plan offers you to choose from and the individual portfolio you create. And of course, it also depends on what the market is doing from day to day and year to year.

Despite the many variables, you may often hear an annual return that ranges from 5% to 8% cited as what you can expect. But that doesn’t mean an investor will always be in that range. Sometimes you may have double-digit returns. Sometimes your return might drop down to negative numbers.

Issues With Looking Up Average Returns As a Metric

It’s good to keep in mind, too, that looking up average returns can create some issues. Specifically, averages don’t often tell the whole story, and can skew a data set. For instance, if a billionaire walks into a diner with five other people, on average, every single person in the diner would probably be a multi-millionaire — though that wouldn’t necessarily be true.

It can be a good idea to do some reading about averages and medians, and try to determine whether aiming for an average return is feasible or realistic in a given circumstance.

Some Common Approaches to 401(k) Investing

There are many different ways to manage your 401(k) account, and none of them comes with a guaranteed return. But here are a few popular strategies.

60/40 Asset Allocation

One technique sometimes used to try to maintain balance in a portfolio as the market fluctuates is a basic 60/40 mix. That means the account allocates 60% to equities (stocks) and 40% to bonds. The intention is to minimize risk while generating a consistent rate of return over time — even when the market is experiencing periods of volatility.

Target-Date Funds

As a retirement plan participant, you can figure out your preferred mix of investments on your own, with the help of a financial advisor, or by opting for a target-date fund — a mutual fund that bases asset allocations on when you expect to retire.

A 2050 target-date fund will likely be more aggressive. It might have more stocks than bonds, and it will typically have a higher rate of return. A 2025 target-date fund will lean more toward safety. It will likely be designed to protect an investor who’s nearer to retirement, so it might be invested mostly in bonds. (Again, the actual returns an investor will see may be affected by the whims of the market.)

Most 401(k) plans offer target-date funds, and they make investing easy for hands-off investors. But if that’s not what you’re looking for, and your 401(k) plan makes an advisor available to you, you may be able to get more specific advice. Or, if you want more help, you could hire a financial professional to work with you on your overall plan as it relates to your long- and short-term goals.

Multiple Retirement Accounts

Another possibility might be to go with the basic choices in your workplace 401(k), but also open a separate investing account with which you could take a more hands-on approach. You could try a traditional IRA if you’re still looking for tax advantages, a Roth IRA (read more about what Roth IRAs are) if you want to limit your tax burden in retirement, or an account that lets you invest in what you love, one stock at a time.

There are some important things to know, though, before deciding between a 401(k) vs. an IRA.


💡 Quick Tip: Can you save for retirement with an automated investment portfolio? Yes. In fact, automated portfolios, or robo advisors, can be used within taxable accounts as well as tax-advantaged retirement accounts.

How Asset Allocation Can Make a Difference

How an investor allocates their resources can make a difference in terms of their ultimate returns. Generally speaking, riskier investments tend to have higher potential returns — and higher potential losses. Stocks also tend to be riskier investments than bonds, so if an investor were to construct a portfolio that’s stock-heavy relative to bonds, they’d probably have a better chance of seeing bigger returns.

But also, a bigger chance of seeing a negative return.

With that in mind, it’s going to come down to an investor’s individual appetite for risk, and how much time they have to reach their financial goals. While there are seemingly infinite ways to allocate your investments, the chart below offers a very simple look at how asset allocation associates with risks and returns.

Asset Allocations and Associated Risk/Return
Asset Allocation

 Risk/Return
75% Stock-25% Bonds Higher risk, higher potential returns
50% Stock-50% Bonds Medium risk, variable potential returns
25% Stock-75% Bonds Lower risk, lower potential returns

Ways to Make the Most of Investment Options

It’s up to you to manage your employer-sponsored 401(k) in a way that makes good use of the options available. Here are some pointers.

Understand the Match

One way to start is by familiarizing yourself with the rules on how to maximize the company match. Is it a dollar-for-dollar match up to a certain percentage of your salary, a 50% match, or some other calculation? It also helps to know the policy regarding vesting and what happens to those matching contributions if you leave your job before you’re fully vested.

Consider Your Investments

With or without help, taking a little time to assess the investments in your plan could boost your bottom line. It may also allow you to tailor your portfolio to better accomplish your financial goals. Checking past returns can provide some information when choosing investments and strategies, but looking to the future also can be useful.

Plan for Your Whole Life

If you have a career plan (will you stay with this employer for years or be out the door in two?) and/or a personal plan (do you want to buy a house, have kids, start your own business?), factor those into your investment plans. Doing so may help you decide how much to invest and where to invest it.

Find Your Lost 401(k)s

Have you lost track of the 401(k) plans or accounts you left behind at past employers? It may make sense to roll them into your current employer’s plan, or to roll them into an IRA separate from your workplace account. You might also want to review and update your portfolio mix, and you might be able to eliminate some fees.

Know the Maximum Contributions for Retirement Accounts

Keep in mind that there are different contribution limits for 401(k)s and IRAs. For those under age 50, the 2023 contribution limit is $22,500 for 401(k)s and $6,500 for IRAs. For those 50 or older, the 2023 contribution limit is $30,000 for 401(k)s and $7,500 for IRAs. Other rules and restrictions may also apply.

Learn How to Calculate Your 401(k) Rate of Return

This information can be useful as you assess your retirement saving strategy, and the math isn’t too difficult.

For this calculation, you’ll need to figure out your total contributions and your total gains for a specific period of time (let’s say a calendar year).

You can find your contributions on your 401(k) statements or your pay stubs. Add up the total for the year.

Your gains may be listed on your 401(k) statements as well. If not, you can take the ending balance of your account for the year and subtract the total of your contributions and the account balance at the beginning of the year. That will give you your total gains.

Once you have those factors, divide your gains by your ending balance and multiply by 100 to get your rate of return.

Here’s an example. Let’s say you have a beginning balance of $10,000. Your total contributions for the year are $6,000. Your ending balance is $17,600. So your gains equal $1,600. To get your rate of return, the calculation is:

(Gains / ending balance) X 100 =

($1,600 / $17,600) X 100 = 9%

Savings Potential From a 401(k) Potential by Age

It can be difficult to really get a feel for how your 401(k) savings or investments can grow over time, but using some of the math above, and assuming that you keep making contributions over the years, you’ll very likely end up with a sizable nest egg when you reach retirement age.

This all depends, of course, on when you start, and how the markets trend in the subsequent years. But for an example, we can make some assumptions to see how this might play out. For simplicity’s sake, assume that you start contributing to a 401(k) at age 20, with plans to start taking distributions at age 70. You also contribute $10,000 per year (with no employer match, and no inflation), at an average return of 5% per year.

Here’s how that might look over time:

401(k) Savings Over Time
Age

 401(k) Balance
20 $10,000
30 $128,923
40 $338,926
50 $680,998
60 $1,238,198
70 $2,145,817

Using time and investment returns to supercharge your savings, you could end up with more than $2 million through dutiful saving and investing in your 401(k). Again, there are no guarantees, and the chart above makes a lot of oversimplified assumptions, but this should give you an idea of how things can add up.

Alternatives to 401(k) Plans

While 401(k) plans can be powerful financial tools, not everyone has access to them. Or, they may be looking for alternatives for whatever reason. Here are some options.

Roth IRA

Roth IRAs are IRAs that allow for the contribution of after-tax dollars. Accordingly, the money contained within can then be withdrawn tax-free during retirement. They differ from traditional IRAs in a few key ways, the biggest and most notable of which being that traditional IRAs are tax-deferred accounts (contributions are made pre-tax).

Learn more about what IRAs are, and what they are not.

Traditional IRA

As discussed, a traditional IRA is a tax-deferred retirement account. Contributions are made using pre-tax funds, so investors pay taxes on distributions once they retire.

HSA

HSAs, or health savings accounts, are another vehicle that can be used to save or invest money. HSAs have triple tax benefits, in that account holders can contribute pre-tax dollars to them, allow that money to grow tax-free, and then use the holdings on qualified medical expenses — also tax-free.

Retirement Investment

Typical returns on 401(k)s may vary, but looking for an average of between 5% and 8% would likely be a good target range. Of course, that doesn’t mean that there won’t be up or down years, and averages, themselves, can be a bit misleading.

While your annual return on your 401(k) may vary, the good news is that, as an investor, you have options about how you save for the future. The choices you make can be as aggressive or as conservative as you want, as you choose the investment mix that best suits your timeline and financial goals.

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

What is the typical 401(k) return over 20 years?

The typical return for 401(k)s over 20 years is between 5% and 8%, assuming a portfolio sticks to an asset mix of roughly 60% stocks and 40% bonds. There’s also no guarantee that returns will fall within that range.

What is the typical 401(k) return over 10 years?

Again, the average rate of return for 401(k)s tends to land between 5% and 8%, with some years providing higher returns, and some years providing lower, or even negative returns.

What was the typical 401(k) return for 2022?

The average 401(k) lost roughly 20% of its value during 2022, as increasing interest rates and shifting economic conditions over the course of the year (largely due to increasing inflation) caused the economy to sputter.

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.

SOIN0123020

Read more

CATEGORIES

  • All
  • No categories
Close modal

See what SoFi can do for you and your finances.

Select a product below and get your rate in just minutes.

Student Loan
Refinancing

Personal
Loans

Online
Investments

Other

Terms and conditions apply. SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. To qualify, a borrower must be a U.S. citizen or other eligible status, be residing in the U.S., and meet SoFi's underwriting requirements. Not all borrowers receive the lowest rate. Lowest rates reserved for the most creditworthy borrowers. If approved, your actual rate will be within the range of rates at the time of application and will depend on a variety of factors, including term of loan, evaluation of your creditworthiness, income, and other factors. If SoFi is unable to offer you a loan but matches you for a loan with a participating bank, then your rate may be outside the range of rates listed above. Rates and Terms are subject to change at any time without notice. SoFi Personal Loans can be used for any lawful personal, family, or household purposes and may not be used for post-secondary education expenses. Minimum loan amount is $5,000. The average of SoFi Personal Loans funded in 2023 was around $33K. Information current as of 2/26/24. SoFi Personal Loans originated by SoFi Bank, N.A. Member FDIC. NMLS #696891 (www.nmlsconsumeraccess.org). See SoFi.com/legal for state-specific license details. See SoFi.com/eligibility for details and state restrictions.

✝ To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.

©2024 Social Finance, LLC All rights reserved.
TLS 1.2 Encrypted
Equal Housing Lender