Retirement Options For the Self-Employed

Being your own boss is great. You get flexibility and the ability to pursue the things you care about. But as the boss, you also have to deal with all the administrative and financial details an employer might typically take care of—like choosing the right retirement plan.

Though it may require a little more action on your part, there are different kinds of self-employed retirement plans to explore. In fact, some self-employed retirement plans actually have high contribution limits and tax benefits.

And it’s a good thing too, since more people than ever are self-employed or starting their own businesses. According to Fresh Books third annual self-employment report annual self-employment report, 27 million Americans are expected to leave the traditional workforce for self-employment in the next two years.

So what does retirement for self-employed people look like? Well, a little like retirement for the traditionally employed. The general rules of thumb still apply: You can calculate how much you’ll need to save for retirement based on your current age and when you plan to retire.

No matter what your age, it’s a good idea to do the math now, so you can hypothetically see how much money you could be contributing to your retirement and whether you’re on track for your age and retirement goals.

Self-Employed Retirement Plans

In some ways, self-employed retirement plans aren’t too different from regular retirement plans. Certainly, the principles of retirement are the same: set aside money now to use in retirement—ideally providing an income when it’s time to retire.

The most common retirement savings plan, though, is a 401(k), but a 401(k) is, by definition, an employer-sponsored retirement account. For those who are self-employed that’s not an option.

The IRS breaks down a number of retirement plans for the self-employed or for those who run their own businesses, but we’ll lay out the basics here for you to start thinking about.

Traditional or Roth IRA

One of the most popular self-employed retirement plans is an IRA—or an individual retirement account. Anyone can open an IRA either with an online brokerage firm or at a traditional financial institution. And if you’re leaving a regular job where you had an employer-sponsored 401(k), then you can roll it over into an IRA.

If you meet eligibility requirements, you can contribute up to $6,000 annually to an IRA, with an additional $1,000 catch-up contribution allowed for people over 50 years old. (These limits are for 2021—the IRS does adjust them from time to time.)

The main difference between a traditional vs. Roth IRA is when the taxes are paid. In a traditional IRA, the contributions you make to your retirement account are tax-deductible when you make them, and the withdrawals during retirement are taxed at ordinary income rates. With a Roth IRA, there are no tax breaks for your contributions, but you’re not taxed when you withdraw.

Choosing which IRA makes sense for you can depend on a few factors, including what you’re earning now vs. what you expect to be earning when you retire. Additionally, you can only contribute to a Roth IRA if your income is below a certain limit : For 2021, that’s less than $208,000 adjusted gross income (AGI) for a person who is married filing jointly, and less than $140,000 for a person who is filing as single.

Solo 401(k)

A solo 401(k) is a self-employed retirement plan that the IRS also refers to as one-participant 401(k) plans . It works a bit like a regular employer-backed 401(k), except that in this instance you’re the employer and the employee.

For 2021, you can contribute $19,500 (or $26,000 if age 50 or over) in salary deferrals as you would normally contribute to a standard 401(k). Then, as the “employer”, you can also contribute up to 25% of your net earnings, with additional rules for single-member LLCs or sole proprietors. Total contributions cannot exceed a total of $58,000.

From there, it works more or less like a regular 401(k): the contributions are made pre-tax and any withdrawals or distributions after age 59.5 are taxed at the regular rate. You can also set up the plan to allow for potential hardship distributions under specific circumstances, like a medical emergency.

You can not use a solo 401(k) if you have any employees, though you can hire your spouse so they can also contribute to the plan (as an employee; you can match their contributions as the employer). 401(k) contribution limits are per person, not per plan, so if either you or your spouse are enrolled in another 401(k) plan, then the $58,000 limit per person would include contributions to that other 401(k) plan.

A solo 401(k) makes the most sense if you have a highly profitable business and want to save a lot for retirement, or if you want to save a lot some years and less others. You can set up a solo 401(k) with most wealth management firms.

Simplified Employee Pension (or a SEP IRA)

A SEP IRA is an IRA with a simplified and streamlined way for an employer (in this case, you) to make contributions to their employees’ and to their own retirement.

For 2021, the SEP IRA rules and limits are as follows: you can contribute up to $58,000 or 25% of your net earnings, whichever is less. As is the case with a number of these retirement for self-employed options, there is a cap of $290,000 on the compensation that can be used to calculate that cap. You can deduct your contributions from your taxes, and your withdrawals in retirement will be taxed as income.

A key difference in a SEP vs. other self-employment retirement plans is this is designed for those who run a business with employees. You have to contribute an equal percentage of salary for every employee (and you are counted as an employee). That means you can not contribute more to your retirement account than to your employees’ accounts, as a percentage not in absolute dollars. On the plus side, it’s slightly simpler than a solo 401(k) to manage in terms of paperwork and annual reporting.

SIMPLE IRA

A SIMPLE IRA (which stands for Savings Incentive Match Plan for Employees ) is like a SEP IRA except it’s designed for larger businesses. Unlike the SEP plan, the employer isn’t responsible for the whole amount of an employee’s contribution. Individual employees can also contribute to their own retirement as salary deferrals out of their paycheck.

You, as the employer, have to simply match contributions up to 3% or contribute a fixed 2%. This sounds complicated, but the point is it’s designed for larger companies, so that you can manage the contributions to your employees’ retirement plans as well as your own. The trade-off, however, is that the maximum contribution limit is lower.

You can contribute up to $13,500 to your SIMPLE IRA, plus a catch-up contribution of $3,000 if you’re 50 or over. And your total contributions, if you have another retirement employer plan, maxes out at $19,500 annually.

There are a few other restrictions: If you make an early withdrawal before the age of 59 ½ , you’ll likely incur a 10% penalty much like a regular 401(k); do so within the first two years of setting up the SIMPLE account and the penalty jumps to 25%. (There is also a SIMPLE 401(k) that does allow for loan withdrawals, but requires more set-up administrative oversight on the front end.)

Defined Benefit Retirement Plan

Another retirement option you’ve probably heard a lot about is the defined benefit plan, or pension plan. Typically, a defined benefit plan pays out set annual benefits upon retirement, usually based on salary and years of service.

For the self-employed, your defined benefit has to be calculated by an actuary based on the benefit you set, your age, and expected returns. The maximum annual benefit you can set is currently the lesser of $230,000 or 100% of the participant’s average compensation for his or her highest three consecutive calendar years, according to the IRS.
Contributions are tax-deductible and your withdrawals during retirement will be taxed as income. And, if you have employees, then you typically must also offer the plan to them.

Defined benefit plans guarantee you a steady stream of income in retirement and with no set maximum contribution limit, if you’re earning a lot (and expect to keep earning a lot through retirement), they may be a good way to save up money.

These self-employed retirement plans can, however, be complicated and expensive to set up and require ongoing annual administrative work. Not every financial institution even offers defined benefit plans as an option for an individual. You’ll also have to be committed to funding the plan to a certain level each year in order to achieve that defined benefit—and if you have to change or lower the benefit, there may also be fees.

Other Retirement Options for the Self-Employed

While these are the most common self-employed retirement account options and the ones that offer tax benefits for your retirement savings, there are other options self-employed individuals might consider, like a profit-sharing plan if you own your own business.

Plus, don’t forget: You also have Social Security funds in retirement. Full retirement age for Social Security is considered 67 years old.

The IRS does offer what it calls annual check-ups to check on your retirement account and to go through a checklist of potential issues or fixes. However, you may want some additional human guidance, especially if you have specific questions.

The Takeaway

When you’re an entrepreneur or self-employed it can feel like your options are limited in terms of retirement plans, but in fact there are a number of options open, including various IRAs and a solo 401(k).

Looking to open a new retirement account? SoFi Invest® offers traditional, Roth, and SEP IRAs. Plus, you’ll get access to a broad range of investment options, member services, and our robust suite of planning and investment tools.

Find out how to save for retirement with SoFi Invest.

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).

2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.

3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.

For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.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. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
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.
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.
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Pros & Cons of Using Retirement Funds to Pay for College

In a perfect world, all parents would have a 529 plan—or another education savings account—full of funds to cover their children’s college years. But there are many reasons why that may not be the case for you. If so, you’re likely looking into other options to pay for college.

One possibility you may be considering is dipping into your retirement funds. Depending on the type of retirement account you have, you might be able to take an early withdrawal or a loan from your retirement account, which you could use to fund your child’s education.

But using your retirement funds to pay for college isn’t always the best move. Before you decide to do it, you may want to consider both the benefits and the drawbacks, as well as some potentially less costly alternatives.

Before we jump in, it’s important that you’re aware that this article is a basic, high-level overview of some potential options when it comes to using retirement funds to pay for college. Further, because these topics (taxes and investments) are complicated, none of what’s written here should be taken as tax advice or investment guidance. Always talk to qualified tax and investment professionals with questions about your retirement accounts, and never rely on blog posts (like this one) to make important financial decisions.

A Few Pros of Using Retirement Funds to Pay for College

If you already have the money saved up, there can be some upsides to taking money out of your retirement funds so that your child won’t need to take out student loans.

You May Be Able to Avoid an Early Withdrawal Penalty

If you have an individual retirement account (IRA), taking an early withdrawal typically results in income taxes on the withdrawal amount plus a 10% penalty. However, if you withdraw funds for qualified higher education expenses, the 10% penalty is waived .

That said, the withdrawn funds will still be considered taxable as income. Also, this tax break does not apply to 401(k) accounts. But if you roll over your 401(k) into an IRA, then you would be able to withdraw the funds from the IRA and avoid the penalty.

You May Be Able to Avoid Taxes Altogether

If you have a Roth IRA, you can withdraw up to the amount you’ve contributed to the account over the years without any tax consequences at all.

You’re Paying Interest to Yourself With a 401(k) Loan

In addition to allowing you to take early withdrawals, some 401(k) plans also let you borrow from the amount you’ve already saved and earned over the years.

If you borrow from a 401(k) account, that money won’t be subject to taxes the way an early withdrawal would. Also, when you’re paying that loan back, the money you pay in interest goes back into your 401(k) account rather than to a lender.

A Few Drawbacks of Using Retirement Funds to Pay for College

Before you raid your retirement to pay for your child’s college tuition, here are some potentially negative aspects to consider.

There May Be Negative Tax Consequences

Even if you manage to avoid being charged a 10% early withdrawal penalty on your retirement account, some or all of the money you withdraw from a retirement account may be considered taxable income. Depending on how much it is, you could face a larger-than-usual tax bill when you file your tax return for the year.

401(k) Loan Repayment Can Be Affected by Your Job Status

If you take out a large loan from your 401(k), then leave your job, you may be required to pay the loan in full right then, regardless of your original repayment term. If you can’t repay it, it’ll likely be considered an early withdrawal and be subject to income tax and the 10% penalty.

You May Have to Work Longer

Taking money out of a retirement account lowers your balance. But it also means that the money you’ve withdrawn is no longer working for you.

Due to compound interest, the longer you have money invested, the more time it has to grow. But even if you replace the money you’ve taken out over time, the total growth may not be as much as if you’d left the money where it was all along.

Alternatives to Using Retirement Funds to Pay for College

Can you use retirement funds to pay for college? If you have the funds, it’s generally an option. But before you go ahead, consider these alternatives.

Scholarships and Grants

One of the best ways to pay for a college education is with scholarships and grants, since you typically don’t have to pay them back.

Check first with the school that your child is planning to attend (or is already attending) to see what types of scholarships and grants are available.

Than make sure your child fills out the Free Application for Federal Student Aid (FAFSA®). The information provided in the FAFSA will help determine his or her federal aid package, which typically includes grants, federal student loans, and/or work-study.

Finally, you and your child can search millions of scholarships from private organizations on websites like Scholarships.com and Fast Web . While your child may not qualify for all of them, there may be enough relevant options to help reduce that tuition bill.

Federal Student Loans

As mentioned above, filling out the FAFSA will give your child an opportunity to qualify for federal student loans from the U.S. Department of Education.

These loans have low fixed interest rates, plus access to some special benefits, including loan forgiveness programs and income-driven repayment plans.

With most federal student loans, there’s no credit check requirement, so you don’t have to worry about needing to cosign a loan with your child.

Parent PLUS Loans

If you’re concerned about the effect of student loan debt on your child, you can opt to apply for a federal Parent PLUS loan to help cover the costs of college.

Keep in mind that the terms aren’t usually as favorable for Parent PLUS loans as they are for federal loans for undergraduate students. The interest rates are currently higher, and you may be denied if you have certain negative items on your credit history.

Private Student Loans

If your child can’t get federal student loans, is maxed out on loans, or has pursued all other options to no avail, private student loans may be worth considering to make up the difference.

To qualify for private student loans, however, you and/or your child may need to undergo a credit check. If your child is new to credit, you may need to cosign to help them get approved by being a cosigner—or you can apply on your own.

Private student loans don’t typically offer income-driven repayment plans or loan forgiveness programs, but if your credit and finances are strong, it may be possible to get a competitive interest rate.

Balance Your Child’s Needs and Your Own

Using retirement funds to pay for college is one way to help your child. But you probably don’t want to risk your future financial security. Take the time to help your child consider all of the options to get the money to pay for school.

If you do decide a private student loan is the right fit, SoFi is happy to help. In the spirit of complete transparency, we want you to know that we believe you should exhaust all of your federal grant and loan options before you consider SoFi as your private loan lender. That said, we do offer flexible payment options and terms, and don’t worry, there are no hidden fees.

If you’re considering a private student loan, you can find your SoFi rate today.


SoFi Private Student Loans
Please borrow responsibly. SoFi Private Student Loans are not a substitute for federal loans, grants, and work-study programs. You should exhaust all your federal student aid options before you consider any private loans, including ours. Read our FAQs.
SoFi Private Student Loans are subject to program terms and restrictions, and applicants must meet SoFi’s eligibility and underwriting requirements. See SoFi.com/eligibility for more information. To view payment examples, click here. SoFi reserves the right to modify eligibility criteria at any time. This information is subject to change.

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.
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SoFi loans are originated by SoFi Lending Corp (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license # 6054612; NMLS # 1121636 . For additional product-specific legal and licensing information, see SoFi.com/legal.

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Comparing the SIMPLE IRA vs. Traditional IRA

One of the most popular retirement accounts is an IRA, or Individual Retirement Account. IRAs allow individuals to put money aside over time to save up for retirement, with tax benefits similar to that of other retirement plans.

Two common IRAs are the SIMPLE IRA and the traditional IRA, both of which have their own benefits, downsides, and rules around who can open an account. For investors trying to decide which IRA to open, it helps to know the differences between SIMPLE IRAs and traditional IRAs.

SIMPLE IRA vs Traditional IRA: Side-by-Side Comparison

Although there are many similarities between the two accounts, there are some key differences. This chart details the key attributes of each plan.

SIMPLE IRA Traditional IRA
Offered by employers Yes No
Who it’s for Small-business owners and their employees Individuals
Eligibility Earn at least $5,000 per year Under 70 ½ years old and earned income in the past year
Tax deferred Yes Yes
Tax deductible contributions Yes, for employers and sole proprietors only Yes
Employer contribution Required No
Fee for early withdrawal 10% plus income tax
25% if money is withdrawn within two years of an employer making a deposit
10% plus income tax
Contribution limits $13,500 per year
10% plus income tax
$6,000 per year
10% plus income tax
Catch-up contribution $3,000 additional per year for people under 50
10% plus income tax
$$1,000 additional per year for people under 50

What is a SIMPLE IRA?

The SIMPLE IRA, which stands for Savings Incentive Match Plan for Employees, is set up to help small-business owners help both themselves and their employees save for retirement. It’s a retirement plan that small businesses with fewer than 100 employees can offer employees who earn at least $5,000 per year.

A SIMPLE IRA is similar to a traditional IRA, in that a plan participant can make tax-deferred contributions to their account, so that it grows over time with compound interest. When the individual retires and begins withdrawing money, then they must pay income taxes on the funds.

With a SIMPLE IRA, both the employer and the employee contribute to the employee’s account. Employers are required to contribute in one of two ways: either by matching employee contributions between 1% and 3% of their salary, or to contribute a flat rate of 2% of the employee’s salary—even if the employee doesn’t contribute. With the matching option, the employee must contribute money first.

There are yearly employee contribution limits to a SIMPLE IRA; in 2021 the annual limit is $13,500, with an additional $3,000 in catch-up contributions for people over age 50.

Pros and Cons of SIMPLE IRA

It’s important to understand both the benefits and downsides of the SIMPLE IRA in order to make an informed decision about retirement plans.

SIMPLE IRA Pros

There are several benefits—to both employers and employees—to choosing a SIMPLE IRA, including:

•  For employers, it’s easy for employers to set up and manage, including online set-up through most banks.
•  For employers, management costs are low compared to other retirement plans.
•  For employees, taxes on contributions are deferred until the money is withdrawn.
•  Employers can take tax deductions on contributions. Sole proprietors can deduct both salary and matching contributions.
•  For employees, there is an allowable catch-up contribution for those over 50.
•  For employers, the IRA plan providers send tax information to the IRS, so there is no need to do any reporting.
•  Employers and employees can choose how the money in the account gets invested based on what the plan offers. Options may include mutual funds aimed towards growth or income, international mutual funds, or other assets.

SIMPLE IRA Cons

Although there are multiple benefits to a SIMPLE IRA, there are some downsides as well, such as:

•  Employers must follow strict rules set by the IRS.
•  Other employer-sponsored retirement accounts have higher limits, such as the 401(k), which allows for $19,500 per year. (Check out our IRA calculator to see what you can contribute to each type of IRA.)
•  If account holders withdraw money before they reach age 59 ½ they must pay a 10% fee and income taxes on the withdrawal.
•  There is no option for a Roth contribution to a SIMPLE IRA, which would allow account holders to contribute post-tax money and avoid paying taxes later.

What is a Traditional IRA?

The traditional IRA is set up by an individual to contribute to their own retirement. Employers are not involved in traditional IRAs in any way. The main requirements to open an IRA are that the account holder must have earned some income within the past year and they must be younger than 70 ½ years old at the end of the year.

Pros and Cons of Traditional IRA

When it comes to benefits and downsides, there’s not too much difference between traditional vs SIMPLE IRAs—though there are a few that are unique to this type of plan.

Traditional IRA Pros

•  It allows for catch-up contributions for those over age 50.
•  One can choose how the money in the account gets invested based on what the plan offers. Options may include mutual funds aimed towards growth or income, international mutual funds, or other assets.
•  Contributions are tax-deferred, so taxes aren’t paid until funds are withdrawn.

Traditional IRA Cons

•  Much lower contribution limits than a 401(k) or a SIMPLE IRA, at $6,000 per year.
•  Penalties for early withdrawal are also the same: withdraw money before age 59 ½ and pay a 10% fee plus income taxes on the withdrawal.

Can I Have Both a SIMPLE IRA and a Traditional IRA?

Yes, it is possible for an individual to have both a SIMPLE IRA through their employer and also a traditional IRA on their own—though they may not be able to deduct all of their traditional IRA contributions. The IRS sets a cap on deductions per calendar year.

Single people with an AGI (adjusted gross income) of more than $66,000 are restricted to a partial deduction; those with AGI above $76,000 may not take a deduction at all. Married couples filing jointly with an AGI of $105,000 to $125,000 may take a partial deduction; those with AGI above $125,000 may not take a deduction at all.

The Takeaway

The SIMPLE IRA and traditional IRA are both individual retirement accounts, but the SIMPLE is set up through one’s employer—typically a small business of 100 people or less—while the traditional IRA is set up by an individual.

There are many similarities in attributes of the plans, though some major distinctions is that the SIMPLE IRA requires employer contributions (though not necessarily employee contributions) and allows for a higher amount of employee contributions per year.

Understanding the differences between retirement accounts like the SIMPLE and traditional IRA is one more step in creating a personalized retirement plan that works for you and your goals. If you’re looking to start saving for retirement now, or add to your investments for the future, SoFi Invest® online retirement accounts offers both traditional and Roth IRAs that are simple to set up and manage.

Find out how to further your retirement savings goals with SoFi Invest.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).

2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.

3) Digital Assets—The Digital Assets platform is owned by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.

For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, http://www.sofi.com/legal.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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Is a Backdoor Roth IRA Right for You?

A Roth IRA is an individual retirement account that may provide investors with a tax-free income once they reach retirement. With a Roth IRA, investors save after-tax dollars, and their money grows tax-free. Roth IRAs also provide additional flexibility for withdrawals—once the account has been open for five years, contributions can be withdrawn at any time, for any reason.

But there’s a catch: Investors can only contribute to a Roth IRA if their income falls below a specific limit. If your contribution is for 2020, that maximum is $124,000 for a single person or $196,000 for a married couple filing jointly (based on modified adjusted gross income). Though, if you make slightly more than that, you may qualify to contribute a reduced amount.

Related: What Is a Roth IRA?

Want to contribute to a Roth IRA, but have an income that exceeds the limits? Good news: There’s another option. It’s called a backdoor Roth IRA.

What is a Backdoor Roth IRA?

If you aren’t eligible to contribute to a Roth IRA outright because you make too much, you can do so through what’s called a “backdoor Roth.” This process involves converting funds in a Traditional IRA into a Roth IRA.

The government allows you to do this as long as investors pay income taxes on any contributions deducted on taxes (and any profits made) when the investor converted the account. Unlike a standard Roth IRA, there is no income limit for doing the conversion, nor is there a ceiling to how much can be converted.

Related: Traditional Roth vs. Roth IRA: How to Choose the Right Plan

Is a Backdoor Roth Worth Doing?

It depends. Use SoFi’s IRA Contribution Calculator to make an informed decision.

High earners who don’t qualify to contribute under current Roth IRA rules may opt for this route. As with a typical Roth IRA, a backdoor Roth may be a good option when an investor expects their taxes to be lower today than in retirement. Investors who hope to avoid required minimum distributions (RMDs) when they reach age 72 might also consider doing a backdoor Roth.

But if someone is eligible to contribute to a Roth IRA, it may not make sense to bother with a backdoor conversion.

Another thing: A conversion can also move people into a higher tax bracket, so investors may consider waiting to do a conversion when their income is lower than usual.

Related: How Much Can You Put in an IRA This Year?

If an investor already has traditional IRAs, it may create a situation where the tax consequences outweigh the benefits. Say an investor has money deducted in any IRA account, including SEP or SIMPLE IRAs, the government will assume a Roth conversion represents a portion of all the balances. For example, if they contributed $5,000 to an IRA that didn’t deduct and another $5,000 to an account that did deduct. If they converted $5,000 to a Roth IRA, the government would consider $2,500 of the conversion taxable.

If an investor plans to use the converted funds within five years, a backdoor Roth may not be the best place to park their cash. That’s because withdrawals before five years are subject to income tax and a 10% penalty.

Related: Roth IRA 5-Year Rule Explained

How to Open a Backdoor Roth IRA

If an investor has no other Traditional IRAs, here’s how to make a backdoor Roth IRA happen with SoFi:

•  Open both a Traditional IRA and a Roth IRA with SoFi Invest®.
•  Make a non-deductible contribution to the Traditional IRA by the tax deadline (April 15, 2021 for tax year 2020). The maximum allowable yearly contribution is $6,000 (or $7,000 if you’re 50 or older).
•  SoFi will send you a form to transfer the money into your Roth IRA. Sign and return it.
•  If you choose an automated investing account, once the funds are in your Roth IRA, SoFi will invest them in the portfolio you’ve chosen.

Related: 3 Easy Steps to Starting A Retirement Fund

If you have any questions or want some help as you go through the process, schedule a complimentary appointment with one of our licensed financial advisors. SoFi Invest is all about empowering you and your financial future, and we’re here to help.

The Takeaway

A backdoor Roth IRA may be worth considering if tax-free income during retirement is part of an investor’s financial plan, and they make too much to contribute directly to a Roth. Roth IRAs are a good option for younger investors at low tax rates and people with a high disposable income looking to reduce tax bills on capital gains in retirement.

Learn more about your retirement account options with SoFi.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).

2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.

3) Digital Assets—The Digital Assets platform is owned by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.

For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, http://www.sofi.com/legal.

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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Source: sofi.com