If you’re on TikTok or Reddit, it’s likely you’ve come across a tenacious rumor: That it’s better to invest in life insurance than a 401(k) for retirement. So, is it true?
Life insurance vs. 401(k)
Life insurance isn’t an investment, while a 401(k) is a type of investment account offered through your employer. Permanent life insurance (which offers lifelong coverage) isn’t an investment, and its exorbitant fees erode the money you pay into your policy and any earnings you might make for the first decade.
“It was very strange to me that there were so many life insurance salespeople all over TikTok, basically soapboxing about life insurance, like it was the next big thing like it was the most amazing investment on Earth,” says Vivian Tu, founder of Your Rich Bff, a TikTok channel that focuses on financial education, based in Miami Beach, Florida.
Can life insurance grow like an investment account?
In some cases, yes. There are some types of life insurance, such as whole life insurance or universal life insurance, that have the ability to increase in cash value. But how do some of those policies earn money like an investment return? By tracking market indexes.
One of the features touted by TikTok influencers is that returns made on insurance policies aren’t affected by the overall stock market, but that isn’t necessarily true. The insurance companies may invest in the stock market with part of their portfolio, which is technically a portion of a policy owner’s premium. Though some policies provide fixed returns, some depend on current interest rates and investments. Some policies have you pick the stock or bond indexes for your policy to mirror, such as the S&P 500, and the insurance company pays you interest based on how those indexes perform.
Life insurance vs. 401(k): Fees
If life insurance can earn stock market interest in a way similar to that of a 401(k), what’s the issue?
The issue is that, depending on the policy, the staggering fees insurance policies charge often wipe out the amount you would get back from those premiums and any investment returns.
For example, if you pay the premium for seven to 10 years, most of those premiums go toward the cost of providing that insurance. In addition, there are administrative fees and the agent’s commission, though you may not see a commission listed on a statement and it may be difficult to figure out exactly how much those commissions are. Those commissions aren’t a one-time payment: You may continue to pay them for seven to 10 years, or as long as the policy is active.
The premiums you pay that cover fees don’t sit in an account waiting for you to cash them in. If you pay into a 401(k) for a decade, you get to keep all that money less any fees and investment losses. With an insurance product, it’s only after a decade (again, depending on your policy) of monthly payments that you actually start accruing premium money and interest in a cash value account the insurance company holds for you.
That interest percentage is less than you can get in a high-yield savings account and far less than the stock market’s long-term average of 10% (not accounting for inflation).
Insurance policies also have significant surrender charges, which are fees you have to pay if you withdraw money from your policy early. These charges are often so large that they can dramatically reduce the net value of your policy until the first few years pass.
For example, if you wanted to take money out of your policy after the first two years, your surrender charge would likely be so high that there would be little to no money to take out. These charges eventually reduce to zero, but it can take 10 to 16 years.
While 401(k)s do charge a 10% penalty if you want to take money out of your account before you’re 59½, that 10% is likely to be far less than a surrender charge. Plus, there are lots of exceptions to the 401(k)’s 10% penalty, including disabilities, the birth of a child, medical expenses and emergency personal expenses.
If you were to invest in the stock market through a 401(k), you wouldn’t lose 10 years’ worth of investment dollars to the cost of insurance, and your management fee would likely be less than 1%.
“The idea that 401(k) fees are higher than an insurance product that would be serving as an investment, I don’t even know how you support that idea,” says Georgia Lee Hussey, a certified financial planner and founder of Modernist Financial, a wealth management firm in Portland, Oregon.
Insurance fees are complex
In addition to paying commissions and exceptionally high fees, you may not even know how much you’re paying because insurance fee structures are so complicated.
“Whole life policies are basically called the black box of insurance policies. You can’t really see what’s happening inside them,” Hussey says. “You can understand the internal expense ratio sometimes but you usually have to go deep into the disclosure documents to understand what the insurance company is really getting paid.”
If you purchase insurance through an agent or broker (or a TikTok influencer), it’s possible that that person will be making a commission, and that’s on you to figure out.
“When you actually look into it, you realize that all of these people are, in fact, life insurance brokers. They don’t even work at life insurance companies that provide the policies,” Tu says. “The vast majority of them are not fiduciaries, so they are not legally obligated to do right by you financially.”
On the topic of using insurance to invest, it’s good to remember two cardinal rules of investing: If it sounds too good to be true, it probably is. And if you can’t explain it clearly to a friend, you probably don’t understand it, which could be a sign to steer clear.
As Tu says: “It’s insurance. It’s not an investment.”
One of the best things you can do for your future self is to save for retirement. Unfortunately, recent research indicates that a significant portion of Americans are falling short in this area. According to a 2023 survey, about 22% of Americans have less than $5,000 in retirement savings.
This highlights the importance of early and consistent financial planning for your post-working years. It’s never too early to start thinking about your financial future, and actively contributing to your retirement savings is essential.
If you’re looking for a way to sock money away for retirement, your 403(b) plan could be just what you need. These retirement plans are offered by employers in the nonprofit sector and some other careers, like public education and healthcare. If your employer offers a 403(b) plan, here’s what to expect.
Key Takeaways
A 403(b) plan is a retirement savings plan available to employees of tax-exempt organizations, public schools, and certain other employers. It functions similarly to a 401(k) but is specifically designed for the nonprofit sector.
Contributions to a 403(b) are automatically deducted from your paycheck, can be made pre-tax (traditional) or after-tax (Roth), and may be matched by your employer, providing significant potential for growth through compounding returns and employer contributions.
While 403(b) plans offer advantages like tax benefits and employer matching, they have contribution limits and penalties for early withdrawals, and the investment options are usually limited to mutual funds and annuities, which may carry higher fees.
403(b) Plan
A 403(b) is sometimes called a Tax-Sheltered Annuity (TSA) plan. For practical purposes, it’s basically a 401(k) plan for people who work for qualifying tax-exempt organizations, certain hospital organizations, or employees of public schools. Government employees, church workers, and even librarians might also have access to a 403(b) plan.
See also: What’s the Difference Between a 401(k) and 403(b)?
Your employer chooses what type of plan they are willing to offer, so you can’t choose to participate in a 401(k) instead. Your 403(b) plan will come with different investment options, usually in the form of mutual funds that allow you to create a portfolio that matches your risk tolerance.
However, it’s important to understand that the annuity agreement involved makes for a couple of tricky situations that might not apply to other retirement plans:
Withdrawals are subject to a 20% federal income tax withholding, except in specific circumstances.
To dissolve the annuity investment aspect of a 403(b), there might be a surrender charge of up to 8%.
Speaking with a professional to help you with these situations can help you understand some of the quirks involved.
How does a 403(b) work?
Your employer will automatically deduct your contributions to the 403(b) from your paycheck in many cases. This deduction is usually expressed as a percentage. For example, if you make $2,500 each paycheck and want your employer to withhold 4% of your income, $100 will be diverted to your retirement account each payday.
If you choose a traditional 403(b) arrangement, your employer will deduct your contribution from your pay before taxes are figured. This reduces your tax bill today, but you’ll still have to pay income taxes when you withdraw money later. On the other hand, your employer might offer a Roth option, which doesn’t result in a tax benefit today. Instead, your money grows tax-free, and you won’t have to pay taxes when you withdraw.
Some employers also match your contributions. For example, they may match a certain percentage of your income or offer a dollar-for-dollar match up to a cap. Either way, an employer match on your plan is free money that you can put toward your retirement.
Thanks to compounding returns, the money grows over time, and you have a chance to build wealth, so you have financial resources when you quit working. It’s possible to adjust how much you save by letting your human resources representative know, or by managing your contributions through your employer’s online benefits portal.
403(b) Contribution Limits
The government wants to encourage retirement saving, so they offer tax advantages when you contribute to a 403(b) plan. However, you can’t just put everything into a tax-advantaged plan. Your 403(b) comes with limits.
For 2024, you can contribute up to 23,000 a year, which is a $500 increase over the 2023 limit. If you’re age 50 or over, you can make extra contributions totaling $7,500 a year in 2024. The combined employer and employee contributions can be a maximum of either $69,000 or 100% of your most recent yearly salary, whichever amount is lower.
The IRS also allows for additional catch-up contributions if you’ve given 15 years of service with an employer. Pay attention to the contribution limits and your employer’s plan so you can take advantage of what’s available to you.
When can you withdraw money from your 403(b)?
Because your 403(b) is a retirement plan, you can’t just take money out when you want — at least not without paying a penalty. If you withdraw money before reaching age 59 ½, you’ll have to pay taxes, and the IRS will charge you an extra 10% penalty. The only exception is if you have a Roth account. At that point, as long as the account is at least five years old, you can withdraw your contributions without penalty.
Be aware, too, that when you reach age 70 ½, you’ll have to start taking Required Minimum Distributions (RMDs) from your non-Roth 403(b). The government uses a formula to determine how much you should be taking each year in RMDs. You’ll have to pay taxes on the amount, as with any other tax-deferred retirement plan withdrawal.
As you approach retirement and begin figuring out how much money to withdraw and which accounts to start with, consult a retirement professional. A knowledgeable professional can help you manage your different accounts and figure out how withdrawals interact with Social Security benefits.
What happens if you leave your job?
You might have a vesting requirement with your 403(b). Vesting requires you to be with an employer for a set amount of time before you get to keep all the money from the match. However, the money you contribute on your own is not subject to vesting.
In some cases, you might be able to keep your money in the 403(b) account, even after you leave. However, you can’t make new contributions. As a result, it might make sense to roll your money into an IRA. That will allow you to keep growing the account and control where the money is invested.
How much should you contribute to your 403(b) plan?
Putting money into an employer-sponsored retirement plan is one of the easiest ways to save. It comes out of your paycheck, so you don’t have to think about it. However, you might be concerned about how much you can afford to divert from other goals.
A good place to start is to maximize your employer match. If your employer will match your contributions up to 3% of your income, consider saving 3% of your income. That way, you at least get some additional free money going toward your financial future.
If your employer doesn’t offer matching contributions, your 403(b) is not required to meet the burdensome oversight rules of the Employee Retirement Income Security Act (ERISA). This means you could have lower administrative fees than you would with 401(k)s or other funds subject to greater oversight.
Factors to Consider
Next, you need to consider different factors related to your current situation. Some things to keep in mind as you determine how much to put into your 403(b) include:
Debt: High-interest debt can weigh you down. It’s ok to save a little less for retirement in the name of paying down debt faster. You can work toward both goals, but just know where the bulk of your focus should be, based on your goals.
Emergency fund: Once you have a baseline established for retirement saving, you might want to focus on another goal. Consider building at least three to six months’ worth of expenses in an emergency fund.
Other savings goals: Maybe you have goals like buying a home or starting a college fund. You don’t want to put your own retirement at risk to pay for your child’s college, though. Think about what you want your money to accomplish, and then go from there.
Once your goals are met, return to the 403(b) and considerably boost your retirement savings. It’s a good idea to increase your retirement savings each time your finances improve, or you get a raise.
How to Invest in a 403(b)
The investment options available in a 403(b) plan are generally more limited compared to other tax-advantaged retirement plans. These options typically include mutual funds and annuities.
Unlike 401(k) plans, it is not typically possible to invest in individual stocks, exchange-traded funds (ETFs), or real estate investment trusts (REITs) through a 403(b) plan. However, many 403(b) plans do offer low-cost bond and stock index funds, which are often recommended by financial experts for retirement investing.
To determine the right mix of stock and bond funds, you should consider your age, risk tolerance, and the amount of time you have before retirement. As you get closer to retirement, it may be appropriate to increase the proportion of bond funds in your portfolio.
Target-date funds, which are mutual funds that automatically adjust their holdings to suit your target retirement date, can be a good choice if they are offered by your 403(b) plan. Alternatively, you can consider investing in an annuity through your 403(b).
However, it is important to be aware that annuities can be complex financial instruments with high fees and potentially lower returns than other options. It is a good idea to speak with a financial advisor before deciding to invest in an annuity.
If your 403(b) plan does not offer the investment options you want, consider using an individual retirement account (IRA) to supplement your portfolio. If your employer offers a matching contribution to your 403(b) plan, ensure that you are contributing enough to take advantage of this benefit before investing in an IRA.
Are there other ways to prepare for retirement?
A 403(b) is not the only way to save for retirement. In fact, you should consider retirement planning holistically, working it into your other short-term and long-term money goals.
In addition to using a 403(b), you can also open an IRA to set aside money in an account that you have more control over. If you qualify, you might also be able to use a Health Savings Account to begin saving up for healthcare costs in retirement.
Please keep in mind that you might have other accounts from previous jobs. Rolling them all into one IRA can help you consolidate the money to more effectively plan for the future. Make sure you consider taxable investment accounts, savings accounts, pensions, and even Social Security benefits in your planning.
For the most part, though, the first step is getting in the habit of saving money. You might not feel like you have “enough” money to invest for retirement. This isn’t true. Even if you only set aside 1% of your income, it’s still better than nothing.
Here are some tips for managing your retirement portfolio:
Work toward increasing your contribution a bit each year.
Review your accounts once a year and rebalance as needed.
Consolidate accounts to reduce fees and improve management.
Be realistic about your retirement needs and plan accordingly.
Incorporate other financial goals and prioritize retirement.
Use windfalls, bonuses, and other unexpected income sources to pad your account.
Bottom Line
The earlier you start saving for retirement, the less you have to contribute each month to meet your goals. However, it’s better to start late than never. Put as much as you can into your 403(b) from the get-go, taking special advantage of any employer match. As you develop the habit of setting goals and saving for them, you’ll position yourself for financial success.
This post may contain affiliate links, which helps us to continue providing relevant content and we receive a small commission at no cost to you. As an Amazon Associate, I earn from qualifying purchases. Please read the full disclosure here.
Welcome to the 30 Day Money Challenge!
Today, you will learn how to make your money work for you. You don’t have to be a millionaire before knowing these things, but it’s important for everyone who wants financial stability.
Remember these keywords: saving and investing? This is where they come into play for long term success.
It’s not too late to make the right financial decisions.
But, finances are complicated and intimidating for most people so it can be hard to get started.
The 30 Day Money Challenge is here to help with that.
This 30 day financial challenge will help you create a strategy that can save, spend less, and make more by the end of this month!
Are you ready to dig into this month-long money challenge?
What is the 30 Day Money Challenge?
A money challenge is a plan for how to make your finances work better.
It can be as simple as spending less or eating out less, or something more complicated like saving up for retirement or buying a house.
During this month’s timeframe, you will dig into all areas of your finances to make sure you are on track to reach your money goals.
If you do not have financial goals, then we will make sure you do at the end of this money challenge.
I’ve seen a lot of spending challenges out there that are basically just a saving money chart telling you how much money to save each day to save $1000 or $500 in one month, but they don’t tell you how to save the money. That is where the rubber meets the road and this challenge will motivate you to improve your money habits.
Overall, you will learn more about your finances than you did previously.
Why a Money Challenge is Important
A 30 day challenge is a great way to get yourself motivated and focused on saving money and improving your money management.
The goal is not enough, you need the why behind it in order to see your savings grow.
This can be as simple as:
– Setting up a direct deposit from your paycheck to an account you control and only spending what’s in that account.
– Spending less on impulse buys.
– Cutting back on luxury items to save money.
– Living more in cash and less in credit card debt.
You can also take knowledge in knowing the number of our readers who have taken the challenge to improve their money management skills.
3 Steps to Start the Money Challenge
The 30 Day Money Challenge is a simple process that starts with 3 steps.
Your reward for participating in the challenge is pretty appealing, but the process can be hard for some.
So, know these steps before you start the challenge.
1. Pick a Time
While there is no good time to start, you need to find a time when you have the highest probability of success.
Starting the money challenge during the holidays will leave you defeated. Maybe starting as a New Year’s Resolution. Or during a quieter time throughout the year.
You need to find the “right” time because you will have to dedicate at least 10-30 minutes per day. However, the longer you put it off, the less likely you are to start.
2. Be Prepared
More than likely, you will be ripping off the band-aid on some old money failures and defeats. This is common.
You have to be mentally prepared to overcome these negative feelings towards money in order to find that breakthrough moment.
3. Accountability
Find someone to keep you accountable during the challenge.
There will be points when you want to accept defeat and run back to your old money ways. It’s great to create a support system for managing money wisely.
If those old money habits didn’t serve you well before, then how will they serve you moving forward.
You need to keep your eye on the prize!
Thirty Days of Money Challenges
A 30-day money challenge is a popular type of personal finance experiment in which participants take a pledge to review their finances and overcome any obstacles that are preventing them from long term financial stability.
The goal is to teach people how quickly they can change the trajectory of their personal finances before they snowball into a serious money problem.
Day 1 – Get Organized
If you don’t have an understanding of how many accounts you have, credit cards you have open, or debt payments that are due, then you must get your personal finances organized.
Start here to learn how to organize personal finances.
Day 2 – Understand your Income
If you do not know how much do I make a year, then you must figure that out first.
It is impossible to manage money if you do not know how much money is coming in.
Also, consider all types of income sources – earned, passive or investment.
Day 3 – Understand your Expenses
Understand where your paycheck is going. When you understand how much of your money is going to things like rent, utilities, and mortgage, you can make better decisions about spending.
This is not the time for “this-is-where-I-hope-my-spending-goes;” this is the true reality of how you spend money.
Day 4 – Pay Yourself First
This is a must for long-term success. Every time you get paid, you need to pay yourself first. Put a percentage of your paycheck into savings each month before anything else is spent on non-essential items.
We suggest starting with at least 5% of your income. Even better, you want to start with 20% of your income.
You must cut your fun spending until you can save money first.
When saving becomes an automatic habit, start investing through high yield accounts like IRAs and 401(K)s.
Day 5 – Automate your Emergency Savings
Set up a transfer to put $50 into your Emergency Fund every time you get paid.
Learn how much you need in your emergency fund. Remember, the goal is never to use your emergency fund, but you always want one – just in case!
Day 6 – Create Money Goals
Figure out what your financial goals are and how much they will cost over time, then come up with a strategy to achieve them.
You need to make a plan to reach your money goals.
If you skip this step, you may be lucky and still reach your goals. But, you can find better prosperity but writing out those money goals and maybe even using a vision board.
Learn how to create smart financial goals.
Day 7 – Budget Time
Crazy! I know. Most people would think that creating a budget would need to be first. But, it isn’t. You need to figure out days 1-6 first before you dig into budgeting.
Begin tracking your expenses on paper or online as soon as possible. Here are the best budgeting apps available.
The goal with the budget is to focus on saving first, then your expenses. you must spend less than you make.
Day 8 – Make More Money
Come up with ways to generate more income. Period. You need to make your money work for you.
You need to learn how to make your income work for you by creating streams of income outside of your primary work or “earned” income.
Theoretically, if multiple streams of revenue exist at your full-time job, you can work fewer hours than necessary.
Ways to Make Money:
Day 9 – Enough with Debt
Debt will hold you back. Period.
You need to recognize that paying off your debt is the best thing you can do for your finances. However, during this 30 day financial challenge, it is not the time to focus on paying off debt.
Calculate the total amount of debt (except mortgage).
Put down getting out of debt as one of your money goals and the timeframe to make it happen.
For now, don’t take on more debt, and make sure you’re paying the minimum on your credit card balance.
Day 10 – Understand Investing
Investing is a way of giving your money the opportunity to work for you. In other words, you are using what you have now in order to make more out of what you have in the future.
This is the first step to earning investment income that will fund your lifestyle.
Typically, most people associate investing in the stock market. Many people invest with their 401ks or IRAs. However, you can invest your personal income as well.
What if you could earn a return on that opportunity cost? For example, what if you invested the $10 in your wallet and it grew to be $20?
Learn how to start investing.
Trade and Travel 2.0
Learn to trade stocks with confidence.
Whether you want to:
Retire in peace without financial anxiety
Pay your bills without taking on a side hustle
Quit your 9-5 and do what you love
Or just make more than your current income….
Making $1,000 every.single.day is NOT a pie-in-the-sky goal.
It’s been done over and over again, and the 30,000 students that Teri has helped to be financially independent and fulfill their financial dreams are my witnesses…
Day 11 – Control Excess Spending
Every time you spend money, it is an opportunity cost to your future self. You are trading away your future self’s money to buy something today.
Is that what you want?
More than likely, no.
Learn how to drastically cut expenses.
Day 12 – Autopay your Bills
Consider setting up an autopay feature for your bills. It can help you avoid late fees and will have a steadier flow of money coming in.
This will help you to make sure you have the cash flow available to meet your expenses.
Day 13 – Avoid Fees
One of the best ways to save money is by avoiding fees.
If you have a credit card, consider switching to one with no annual fee or an introductory offer that expires after one year.
Check your bank and credit card statements for any fees you may not be aware of.
If there is a fee, call the company and negotiate to have it removed or reduced.
Day 14 – Automate Retirement Contributions
You should automatically make a certain percentage of your salary go to a 401k or other savings account, and the other percentage goes to your checking account for spending money.
This is something your human resources department can help you set up.
Day 15 – Increase your Retirement Contributions
Now, that you have automated your retirement contribution, you want to increase you much your contribution each year until you are maxed out by IRS limits.
Start to increase your retirement contributions by 1%.
Set a five-year goal to fully max your retirement contributions!
Halfway Point!!
You’re halfway through the 30 day money challenge!
Keep up the good work and keep reaching for your goals.
You’ve made it this far, so just imagine what you’ll be able to do in another month of working hard towards saving more money.
Day 16 – Communication
Don’t think money has to be a taboo topic. In fact, you need to be comfortable talking about money.
The key is to be on the same page with key family members about where money should go. This is something that we struggled with our marriage and had to overcome. Thankfully, we did and we made way more progress than previously.
Day 17: Invest in yourself
I know you’re probably tired of hearing about investing in yourself, but it’s important. Investing means putting money into something that will make more money back. You might not think this applies to you, but it really can! You might not have a big budget for investing in stocks or mutual funds right now, so let’s talk about something you do spend money on every day: you.
You only learn by growing.
Day 18 – Start Reading About Personal FInance
This isn’t something that you do once or twice. Make it a goal to read books on money or personal finances each month.
Importantly, make sure you are reading books, regardless of what aspect they look at money. It is never too late to pick up new tricks or ideas.
Plus learning from others’ money stories is powerful.
Day 19 – Free Fun
Participating in only free activities for 30 days, and refusing to spend a single penny, we created a guide to make that happen for you.
101+ Things to Do with No Money
After writing that post, we discovered this is one of the best money saving ideas out there. This guide not only teaches you how to save money but also teaches about where you want to spend money and the importance of living a purposeful life.
Day 20 – Review Insurance
You need to make sure you are properly covered with insurance as well as not paying too much money for your policies.
There are all of the types of insurance you need to review:
This is something you should do once a year.
Day 21 – Waste Less Food
You need to learn to save money by wasting less food.
This doesn’t mean you have to make homemade meals every night of the week! The goal is not to throw food away – that is hard earned cash going right down the trash.
Ways to Save Money on Groceries:
Day 22 – Buy Second Hand
Consider second-hand stores and consignment sales as options for buying used items. Thrift stores are also great to save money on clothes and other household items.
The same is true for buying cars, baby equipment, kids clothes, etc. Plus you protect our world.
Day 23 – Save Money
So, this day is all about saving money and I think that it’s the most important one of them all because if you’re not saving your money, then what are you doing with it? You’re throwing it away.
So today, I want to talk about two different types of saving money – physical and mental. The first one is all about physically saving your money. This is the easiest one because it doesn’t require any effort on your part to do so, but it’s also very important as well.
The second type of saving money is mental saving. This is all about saving your money because you know that something better will come along soon and it gives you hope for the future!
So, I think these two types of savings are both really important.
Day 24 – Give Back
This is the time to give back to others, donate money to charities, and put small contributions into charity.
By hoarding money, you are not learning the principles of helping others just like you have been helped along the way.
Day 25 – Renegoite Interest Rates
Right now, we are not starting to pay off debt. We are looking for ways to save on higher interest payments.
Make calls to renegotiate your interest rates on your debt. If the credit card company says no, then look at a zero interest transfer.
Just no more debt.
Day 26 – Avoid Scarity Mindset
You have to believe in yourself that you are capable of achieving great things and that includes success money.
However, we get caught in this trap of hoarding materialistic items in order to make up for the dollars in our bank account or money that was wasted in buying them.
If you don’t believe how poverty mentality overwhelms your life, then read this story of reclaiming your home with decluttering.
Day 27 – Cut Out What you Don’t Need
If you are not using something, sell it or give it away to someone who can use it more than you do!
You’ll save money and make room in your budget for the things that matter.
We learned a lot when we started to own less stuff.
Day 28 – Prepare for a No Spend Challenge
If you have not been able to keep your spending in check, this is an excellent opportunity for you to try out a no spend challenge once this challenge finishes.
A no spend challenge will help you to review your budget and see what areas of spending need more attention in order to increase savings or pay down debt.
Also, it will help you focus on what area are important to spend money.
Day 29 – Reward Yourself
This is the biggest lesson I learned when paying off debt and trying to increase our savings percentage. I became unable to spend money. I would feel guilty about spending money.
That is not the type of life you want. You must be comfortable spending money (especially if you are a thrifty person).
Pick rewards to match your smart financial goals. Keep motivated with those rewards.
Day 30 – Stay on Track
Proper money management does not end just because the end of the 30 day challenge is over. This is a lifelong skill to master and perfect.
Keep focused by not going over budget limits and being honest about where you really stand financially today as opposed to where you want it to be in the future.
You can stay on track if you have a deep desire to continue.
30 Day Money Saving Challenge
This one is just about saving money. Period.
Each day, you save money to reach your goal.
For many people, the 30 day money saving challenge will make sure you are on track with your goals and objectives.
At the minimum, you should be able to save $500 in 30 days. But, you need to decide what you want to save in a month.
The challenge is open to everyone, so this might be the perfect opportunity for you!
What is the 30 Day Money saving Challenge?
The 30 day money saving challenge is saving a set amount of money during the month.
Keep in mind, not everyone will be able to save this much in 30 days and that’s perfectly okay.
You need to make it work with your budget.
Another option for the 30 Day Money Challenge is committing to give up one or more expenses for the whole month. For instance, pick ten things that cost you money and give them up for 30 days.
How to get started with the 30 day savings challenge
The 30 day savings challenge is a simple but effective way to get started saving money.
You can choose any of these methods:
Take the amount you want to save and divide by 30. That is how much to save daily.
Determine the amount to save and take that immediately when you are paid.
It is easy to go in order or skip around depending on what amount you want to save each day.
Keep change hidden in jars and watch it add up over time, then put the money away every day and see where they rank at the end of the month.
Give up a certain expense and save that money.
Try a modified version of the 100 day challenge.
You can find plenty of money saving challenge printable or PDF in our resource library.
Want more easy money saving challenges?
Are you in for this 30 Day Money Reset Challenge?
This is only a 30 day money challenge because it’s a short period of time to gain a win. That is what you need to keep up the motivation as well as have a strong kickstart to your finances.
In order to build wealth through their finances, these are 30 smart moves that require no time on some days.
Don’t lose momentum. If you miss a day, then jump back into the challenge the next day.
The key to success for 2021 is to take control of your finances.
Photo Credit:
www.rakuten.com
The Shopping Trick to Save Hundreds of Dollars
Personally, I love to shop online from the convenience of my own home and have packages delivered to my house. Plus you can get paid to shop online!! The process is super simple.
Just head here to get an Rakuten/Ebates account, click on the retailer you are shopping online, and then complete your checkout process as normal.
Already a Rakuten / Ebtaes member? Make sure you have the Extension Buttonfor automatic savings!
Photo Credit:
www.asktrim.com
Perfect for the person who hates to hassle with canceling subscriptions and checking spending. Trim is a virtual personal assistant that constantly works to save users money.
Trim adds value in such ways as canceling old subscriptions, setting spending alerts, checking how much users spent on ride-sharing apps the previous month, and automatically fighting fees.
Photo Credit:
ibotta.com
Ibotta can be used for grocery stores, drugstores or online shopping. Once you accrue $20 in your account, you can transfer it to PayPal or venmo or buy gift cards to selected retailers.
Just for signing up, they will give you a bonus when you use use this link. Ibotta rocks at bonus categories and offers. This is where your cash back can really add up fast.
Photo Credit:
checkout51.com
Checkout 51 can be used for grocery stores or drugstores. Their offers are valid each week from Thursday-Wednesday. With new offers released each Thursday.
One of my favorite offers is the “Pick your own offer” – it is a selection of 5 fruits of veggies to redeem for extra cents cash back. Once your account balance is over $20, they will mail you a check.
Know someone else that needs this, too? Then, please share!!
Did the post resonate with you?
More importantly, did I answer the questions you have about this topic? Let me know in the comments if I can help in some other way!
Your comments are not just welcomed; they’re an integral part of our community. Let’s continue the conversation and explore how these ideas align with your journey towards Money Bliss.
Investing can feel like riding a rollercoaster, especially when you’re trying to keep up with market fluctuations. One popular technique that long-term investors use to smooth out this ride is dollar-cost averaging (DCA).
This investment strategy offers a methodical approach to investing that can eliminate the guesswork and stress of trying to time the market. Let’s dive into the world of DCA and see how it might serve your personal finance goals.
Basics of Dollar-Cost Averaging
Dollar-cost averaging is a simple but effective investment strategy. The basic idea is to invest a fixed dollar amount at regular intervals into a particular investment, such as a stock or mutual fund, regardless of its share price. Over time, this approach can result in a lower average price per share compared to making a lump sum investment at a higher price.
Here’s how to dollar-cost average: Suppose you decide to invest $500 into an index fund every month. The share price of the fund fluctuates from month to month, sometimes high, sometimes low. By investing regularly, you buy more shares when the price is low and fewer shares when the price is high. Over time, this can lead to a lower average purchase price.
A Deeper Dive Into How Dollar-Cost Averaging Works
One way to get a better grasp of how dollar-cost averaging works is to look at a hypothetical scenario. Suppose you decide to invest $200 in a mutual fund every month. In January, the share price is $20, so you buy 10 shares.
In February, the share price drops to $10, so your $200 buys you 20 shares. In March, the price goes up to $25, so you can only afford 8 shares. Despite the market’s fluctuations, your regular investment allowed you to purchase more shares when the price was low and fewer shares when the price was high, resulting in a lower average purchase price.
Benefits of Dollar-Cost Averaging
The key advantage of the dollar-cost averaging approach is that it mitigates market volatility. Instead of trying to time the market and potentially making ill-timed investment decisions, DCA allows you to follow a fixed schedule and make regular investments.
This strategy can be especially beneficial in declining markets. When stock prices fall, your fixed dollar amount can purchase more shares. If the stock market recovers, you would have bought those shares at lower prices, potentially leading to gains. This way, DCA can turn market declines into opportunities.
Another benefit of dollar-cost averaging is that it can promote disciplined investing. By investing a fixed amount at regular intervals, you are more likely to stick with your investing strategy, even when the market is turbulent.
The Psychology Behind Dollar-Cost Averaging
Dollar-cost averaging isn’t just about mathematical probabilities and financial strategy—it’s also deeply intertwined with investor psychology. Investing can be an emotional roller coaster, especially during periods of significant market volatility. When stock prices swing wildly, investors often let their emotions guide their decisions, which can lead to costly mistakes.
For instance, a sudden market downturn might provoke feelings of fear and uncertainty. In response to these emotions, some investors may resort to panic selling, hastily offloading their investments to stave off further losses. This can be detrimental to their long-term financial goals because they might miss out on potential gains when the market eventually rebounds.
On the flip side, during a bullish market when prices are high, feelings of greed and fear of missing out (FOMO) might take over. These emotions can lead to impulsive buying, where investors pour money into the market hoping to ride the wave. But if the market corrects or crashes, these investors stand to lose a significant portion of their investment.
This is where the dollar-cost averaging approach comes into play. The discipline of investing a fixed amount at regular intervals removes the need to time the market and reduces the influence of emotions on investment decisions. It provides a systematic investment plan that is followed regardless of whether the market is up or down. This disciplined approach can prevent impulsive decisions, providing a level of emotional comfort and stability.
Limitations and Risks of Dollar-Cost Averaging
While dollar-cost averaging offers many benefits, it’s not without its potential drawbacks. One potential downside is that if the market consistently rises, a dollar-cost averaging strategy could yield lower returns compared to lump sum investing. In bullish markets, a lump sum invested early would have more time to grow.
Another risk is that despite the potential to achieve a lower average price per share, DCA doesn’t guarantee profits or protect against losses. If the market continually declines, you may lose money, especially if you need to withdraw your investment before the market has a chance to recover.
Finally, for dollar-cost averaging to work effectively, it requires regular and continuous investments. This may pose a challenge if you have a tight budget or unpredictable cash flow.
Dollar-Cost Averaging vs. Lump Sum Investing
Lump sum investing is another common strategy where an investor puts a large sum of money into the market at once. This approach can yield higher returns during a bull market because your entire investment is exposed to the market’s growth from the beginning.
However, timing the lump sum investment correctly can be challenging, even for professional investors. Misjudging the market can lead to buying high, which could result in lower returns or even losses. It’s also worth noting that investing a large sum all at once can be a significant risk if the market takes a downturn shortly after.
Choosing between dollar-cost averaging and lump sum investing largely depends on factors like your risk tolerance, investment horizon, and the amount of money you have to invest.
Implementing Dollar-Cost Averaging in Your Investment Strategy
If you’re interested in implementing a dollar-cost averaging strategy, you’ll need to consider several factors:
Choosing an investment: First, choose a suitable investment option. This could be individual stocks, mutual funds, or exchange-traded funds (ETFs). It’s wise to diversify across different asset classes to reduce risk.
Budget: Decide how much money you can invest regularly. This could be a fixed dollar amount you set aside from your paycheck every month. The key is to ensure it’s an amount you can commit to over time.
Frequency: Determine how often you want to invest. This could be monthly, quarterly, or any interval that fits your financial situation. The main point is to stick to a regular schedule.
Duration: Consider how long you plan to keep investing. This would typically be linked to your financial goals. Are you saving for retirement, a down payment on a home, or your child’s college education? Your end goal can help you determine how long you dollar-cost average.
Dollar-Cost Averaging in Different Market Conditions
Dollar-cost averaging can prove beneficial in various market conditions:
Bullish markets: In a steadily rising market, a DCA strategy may underperform a lump sum investing approach. However, the benefit is that you’re not risking a large sum of money at once and aren’t trying to time the market.
Bearish markets: In declining markets, DCA comes into its own by allowing you to buy more shares at lower prices. This can reduce the average cost of your investment over time.
Volatile markets: Market volatility can make it difficult to time your investments. With DCA, you’re investing at regular intervals, which means you’re less likely to be swayed by short-term market swings.
Dollar-Cost Averaging With Robo-Advisors and Investment Apps
Nowadays, you don’t need to manually make investments at regular intervals. Many financial institutions offer automatic trading plans, and several robo-advisors and investment apps also provide automated DCA services.
These tools can automatically deduct a set amount from your bank or brokerage account and invest it according to your preferences, making DCA even more straightforward.
Conclusion
Dollar-cost averaging helps you manage fluctuations in the market, mitigate the risks of market timing, and potentially lower your average purchase price. It offers a systematic and disciplined approach to investing. However, like any investment strategy, it’s not without risks. Always consider your financial goals, risk tolerance, and investment horizon before deciding to implement DCA.
Remember, past performance is not indicative of future results, and it’s important to evaluate your investment options carefully. While this article provides a thorough understanding of how dollar-cost averaging works, it does not provide investment advice. You should consider seeking advice from professional advisory or brokerage services that can provide personalized advice based on your circumstances.
Frequently Asked Questions
Can I use dollar-cost averaging in my retirement account?
Yes, DCA fits perfectly in retirement accounts like 401(k)s or IRAs. You’re typically contributing a set amount regularly, which is DCA in practice. Over time, this can help smooth out the impact of market volatility on your retirement savings.
Do I need a large sum of money to start dollar-cost averaging?
No, the advantage of DCA is that it allows you to start investing with any amount you’re comfortable with. You simply invest a fixed amount at regular intervals, which could be as little as a few dollars every month.
How does dollar-cost averaging help me build wealth over time?
DCA can contribute to wealth building by potentially lowering the average cost of your investments over time. By buying more shares when prices are low and fewer when they’re high, you might lower your average cost per share, setting the stage for potential gains in the long run.
Can dollar-cost averaging protect me from all investment losses?
While DCA can help mitigate the effects of volatile markets, it does not guarantee protection from all investment losses. The value of your investments can still go down, particularly if the entire market is in a prolonged downturn. It’s important to have a diversified portfolio and a strategy that aligns with your risk tolerance.
Is dollar-cost averaging only suitable for stocks?
Not at all. While often associated with buying stocks, you can apply dollar-cost averaging to other types of investments as well, like mutual funds, index funds, exchange-traded funds (ETFs), or even Bitcoin. The key is that the asset’s price changes over time.
How often should I make investments if I’m using a dollar-cost averaging strategy?
The frequency of investments in a DCA strategy can vary based on your personal finance situation and goals. Common intervals include monthly and bi-weekly, often aligned with pay periods. The key is to be consistent and stick to your predetermined schedule.
A nest egg is a substantial amount of money that you save for a specific purpose. Savings accounts, investment accounts and working financial professionals can help you grow your nest egg.
A nest egg is a fund that you set aside for a specific purpose. Nest eggs can be large sums of cash that you store in a safe, retirement accounts like 401(k)s and IRAs, or investments like index funds and government bonds.
Nest eggs are one of the best investments for long-term financial goals. This fund shouldn’t be touched until months or years into the future. Below, we’ll further break down what a nest egg is, how it works, and how you can contribute to it over time. We’ll also share helpful financial tools like Credit.com’s 401(k) calculator.
Key Takeaways:
Cash, savings accounts, and investments can all be a part of your nest egg.
An FDIC-insured savings account protects up to $250,000 from losses.
Once you reach age 59 ½, you can withdraw funds from retirement plans, like your 401(k) and IRA, without penalties.
What Can You Use a Nest Egg For?
Funds that you place in a nest egg can serve various purposes later in life. Some of the most common reasons people utilize this savings tool include:
Family: A nest egg can cover costs if you have to go on unpaid family leave.
Education: Saved funds can help you pay for your children’s education or your post-graduate studies.
Rainy days: A nest egg can double as an emergency fund.
Early retirement: Some people save money to retire before age 59 1/2
Big purchases: Saving for a new car, a house, or a business expense.
Inheritance: Here, investors gather their funds for the sake of their beneficiaries.
Charity: The funds in your nest egg can help charities support numerous other people.
No matter your reason for building out your nest egg, knowing how to increase your funds is key.
How to Build a Nest Egg?
You’ll need to set money aside to successfully create a nest egg over time. Savings accounts are excellent tools for storing future funds—especially high-yield savings accounts, which can generate a significant amount of interest based on your initial deposit and subsequent contributions.
Effectively budgeting your funds is crucial to growing your nest egg, and you can do this in many different ways.
Set Clear and Realistic Goals
Creating savings milestones for yourself based on your current finances can help you steadily grow your nest egg over time. This process can be as simple as aiming to save $100 each month or as elaborate as saving to make a down payment on a home in 10 years.
Budget to Ensure Spending Aligns With Nest Egg Goals
Once you have a goal or series of goals in mind, you can adjust your spending habits to help you consistently meet those goals. For example, canceling subscriptions and eating out less can free up more funds to add to your nest egg.
The opposite is also true—once you know you’re regularly hitting your savings goals, you can treat yourself or donate extra funds with far less stress.
Leverage Savings Accounts With High Interest and Tax Advantages
High-yield savings accounts are excellent tools for safely storing funds and building interest long-term. These accounts protect up to $250,000 of your funds from losses via FDIC insurance.
A 401(k) and an IRA can help you save for retirement while offering distinct tax advantages on your funds. Employers offer 401(k)s, and they’ll match a percentage of the money you contribute to this fund. This is why financial experts encourage you to maximize your 401(k) contributions if possible.
IRAs are individual retirement accounts that you contribute to on your own. Traditional IRAs offer tax-deferred growth (meaning, tax payments aren’t due until later), while ROTH IRAs offer tax-free growth for any after-tax dollars you contribute.
Adopt Better Debt Management Strategies
Debt limits the amount of money you can add to your nest egg, so making repayments now can lead to increased funds in the future. The avalanche method and the snowball method are two popular strategies to pay off debt fast.
With the avalanche method, you pay off your debts with the highest interest rates first and work your way down. The snowball method calls for a different approach: you tackle your debts in order from the smallest to the largest amount.
Create a Diversified Investing Portfolio
When you diversify your investments, you create greater opportunities to build your wealth. For example, spreading your funds across a mixture of high-yield savings accounts, tax-advantaged accounts, stocks, bonds, and futures can potentially lead to a bigger return on investment than going all in on one type of account.
It’s important to manage your expectations when investing, as getting too ambitious can lead to big losses. It’s also pivotal to understand the risk involved with each account—stocks are more volatile than government bonds, for the most part.
How Much Should You Have in Your Nest Egg?
Everyone has different financial needs, so there’s no one-size-fits-all amount for nest eggs. Factors like your savings goal, location, and income all influence your unique needs. We recommend speaking with financial advisors to get the most accurate idea of your nest egg goal.
Even if you don’t yet have a specific goal in mind, you can always dedicate funds from each paycheck toward your nest egg. Using tools like a monthly budget template can help you get a better sense of your regular expenses and how much you can afford to save each month.
How Do You Protect a Nest Egg?
The methods for protecting a nest vary based on its form. FDIC insurance can protect a preset amount of the funds in your savings account in the event of a loss. For example, FDIC insurance protects up to $250,000 in a money market account,
Eliminating debts and increasing your financial knowledge will also help your nest egg in the long run. The fewer debts you have, the more money you can contribute to your savings goal—and knowledge will help you wisely allocate your funds.
To best protect your nest egg, watch out for get-rich-quick schemes that promise astronomical returns if you make an equally large investment. Lastly, set up alerts on your banking accounts to notify you about strange transactions.
Find Personal Finance Resources With Credit.com
Growing a nest egg is one of the more intuitive financial concepts out there, and it gets easier the more you know about money management. Check out Credit.com’s personal finance guide to deepen your understanding of methods for growing a nest egg and other investment strategies.
If you’ve been contributing to a 401(k) or employer-sponsored retirement account for several years but are now leaving your job, you may be wondering what to do with your retirement account. Do you cash out your nest egg and let the money sit in a bank account until you retire?
It may be tempting to have unrestricted access to a lump sum of cash. But unfortunately, holding your retirement in a bank account could cost you a fortune. Furthermore, the small returns generated won’t keep up with inflation and your nest egg will actually lose value.
A more suitable option: a rollover IRA. Keep reading to learn how they work, along with key benefits and how to initiate an IRA rollover.
What is a Rollover IRA?
In a nutshell, a rollover IRA is an account that is designed specifically to hold funds transferred from employer-sponsored retirement plans, including 401(k), 403(b), profit-sharing and Keogh plans.
The purpose of a rollover IRA is to keep the tax-deferred status of those assets. Rollover IRAs also offer several distinct benefits.
What are the benefits of a Rollover IRA?
When you cash out or take distributions from retirement plans, two things happen. For starters, the funds are subject to taxation and the tax deferral benefit goes out the window. And if you haven’t yet reached 59 ½, you’ll also incur a 10% early withdrawal penalty.
However, an IRA rollover allows you to avoid taxation as long as you transfer the funds properly. Even better, you’ll also escape the 10% penalty.
Other benefits:
It’s free. You read that correctly. That are no fees to open a rollover IRA and transfer the funds from your 401(k) or other employer-sponsored plans into the new account.
Low fees. You may have to pay minimal fees to cover brokerage commissions and fund expenses associated with transactions. But there are financial entities, like Schwab, that offer rollover IRAs devoid of annual or maintenance fees.
No rollover limits. Fortunately, you’re allowed to roll over all the funds in your retirement account, regardless of the amount, without incurring a penalty.
Flexible investment options. Most 401(k) plans only allow you to select from a limited pool of assets, typically in the form of mutual funds, to build your portfolio. But with a rollover IRA, you’ll be afforded the opportunity to choose from an array of assets, including stocks, ETFs, and bonds, just to name a few.
Funds can be transferred to a new employer’s plan. If you find employment elsewhere, and they offer a qualifying retirement plan, you will be able to transfer the funds from the rollover IRA to their plan if you choose to. You also have the option to leave the funds where they are.
How to Roll Over a 401K to an IRA
Direct Rollover
To ensure the funds from your 401(k) or other employer-sponsored plan are moved seamlessly, a direct transfer is the preferred option. Selecting this option also minimizes the chances of an error occurring with the transfer. You’ll also avoid having to pay taxes on your nest egg and incurring early withdrawal penalties.
Even better, it’s easy to execute direct transfers. As all you need to do is contact your former employer and request that they transfer the funds to the entity that the rollover IRA will be housed. Expect to complete paperwork on both the sending and receiving end, but it shouldn’t take too much of your time. And once you’ve done your part, the direct transfer of funds will be completed in a brief window of time.
Indirect Rollover
If you prefer to set up the new account on your own, you have the option to do what’s referred to as an indirect rollover. Rather than having your former employer send the funds directly to the new entity that will manage the rollover IRA, you’ll need to obtain the funds via check and set up the account yourself.
Another important consideration: with direct transfers, your employer usually won’t deduct income tax before sending the funds to the company in charge of managing the rollover IRA. But if you take the indirect rollover route, there’s a chance they will, to the tune of 20%.
This means you could find yourself paying this amount out of pocket to avoid incurring additional penalties and fees when opening up a new account. Even worse, you won’t be eligible to recoup the funds until you file your annual tax return.
You should also know that you have 60 days to do so, or you’ll be on the hook for federal income tax and a 10% early withdrawal fee (if you aren’t yet 59 ½ years of age or older). To give yourself the best possible chance of avoiding any issues, promptly deposit the funds and notate your rollover IRA account number on the check.
Furthermore, follow up regularly until the funds are posted to your account, and you’ve confirmed the account is all set.
Other Important Considerations
Annual Rollover Limits: In most instances, you are limited to one rollover per year.
Roth IRAs: If you’re interested in a Roth IRA, you have the option to convert the proceeds from the rollover IRA. However, you will have to pay taxes right away, as Roth IRAs are comprised of post-tax contributions and distributions are tax-free.
See also: What’s the Difference Between a Traditional IRA & a Roth IRA?
Bottom Line
Rollover IRAs are an ideal way to avoid taxation and penalties when you leave your employer and are no longer eligible to participate in their retirement plan. But, if you’re uncertain if your plan is eligible for a rollover IRA, inquire with your plan administrator to determine what options are available to you. You can also view IRS Topic Number 413 for additional guidance.
Frequently Asked Questions
Why would I want to roll over my retirement account?
There are several reasons why you might want to roll over your retirement account. For example, you may want to move your money to a new IRA with lower fees, better investment options, or more flexibility.
Can I roll over any type of retirement account into a rollover IRA?
Yes, you can roll over most types of retirement accounts into a rollover IRA, including 401(k)s, 403(b)s, and traditional IRAs.
How do I choose the right rollover IRA provider?
When choosing a rollover IRA provider, you should consider factors such as fees, investment options, customer service, and the provider’s reputation. You may also want to consider whether the provider offers any additional services, such as financial planning or investment advice.
Ready to make your money work for you? Before you jump in and start investing, take the time to learn about brokerage accounts first. After all, in most cases, a brokerage account is the best way to actively manage your investments.
To help you make an informed decision and open a brokerage account, we’ve compiled a comprehensive guide covering everything from fees to plan for your investments. So, take a few moments to equip yourself with all the answers to your burning investment questions, and you’ll be on your way to financial freedom!
How does a brokerage account work?
A brokerage account allows you to purchase and sell stocks and funds through a digital platform. You can generally deposit funds with cash or check and pay a pre-defined commission to your broker.
The fee you pay fluctuates according to the service you get and the level of automation provided by your chosen platform. Unlike a savings account where you gain a consistent interest rate on your deposits, a brokerage account earns (or sustains losses) depending on the performance of your chosen investments.
Although there is more risk involved, you are likely to reap higher profits than a low-interest savings account. However, if you have a strong appetite for risk, particularly if you are aiming for long-term investment, then considering a brokerage account as part of your savings portfolio might be viable.
Check Out Our Top Picks for 2024:
Best Online Brokers for Stock Trading
Types of Brokerage Accounts
When it comes to investing, there are a variety of brokerage accounts available to select from, each tailored to suit your individual investment objectives and risk appetite. Some common types of brokerage accounts include:
Individual brokerage account: An individual brokerage account is a standard taxable account that is held in the name of a single investor, allowing them to purchase and sell securities such as stocks, bonds, mutual funds, and ETFs.
Joint brokerage account: For those who wish to invest together, a joint brokerage account is an option, held in the names of two or more individuals, such as married couples or business partners.
Retirement account: Retirement accounts are specifically tailored to helping investors save for retirement, offering certain tax advantages that can help their savings grow in the long term, including traditional IRAs, Roth IRAs, SEP IRAs, and 401(k)s.
Trust account: Trust accounts are also available, set up to hold assets for a third party, like a minor or estate beneficiary. These can be revocable or irrevocable trusts.
Business brokerage account: Business brokerage accounts are set up to buy and sell securities on behalf of a business, such as a small business or startup looking to invest their cash reserves or raise capital.
Custodial account: Custodial accounts are designed for minors, often set up by a parent or guardian to save for a child’s education or other expenses, such as a 529 savings plan.
What can you invest in with a brokerage account?
There are actually a wide variety of options available. You may want to pick one type to start with, or you could choose several to diversify your portfolio. Perhaps the most familiar type of investment is a common stock, in which you essentially purchase shares of a specific company.
If you work for a large public company, you might receive shares as part of your compensation package. Or you can choose from any of the companies listed in the stock market, ranging from behemoths like Facebook to successful small niche companies. On top of common stocks, you can also add the following to your brokerage account:
Preferred stocks
Corporate or sovereign bonds
Real estate investment trusts (REITs)
Stock options
Certificates of deposit (CDs)
Money market accounts (MMAs)
Exchange-traded funds (ETFs)
Mutual funds
Master limited partnerships (MLPs)
What should you consider when picking an online broker?
When opening an online brokerage account, the first thing to consider is whether you want a full-service or discount broker. Full-service brokerage accounts invariably comes with higher fees. But the upside is that you get a financial advisor who is dedicated to your investment account. You can discuss your financial situation and future monetary goals with your financial advisor and build an ongoing relationship.
With a managed brokerage account, financial advisors perform trades for you based on your financial goals and risk appetite. If you have questions or concerns, you can directly communicate with your broker by phone, email, or even an in-person meeting. You’re likely to pay commissions that are higher than those of a discount broker, but you have access to a seasoned professional at all times.
Discount Brokerage Firms
Discount brokerage firms, on the other hand, typically operate solely online. You execute all of your own trades in a truly do-it-yourself fashion. The advantage is that you can save lots of money. The disadvantage is that you have to rely solely on your own market research to develop your portfolio, and can cost yourself money by making mistakes out of sheer inexperience.
Still, if you want to be hands-on with your investments, online discount brokers make the stock market accessible — and affordable — in a way it has never been before. Here are a few other things to think about when choosing your brokerage firm.
Costs
There are typically two types of costs associated with an online brokerage account. The first is a commission fee, which can range anywhere between $5 and $10 for each trade you make. These fees usually apply to stocks and options, and sometimes ETFs, plus transaction fees for mutual funds.
Trading Fees
However, some online brokerage accounts offer fee-free trades for ETFs and mutual funds. If either of those is a large part of your investment strategy, you may benefit from choosing a brokerage that doesn’t charge any fees for those.
Brokerage Account Fees
The second cost you’ll come across is various potential account fees. These can include an annual fee for maintaining your brokerage account, inactivity fees, and research and data fees for information provided by your broker.
Withdrawal & Transfer Fees
You may also incur fees for withdrawing or transferring your funds. Think about how often you plan to trade and what resources you want access to when assessing the value of these fees at different companies. If your annual fee is high, but you’ll save money on lower trading fees, it might be worth it.
Similarly, if you don’t intend to trade very frequently, you might want to find a brokerage firm with low or no inactivity fees. Be sure to do a full review of all costs involved to make sure you get the best value across the board for your specific needs. Otherwise, your trades could end up costing you money over time, rather than earning you money.
Account Balance
Another factor to consider when choosing a brokerage account is how much money you initially plan to invest. Some online brokerages have a minimum amount just to get started, often requiring at least a few thousand dollars. Others don’t have any minimum requirements. In either case, you may notice varying fees depending on how much you invest.
For example, you may receive a discount by meeting a certain deposit threshold. In those cases, it also means you’ll end up paying more if you have a lower account balance. Carefully consider how much you intend to invest and where you receive the best perks for that amount.
Customer Service
In addition to research and data made available online (and often resulting in fees), consider what type of personal service you receive. Would you like an annual check-in with a real financial advisor? Do you prefer 24/7 email or chat support? Or do you need something more hands-on?
Just as the level of service varies between full-service brokers and discount brokers, you’ll see a difference even among different online brokers. Pay attention to your needs, and don’t be afraid to change your brokerage account further down the road if you feel you need more or less attention.
Cash Account vs. Margin Account
Yet another breakdown in types of brokerage accounts is a cash account versus a margin account. So, what’s the difference? A cash account is extremely straightforward: you simply trade with the exact amount of funds currently available in your account. This can be relatively restrictive for a couple of different reasons.
First, cash used to purchase new stocks must be settled in your brokerage account, so if a previous transaction is still pending, you can’t use that money for a new trade. Second, you can’t make any withdrawals from a cash account until the money is fully settled.
Trading on Margin
A margin account essentially allows you to borrow money from your brokerage firm to cover short-term capital needs. The advantage is that it gives you a bit more flexibility in making time-sensitive trades.
One of the disadvantages is that you’ll have to pay a margin rate, which serves as interest on the short-term loan. Additionally, you may need to place a higher account minimum to compensate for the risk of the broker potentially losing money.
You can potentially qualify for a lower margin rate by permitting rehypothecation, which allows brokerage firms to reuse your collateral for their own purposes. Clearly, this brings additional risk to your portfolio.
If you’re a beginning investor, it’s probably wise to stick to straightforward cash trading. As you become more comfortable and active with the trading process, you can begin exploring the intricacies of margin trading with your broker.
How to Open a Brokerage Account
Opening a brokerage account isn’t terribly difficult and just requires a few pieces of personal information and, of course, money. When you’re ready to get started, gather basic materials such as your Social Security number or tax ID number, driver’s license, date of birth, and contact information.
You’ll also need employment and income information, including your employer, annual income (usually submitted using a W9 form), and your net worth. Assuming this information is easy for you to pull together, the process is both quick and easy, especially if you opt to open a brokerage account online.
You’ll also need cash to open a brokerage account. You cannot use a credit card to deposit funds. Instead, you’ll likely need to perform an electronic funds transfer from your bank account.
Keep a paper check on hand to facilitate the transfer. This process can take anywhere between a few days and a week so that the money can be verified. Once the funds hit your brokerage account, you can get started trading!
Should you use a brokerage account for retirement funds?
This is a very personal question which depends upon your retirement savings goals. First, it’s critical to take advantage of any employer-sponsored retirement accounts like a 401(k), especially if you receive a company match for your contributions. Then, consider contributing to a tax-advantaged retirement account like a Roth IRA.
There are limits on how much you can contribute each year, but you do both to enjoy different tax advantages. For example, a traditional IRA is not taxed until you begin withdrawing, making your annual contributions tax-deductible. Roth IRA contributions, on the other hand, are taxed when you make them.
The upside is that you don’t pay taxes when you start to withdraw, potentially saving you money during your retirement. If you’ve maxed out an appropriate amount of these account types, you might consider supplementing your retirement savings with a brokerage account.
Before you do, consider a few things. First, the earnings you make on selling investments are taxable, usually as capital gains tax. You’ll also want to review the amount of risk in your portfolio as you approach retirement age. Remember to review your holdings regularly, especially if you’re not a frequent trader.
Getting Started
With so many options available for brokerage accounts today, investing is more accessible — and affordable — than ever before. If you’re just beginning to get your feet wet, start by investing just a small amount of money to help you learn through rookie mistakes. Then you can grow into more sophisticated trading methods as you learn the full potential of your brokerage account.
Alternatively, you can switch to a more service-oriented account to take the day-to-day trading out of your hands. The options are quite limitless when it comes to managing a brokerage account.
Frequently Asked Questions
Are brokerage accounts insured?
The Securities Investor Protection Corporation (SIPC) offers insurance for cash and securities held in a brokerage account should the brokerage fail, though this coverage only extends to the custodial function of the brokerage. Unfortunately, it does not extend to losses resulting from inadequate investment decisions or drops in the value of investments.
In addition, SIPC guarantees up to $500,000 per customer, with a $250,000 cap on cash. However, keep in mind that SIPC insurance does not shield against market losses or other dangers associated with investing.
Which brokerage account is the most suitable for beginners?
When selecting a brokerage account as a novice investor, there are a host of factors to consider, including the kind of investment products you have your eye on, fees and commissions, user-friendliness, and customer service. Here are some of the options you may want to think about:
Robinhood: For those wishing to begin investing without incurring too many costs, Robinhood may be a good choice; it offers commission-free trading for numerous popular stocks and ETFs. However, it should be noted that Robinhood does not provide the same features as more traditional brokerage firms, such as access to research and investment advice.
E*TRADE: E*TRADE is a much-revered brokerage firm that provides a vast selection of investment products, including stocks, ETFs, mutual funds, and options. The platform also provides access to educational materials and investment guidance, as well as a navigable platform with a wide range of tools and resources for rookies. That being said, E*TRADE does impose commissions on some trades and, as such, may not be suitable for those looking to make numerous trades.
Charles Schwab: Charles Schwab is yet another highly regarded brokerage firm that offers various investment products and a user-friendly platform, and it boasts a plethora of resources and tools for novice investors, such as educational materials and investment guidance. Although it does charge commissions for certain trades, Charles Schwab does offer commission-free trading for certain ETFs.
At the end of the day, the best brokerage account for a beginner depends on their individual needs and objectives. Hence, it is advisable to shop around and compare the fees, commissions, and features of different brokerage firms before choosing.
How old do you have to be to open a brokerage account?
In the United States, you must be at least 18 to open a brokerage account in your own name. However, some brokerage firms may require a Social Security number or tax identification number to proceed.
If this applies to you, and you are under 18, it may still be possible to open an account with the help of a parent or guardian. A few brokerage firms offer custodial accounts, which are held in the name of minors, but managed by adults.
How much do you need to open a brokerage account?
The amount of capital required to start a brokerage account differs depending on the broker and type of account. Some brokers may require a minimum of $500 or $1,000 to open a regular account, while others may not have any minimum balance requirement. It all depends on the institution and the account you select.
What is a taxable brokerage account?
A taxable brokerage account is a type of investment account funded with after-tax dollars, meaning the money you put in has already been taxed at your marginal tax rate. Capital gains tax is typically assessed on the profits you make when you sell an asset for more than you paid for it, and is based on how long you hold the asset.
If held for a year or less, short-term capital gains are taxed at your ordinary income tax rate; if held for more than a year, the profits are considered long-term capital gains and are taxed at a lower rate.
Additionally, any dividends or interest earned from your investments in the account are considered taxable income, and must be reported and taxed accordingly. To ensure you make the most informed decisions and minimize your tax liability, consult a financial professional or tax advisor before investing.
A 401(k) plan is a retirement savings plan in which employees contribute to a tax-deferred account via paycheck deductions (and often with an employer match). A pension plan is a different kind of retirement savings plan in which a company sets money aside to give to future retirees.
Over the past few decades, defined-contribution plans like the 401(k) have steadily replaced pension plans as the private-sector, employer-sponsored retirement plan of choice. While both a 401(k) plan and a pension plan are employer-sponsored retirement plans, there are some significant differences between the two.
Here’s what you need to know about a 401(k) vs. pension.
What Is the Difference Between a Pension and a 401(k)?
The main distinction between a 401(k) vs. a pension plan is that pension plans are largely employer driven, while 401(k)s are employee driven.
These are some of the key differences between the two plans.
Pension
401(k)
Funding
Typically funded by employers
Funded mainly by the employee; employer may offer a partial matching contribution
Contributions
No more than $275,000 in 2024 or 100% of employee’s average compensation for the highest 3 consecutive years
$23,000 ($30,500 for those 50 and up) for 2024. Contributions from employee and employer cannot exceed $69,000 (or $76,500 for those 50 and up) in 2024
Investments
Employers choose the investments for the plan
Employees choose the investments from a list of options
Value of the Plan
Set amount designed to be guaranteed for life
Determined by how much the employee contributes, the investments they make, and the performance of the investments
Funding
Employees typically fund 401(k) plans through regular contributions from their paychecks to help save for retirement, while employers typically fund pension plans.
Investments
Employees can choose investments (from several options) in their 401(k). Employers choose the investments that fund a pension plan.
Value
The value of a 401(k) plan at retirement depends on how much the employee has saved, in addition to the performance of the investments over time. Pensions, on the other hand, are designed to guarantee an employee a set amount of income for life. 💡 Quick Tip: The advantage of opening a Roth IRA and a tax-deferred account like a 401(k) or traditional IRA is that by the time you retire, you’ll have tax-free income from your Roth, and taxable income from the tax-deferred account. This can help with tax planning.
Pension Plan Overview
A pension plan is a type of retirement savings plan where an employer contributes funds to an investment account on behalf of their employees. The earnings are paid out to the employees once they retire.
Types of Pension Plans
There are two common types of pension plans:
• Defined-benefit pension plans, also known as traditional pension plans, are the most common type of pension plans. These employer-sponsored retirement investment plans are designed to guarantee the employee will receive a set benefit amount upon retirement (usually calculated with set parameters, i.e. employee earnings and years of service). Regardless of how the investment pool performs, the employer guarantees pension payments to the retired employee. If the plan assets aren’t enough to pay out to the employee, the employer is typically on the hook for the rest of the money.
According to the IRS, contributions to a defined-benefit pension plan cannot exceed 100% of the employee’s average compensation for the highest three consecutive calendar years of their employment or $265,000 for tax year 2023 and $275,000 for 2024.
• Defined-contribution pension plans are employer-sponsored retirement plans to which employers make plan contributions on their employee’s behalf and the benefit the employee receives is based solely on the performance of the investment pool. Meaning: There is no guarantee of a set monthly payout.
Like 401(k) plans, employees can contribute to these plans, and in some cases, employers match the contribution made by the employee. Unlike defined-benefit pension plans, however, the employee is not guaranteed a certain amount of money upon retirement. Instead, the employee receives a payout based on the performance of the investments in the fund.
Recommended: What Is a Money Purchase Pension Plan (MPPP)?
When it comes to pension plan withdrawals, employees who take out funds before the age of 59 ½ must pay a 10% early withdrawal penalty as well as standard income taxes. This is similar to the penalties and taxes associated with early withdrawal from a traditional 401(k) plan.
Pros and Cons
There are benefits to and drawbacks of pension plans. It’s important to understand both in order to maximize your participation in the plan.
Advantages of a pension plan include:
Funded by employers
For employees, a pension plan is retirement income from your employer. In most cases, an employee does not need to contribute to a defined-benefit pension plan in order to get consistent payouts upon retirement.
Higher contribution limits
When compared to 401(k)s, defined-contribution pension plans have significantly higher contribution limits and, as such, present an opportunity to set aside more money for retirement.
A set amount in retirement
A pension plan typically provides employees with regular fixed payments in retirement,usually for life.
Disadvantages of a pension plan include:
Lack of control
Employees can’t choose how the money in a pension plan is invested. If the investments don’t pan out, the plan could struggle to pay out the funds.
Vesting
Employees may need to work for the employer for a set number of years to become fully vested in the plan. If you leave the company before then, you might end up forfeiting the pension funds. Find out what the vesting schedule is for your pension plan.
Earnings and years employed
How much an employee gets in retirement with a pension plan generally depends on their salary and how long they work for the employer.
401(k) Overview
A traditional 401(k) plan is a tax-advantaged defined-contribution plan where workers contribute pre-tax dollars to the investment account via automatic payroll deductions. These contributions are sometimes fully or partially matched by their employers, and withdrawals are taxed at the participant’s marginal tax rate.
With a 401(k), employees and employers may both make contributions to the account (up to a certain IRS-established limit), but employees are responsible for selecting the specific investments. They can typically choose from offerings from the employer, which may include a mixture of stocks and bonds that vary in levels of risk depending on when they plan to retire.
Recommended: 401(a) vs 401(k): What’s the Difference?
Contribution Limits and Withdrawals
To account for inflation, the IRS periodically adjusts the maximum amount an employer or employee can contribute to a 401(k) plan.
• For 2024, annual employee contributions can’t exceed $23,000 for workers under 50, and $30,500 for workers 50 and older (this includes a $7,500 catch-up contribution). The total annual contribution by employer and employee in 2024 is capped at $69,000 for workers under 50, and $76,500 for workers 50 and over.
• For 2023, annual employee contributions can’t exceed $22,500 for workers under 50, and $30,000 for workers 50 and older (this includes a $7,500 catch-up contribution). The total annual contribution paid by employer and employee in 2023 is capped at $66,000 for workers under 50, and $73,500 for workers 50 and over.
Some plans allow employees to make additional after-tax contributions to their 401(k) plan, within the contribution limits outlined above.
• Money can be withdrawn from a 401(k) in retirement without penalties. But taxes will be owed on the funds withdrawn. The IRS considers the removal of 401(k) funds before the age of 59 ½ an “early withdrawal.” The penalty for removing funds before that time is an additional tax of 10% of the withdrawal amount (there are exceptions, notably a hardship distribution, where plan participants can withdraw funds early to cover “immediate and heavy financial need”).
Pros and Cons
While a 401(k) plan might not offer as clearly-defined a retirement savings picture as a pension plan, it still comes with a number of upsides for participants who want a more active role in their retirement investments.
Advantages of a 401(k) include:
Self-directed investment opportunities
Unlike employer-directed pension plans, in which the employee has no say in the investment strategy, 401(k) plans offer participants more control over how much they invest and where the money goes (within parameters set by their employer). Plans typically offer a selection of investment options, including mutual funds, individual stocks and bonds, exchange traded funds (ETFs).
Tax advantages
Contributions to a 401(k) come from pre-tax dollars through payroll deductions, reducing the gross income of the participant, which may allow them to pay less in income taxes. Also, 401(k) contributions and earnings in the plan may grow tax-deferred.
Employer matching
Many 401(k) plan participants are eligible for an employer match up to a certain amount, which essentially means free money.
Disadvantages of a 401(k) include:
No guaranteed amount in retirement
How much you have in your 401(k) by retirement depends on how much you contributed to the plan, whether your employer offered matching funds, and how the investments you chose fared.
Contributions are capped
The amount you can contribute to a 401(k) annually is capped by the IRS, as described above.
Less stability
How the market performs generally affects the performance of 401(k) investments. That could make it difficult to know how much money you’ll have for retirement, which could complicate retirement planning. 💡 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.
Which Is Better, a 401(k) or a Pension Plan?
When considering a 401(k) vs. pension, most people prefer the certainty that comes with a pension plan.
But for those who seek more control over their retirement savings and more investment vehicles to choose from, a 401(k) plan could be the more advantageous option.
In the case of the 401(k), it really depends on how well the investments perform over time. Without the safety net of guaranteed income that comes with a pension plan, a poorly performing 401(k) plan has a direct effect on a retiree’s nest egg.
Did 401(k)s Replace Pension Plans?
The percentage of private sector employees whose only retirement account is a defined benefit pension plan is just 4% today, versus 60% in the early 1980s. The majority of private sector companies stopped funding traditional pension plans in the last few decades, freezing the plans and shifting to defined-contribution plans like 401(k)s.
When a pension fund isn’t full enough to distribute promised payouts, the company still needs to distribute that money to plan participants. In several instances in recent decades, pension fund deficits for large enterprises like airlines and steel makers were so enormous they required government bailouts.
To avoid situations like this, many of today’s employers have shifted the burden of retirement funding to their workers.
What Happens to a 401(k) or Pension Plan If You Leave Your Job?
With a 401(k), if you leave your job, you can take your 401(k) with you by rolling it over to your new employer’s 401(k) plan or into an IRA. The process is fairly easy to do.
If you leave your job and you have a pension plan, however, the plan generally stays with your employer. You’ll need to keep track of it through the years and then apply in retirement to begin receiving your money.
The Takeaway
Pension plans are employer-sponsored, employer-funded retirement plans that are designed to guarantee a set income to participants for life. On the other hand, 401(k) accounts are employer-sponsored retirement plans through which employees make their own investment decisions and, in some cases, receive an employer match in funds. The post-retirement payout varies depending on market fluctuations.
While pension plans are far more rare today than they were in the past, if you have worked at a company that offers one, that money will still come to you after retirement even if you change jobs, as long as you stayed with the company long enough for your benefits to vest.
Some people have both pensions and 401(k) plans, but there are also other ways to take an active role in saving for retirement. An IRA is an alternative to 401(k) and pension plans that allows anyone to open a retirement savings account. IRAs have lower contribution limits but a larger selection of investments to choose from. And it’s possible to have an IRA in addition to a 401(k) or pension plan.
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 have both a 401(k) and a pension plan?
Yes. An individual can have both a pension plan and a 401(k) plan, though the two plans may not be from the same employer. If an employee leaves a company after becoming eligible for a pension and opens a 401(k) with a new employer, their previous employer will still typically maintain their pension. An employee can access the pension funds by applying for them in retirement.
How much should I put in my 401k if I have a pension?
If you have both a pension and a 401(k), it’s wise to contribute as much as you can to your 401(k) up to the annual contribution limit. While a pension can help supplement your retirement income, it may not be enough to cover all your retirement expenses, so contributing to your 401(k) can help fill the gap. One rule of thumb says to contribute at least 10% of your salary to a 401(k) if possible to help ensure that you’ll have enough savings for retirement.
Photo credit: iStock/Sam Edwards
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
SoFi Invest® INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected]. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
A traditional 401(k) and a Roth 401(k) are tax-advantaged retirement plans that can help you save for retirement. While both types of accounts follow similar rules — they have the same contribution limits, for example — the impact of a Roth 401(k) vs. traditional 401(k) on your tax situation, now and in the future, may be quite different.
In brief: The contributions you make to a traditional 401(k) are deducted from your gross income, and thus may help lower your tax bill. But you’ll owe taxes on the money you withdraw later for retirement.
Conversely, you contribute after-tax funds to a Roth 401(k) and can typically withdraw the money tax free in retirement — but you don’t get a tax break now.
To help choose between a Roth 401(k) vs. a traditional 401(k) — or whether it might make sense to invest in both, if your employer offers that option — it helps to know what these accounts are all about.
5 Key Differences Between Roth 401(k) vs Traditional 401(k)
Before deciding on a Roth 401(k) or traditional 401(k), it’s important to understand the differences between each account, and to consider the tax benefits of each in light of your own financial plan. The timing of the tax advantages of each type of account is also important to weigh.
1. How Each Account is Funded
• A traditional 401(k) allows individuals to make pre-tax contributions. These contributions are typically made through elective salary deferrals that come directly from an employee’s paycheck and are deducted from their gross income.
• Employees contribute to a Roth 401(k) also generally via elective salary deferrals, but they are using after-tax dollars. So the money the employee contributes to a Roth 401(k) cannot be deducted from their current income.
💡 Quick Tip: The advantage of opening a Roth IRA and a tax-deferred account like a 401(k) or traditional IRA is that by the time you retire, you’ll have tax-free income from your Roth, and taxable income from the tax-deferred account. This can help with tax planning.
2. Tax Treatment of Contributions
• The contributions to a traditional 401(k) are tax-deductible, which means they can reduce your taxable income now, and they grow tax-deferred (but you’ll owe taxes later).
• By contrast, since you’ve already paid taxes on the money you contribute to a Roth 401(k), the money you contribute isn’t deductible from your gross income, and withdrawals are generally tax free (some exceptions below).
3. Withdrawal Rules
• You can begin taking qualified withdrawals from a traditional 401(k) starting at age 59 ½, and the money you withdraw is taxed at ordinary income rates.
• To withdraw contributions + earnings tax free from a Roth 401(k) you must be 59 ½ and have held the account for at least five years (often called the 5-year rule). If you open a Roth 401(k) when you’re 57, you cannot take tax-free withdrawals at 59 ½, as you would with a traditional 401(k). You’d have to wait until five years had passed, and start tax-free withdrawals at age 62.
4. Early Withdrawal Rules
• Early withdrawals from a 401(k) before age 59 ½ are subject to tax and a 10% penalty in most cases, but there are some exceptions where early withdrawals are not penalized, including certain medical expenses; a down payment on a first home; qualified education expenses.
You may also be able to take a hardship withdrawal penalty-free, but you need to meet the criteria, and you would still owe taxes on the money you withdrew.
• Early withdrawals from a Roth 401(k) are more complicated. You can withdraw your contributions at any time, but you’ll owe tax proportional to your earnings, which are taxable when you withdraw before age 59 ½.
For example: If you have $100,000 in a Roth 401(k), including $90,000 in contributions and $10,000 in taxable gains, the gains represent a 10% of the account. Therefore, if you took a $20,000 early withdrawal, you’d owe taxes on 10% to account for the gains, or $2,000.
5. Required Minimum Distribution (RMD) Rules
With a traditional 401(k), individuals must take required minimum distributions starting at age 73, or face potential penalties. While Roth 401(k)s used to have RMDs, as of January 2024, they no longer do. That means you are not required to withdraw RMDs from a Roth 401(k) account.
For a quick side-by-side comparison, here are the key differences of a Roth 401(k) vs. traditional 401(k):
Traditional 401(k)
Roth 401(k)
Funded with pre-tax dollars.
Funded with after-tax dollars.
Contributions are deducted from gross income and may lower your tax bill.
Contributions are not deductible.
All withdrawals taxed as income.
Withdrawals of contributions + earnings are tax free after 59 ½, if you’ve had the account for at least 5 years. (However, matching contributions from an employer made with pre-tax dollars are subject to tax.)
Early withdrawals before age 59 ½ are taxed as income and are typically subject to a 10% penalty, with some exceptions.
Early withdrawals of contributions are not taxed, but earnings may be taxed and subject to a 10% penalty.
Account subject to RMD rules starting at age 73.
No longer subject to RMD rules as of January 2024.
Bear in mind that a traditional 401(k) and Roth 401(k) also share many features in common:
• The annual contribution limits are the same for a 401(k) and a Roth 401(k). For 2024, the total amount you can contribute to these employer-sponsored accounts is $23,000; if you’re 50 and older you can save an additional $7,500 for a total of $30,500. This is an increase over the 2023 limit, which was capped at $22,500 ($30,000 if you’re 50 and older).
• For both accounts, employers may contribute matching funds up to a certain percentage of an employee’s salary.
• In 2024, total contributions from employer and employee cannot exceed $69,000 ($76,500 for those 50 and up). In 2023, total contributions from employer and employee cannot exceed $66,000 ($73,500 for those 50 and up).
• Employees may take out a loan from either type of account, subject to IRS restrictions and plan rules.
Because there are certain overlaps between the two accounts, as well as many points of contrast, it’s wise to consult with a professional when making a tax-related plan.
Recommended: Different Types of Retirement Plans, Explained
How to Choose Between a Roth and a Traditional 401(k)
In some cases it might make sense to contribute to both types of accounts (more on that below), but in other cases you may want to choose either a traditional 401(k) or a Roth 401(k) to maximize the specific advantages of one account over another. Here are some considerations.
When to Pay Taxes
Traditional 401(k) withdrawals are taxed at an individual’s ordinary income tax rate, typically in retirement. As a result these plans can be most tax efficient for those who will have a lower marginal rate after they retire than they did while they were working.
In other words, a traditional 401(k) may help you save on taxes now, if you’re in a higher tax bracket — and then pay lower taxes in retirement, when you’re ideally in a lower tax bracket.
On the other hand, an investor might look into the Roth 401(k) option if they feel that they pay lower taxes now than they will in retirement. In that case, you’d potentially pay lower taxes on your contributions now, and none on your withdrawals in retirement.
Your Age
Often, younger taxpayers may be in a lower tax bracket. If that’s the case, contributing to a Roth 401(k) may make more sense for the same reason above: because you’ll pay a lower rate on your contributions now, but then they’re completely tax free in retirement.
If you’re older, perhaps mid-career, and in a higher tax bracket, a traditional 401(k) might help lower your tax burden now (and if your tax rate is lower when you retire, even better, as you’d pay taxes on withdrawals but at a lower rate).
Where You Live
The tax rates where you live, or where you plan to live when you retire, are also a big factor to consider. Of course your location some years from now, or decades from now, can be difficult to predict (to say the least). But if you expect that you might be living in an area with lower taxes than you are now, e.g. a state with no state taxes, it might make sense to contribute to a traditional 401(k) and take the tax break now, since your withdrawals may be taxed at a lower rate. 💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.
The Benefits of Investing in Both a Roth 401(k) and Traditional 401(k)
If an employer offers both a traditional and Roth 401(k) options, employees might have the option of contributing to both, thus taking advantage of the pros of each type of account. In many respects, this could be a wise choice.
Divvying up contributions between both types of accounts allows for greater flexibility in tax planning down the road. Upon retirement, an individual can choose whether to withdraw money from their tax-free 401(k) account or the traditional, taxable 401(k) account each year, to help manage their taxable income.
It is important to note that the $23,000 contribution limit ($30,500 for those 50 and older) for 2024 is a total limit on both accounts.
So, for instance, you might choose to save $13,500 in a traditional 401(k) and $9,500 in a Roth 401(k) for the year. You are not permitted to save $23,000 in each account.
What’s the Best Split Between Roth and Traditional 401(k)?
The best split between a Roth 401(k) and a traditional 401(k) depends on your individual financial situation and what might work best for you from a tax perspective. You may want to do an even split of the $23,000 limit you can contribute in 2024. Or, if you’re in a higher tax bracket now than you expect to be in retirement, you might decide that it makes more sense for you to put more into your traditional 401(k) to help lower your taxable income now. But if you expect to be in a higher income tax bracket in retirement, you may want to put more into your Roth 401(k).
Consider all the possibilities and implications before you decide. You may also want to consult a tax professional.
The Takeaway
Employer-sponsored Roth and traditional 401(k) plans offer investors many options when it comes to their financial goals. Because a traditional 401(k) can help lower your tax bill now, and a Roth 401(k) generally offers a tax-free income stream later — it’s important for investors to consider the tax advantages of both, the timing of those tax benefits, and whether these accounts have to be mutually exclusive or if it might benefit you to have both.
When it comes to retirement plans, investors don’t necessarily have to decide between a Roth or traditional 401(k). Some might choose one of these investment accounts, while others might find a combination of plans suits their goals. After all, it can be difficult to predict your financial circumstances with complete accuracy — especially when it comes to tax planning — so you may decide to hedge your bets and contribute to both types of accounts, if your employer offers that option.
Another step to consider is a 401(k) rollover, where you move funds from an old 401(k) into an IRA. When you do a 401(k) rollover it can help you manage your retirement funds.
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
Is it better to contribute to 401(k) or Roth 401(k)?
Whether it’s better to contribute to a traditional 401(k) or Roth 401(k) depends on your particular financial situation. In general, if you expect to be in a lower tax bracket in retirement, a traditional 401(k) may make more sense for you since you’ll be able to deduct your contributions when you make them, which can lower your taxable income, and then pay taxes on the money in retirement, when you’re in a lower income tax bracket.
But if you’re in a lower tax bracket now than you think you will be later, a Roth 401(k) might be the preferred option for you because you’ll generally withdraw the money tax-free in retirement.
Can I max out both 401(k) and Roth 401(k)?
No, you cannot max out both accounts. Per IRS rules, the annual 401(k) limits apply across all your 401(k) accounts combined. So for 2024, you can contribute a combined amount up to $23,000 (or $30,500 if you’re 50 or older) to your Roth 401(k) and your traditional 401(k) accounts.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
SoFi Invest® INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
No matter what age you are, it’s never too soon to start thinking about — and actively saving for — your retirement. With reports coming out regularly about the severe retirement savings gap in the U.S., it seems as though the majority of Americans are vastly underprepared for this life event.
If your employer offers a 401(k) at your place of work, this is a great way to get started (or continue) saving for your golden years. Before you jump in, find out exactly what a 401(k) is and how it can help you prepare for retirement. If you already contribute to a 401(k) plan, make sure you know what to expect when it comes time to retire.
How does a 401(k) work?
A 401(k) plan helps you save while investing your contributions in various mutual funds. Employers offer this type of retirement plan, so you can’t sign up for one unless you go through your place of work.
As an incentive to save, you receive a tax break. Depending on the type of 401(k) you choose (or your company offers), you either receive that tax break when you make the contribution or when it comes time to withdrawal.
Employer 401(k) Matching
Many employers offer a match to any contribution you make. This usually happens in one of two ways: they’ll either match dollar for dollar up to a certain limit or up to a percentage of your salary.
The most common type of 401(k), the traditional 401(k), allows you to make any contribution tax-deductible each year. So if you contribute $6,000 a year, you get to knock that off your taxable income amount. If you’re on the edge of a tax bracket and make a sizeable 401(k) contribution, you might even be able to jump down into a different bracket with a lower tax rate.
401(k) Tax Rules
While your investments continue to grow each year, they remain temporarily protected from taxation. Unlike other types of investments, you don’t pay any annual tax on your 401(k) earnings until you start to make withdrawals. At that point, you’ll be subject to regular income tax when you take out money each month.
As you continue to make 401(k) contributions throughout your year, you can adjust your investments to become increasingly less volatile. The idea is that as you get closer to retirement age, you have less risk to ensure a solid nest egg when you need it.
The Benefits of a 401(k)
A 401(k) is a retirement savings plan sponsored by an employer. It allows employees to save and invest a portion of their paycheck before taxes are taken out. Contributions to a 401(k) are made with pretax dollars, which can lower your taxable income in the current year and potentially result in a lower tax bill.
Some other benefits of a 401(k) include:
Employer matching contributions: Many employers will match a portion of their employees’ 401(k) contributions, effectively giving you free money to save for retirement.
Tax-deferred growth: Any investment earnings on your 401(k) account grow tax-free until you withdraw the money in retirement.
Potential for tax credits: Depending on your income and participation in a 401(k) or other qualified retirement plan, you may be eligible for certain tax credits that can help reduce your tax liability.
Retirement income: A 401(k) can provide a source of income in retirement, which can help you maintain your standard of living when you are no longer working.
Convenience: Many 401(k) plans offer a range of investment options, and the contributions are automatically deducted from your paycheck, making it easy to save for the future.
The money you withdraw from a 401(k) in retirement is subject to income tax, and 401(k) plans have contribution limits. However, overall, a 401(k) can be a valuable tool for saving for the future and reducing your tax liability.
401(k) Contribution Limits
There are limits to your 401(k):
While it’s a great financial tool, you can only contribute up to $22,500 each year, amounting to $1,875 per month if you divide it out monthly. If you’re over the age of 50, you’re allowed to contribute up to $30,000 a year ($2,500 per month). These contribution limits are in place so that you can only benefit from so much tax savings each year.
Required Minimum Distributions
Another rule associated with a 401(k) is that you must start taking “required minimum distributions” at some point. That means once you hit a certain age, you must begin withdrawing funds from your 401(k) account — and paying taxes on them.
Currently, the requirement is that you start taking distributions the year after you turn 70 ½. Then you have to take out distributions by December 31 of each following year. Your minimum required amount is determined by the IRS based on your life expectancy. There’s nothing quite like a government tax agency predicting your lifespan, is there?
Still, this information helps you determine what kind of tax burden you can expect when you’ve finally retired. While your income may be lower, your deductions might be as well. After all, you probably don’t have kids left at home to claim as a deduction. And if you’ve paid off your mortgage, you won’t have that interest to deduct either.
It’s great not to have those expenses, but it can be helpful to talk to a tax professional to get a better idea of your taxes, especially in that first year of retirement or required minimum distributions. The more prepared you are, the more financial flexibility you can have!
401(K) Plan Types
There are two main types of 401(k) plans: traditional 401(k)s and Roth 401(k)s.
A traditional 401(k) allows you to contribute pretax dollars to your account. Your contributions and any investment earnings in the account are tax-deferred. This means you won’t have to pay taxes on them until you withdraw the money in retirement. When you withdraw the money in retirement, it is taxed as ordinary income.
A Roth 401(k) is similar to a traditional 401(k), but contributions are made with after-tax dollars. This means you won’t get an immediate tax break on your contributions, but qualified withdrawals from the account in retirement are tax-free.
Some 401(k) plans may offer both traditional and Roth options, allowing you the flexibility to choose the type of plan that best meets your needs.
There are also types of 401(k) plans that are designed for specific types of employers, such as safe harbor 401(k)s and SIMPLE 401(k)s. These plans may have different contribution limits and rules for employer matching contributions. So, it’s important to understand the details of the plan you are enrolled in.
What’s the difference between a traditional 401(k) and a Roth 401(k)?
While a traditional 401(k) offers upfront tax savings in return for taxes paid later during retirement, a Roth 401(k) flips the situation around. Instead, your contributions are made with your taxable income. In return, you don’t have to pay any taxes when you start withdrawing from your account during retirement.
While you miss out on tax savings upfront, you’re only paying on the original contribution amount. If you had to pay taxes when you withdraw, you’re also paying taxes on everything you’ve earned, which is hopefully a lot more money than you started with.
Roth 401(k) Requirements
There are requirements to qualify for the Roth 401(k) benefits:
First, your account must be open for at least five years. You also have to wait until you’re at least 59 ½ before you can start taking distributions, unless you’ve had a disability.
A Roth IRA is particularly useful if you’ve accumulated a lot in retirement savings and other investments. While many people have less income when they retire, that’s not always the case. You may have a comprehensive portfolio of investments, in which case you could be better served by not paying taxes on at least part of your withdrawals.
If you’re nearing retirement and expect to drop in your tax bracket soon, there may be no sense in using a Roth 401(k) now. A Roth 401(k) can be a great choice if you have a lower income now because you’re earlier in your career or have tons of tax deductions because of kids and a mortgage.
Like all retirement plans, there are better products for different points in your life. By constantly reassessing how you contribute to your retirement savings, you can maximize your tax benefits now and in the future.
See also: IRA vs. 401(k): Where Should You Invest Your Money?
Employer Contribution Match
An employer contribution match is a feature of some 401(k) plans in which the employer agrees to contribute a certain amount of money to an employee’s 401(k) account based on employee contributions.
For example, an employer might offer a 50% employer match on the first 6% of an employee’s salary that the employee contributes to their 401(k) account. In this case, if the employee contributes 6% of their salary to their 401(k), the employer would contribute an additional 3% (50% of the employee’s contribution).
Employer contributions are a way for employers to encourage their employees to save for retirement and to provide an additional source of retirement income for their employees. Employers may also use contribution matching as a way to attract and retain top talent.
Employer contribution matches may have certain rules and requirements, such as vesting periods, that determine when an employee becomes fully entitled to employer contributions. Make sure you understand the details of any employer contribution match offered by your employer to make the most of this benefit.
What happens if you leave your job?
Don’t worry. You don’t lose your 401(k) savings if you leave your current employer. You typically have a few different options available to you. First, you can leave it in the company plan if they allow it. You won’t be able to continue making contributions or any changes to your allocations. But you can access it when you’re ready to retire.
401(k) Rollover
Or you can do a rollover:
A rollover allows you to switch the funds to another retirement plan without paying any tax penalties. You can either do an IRA rollover or use a plan from your new employer. You do need to make sure your new employer’s plan allows for rollovers.
Then you can continue your contributions as normal, following the rules of the new account, whatever it may be. An IRA is always a viable option because you’re in control of how you invest. And while the annual contribution limit is $6,500 (or $7,500 if you’re 50 or older), it doesn’t count when you’re rolling over funds.
Your final option for handling your 401(k) when you leave your job is to cash it out. If you do this, you’ll be subject to all the relevant penalties. These include a 10% early withdrawal penalty and income taxes for both federal and state. The exception to the early withdrawal penalty is if you are at least 55 years old when you leave your employer.
How much should you contribute to your 401(k)?
How much you decide to contribute to your 401(k) should depend on numerous factors. At the very least, you should contribute the maximum amount allowed to receive a matching contribution from your employer. That essentially equals free money, which you should never pass up.
Next, think about your financial picture as a whole. What kind of debt do you have? If you have any high-interest credit card or loan balances, you may want to focus your efforts on paying those down before contributing more to your retirement plan. Lower interest debts, like a fixed student loan, may not be as pressing to repay.
Furthermore, consider these recommended saving strategies:
Emergency Fund
You’ll probably want a three to six-month emergency fund in case you lose your job or get a sudden illness or injury. Having a large chunk of money stashed away in an easy-to-access savings account can provide you with financial security here and now.
Roth IRA
Once you’ve got your overall savings plan in order, it’s time to start figuring out where else to invest for retirement. Before you max out your traditional 401(k), think about picking up a Roth IRA. This helps you diversify your retirement plans for tax purposes.
Like a Roth 401(k), a Roth IRA lets you pay taxes on your contributions now, so you don’t have to pay anything when you make withdrawals during retirement. It can certainly help you spread out your tax burdens over the course of your life.
Still have money left over to invest?
If you do, revisit your 401(k). Remember, you can contribute up to $22,500 so you can certainly divert more of your income towards that maximum.
How else should you prepare for retirement?
Preparing for retirement takes a constant reassessment of your current needs versus your future goals. As easy as it is to say, “You need to contribute this-many-thousands of dollars a year to survive retirement,” the reality is that it’s much harder to actually do that.
But saving for retirement is still a challenge worth conquering. Even if you’re in your 40s and haven’t started saving a dime, you can start today. Once you’ve got your current savings fund in place that you can use for emergencies, implement some of these easy tips to get ready for retirement.
For now, worry less about picking the perfect type of account and focus on the habit of retirement saving.
Here are some ideas to get you started:
How to Save Extra Money:
Downsize your living expenses, one step at a time.
Place your tax refund into a retirement account.
Stream television instead of paying for cable.
Cut back on eating out.
Stay healthy to reduce future healthcare costs.
Pay down high interest debt like credit cards.
Sell your stuff and put the money towards retirement.
How to Strategically Manage Your Retirement Accounts:
Create a retirement savings goal as a percentage of your income.
Pay yourself first by setting up auto direct deposit to your retirement account on payday.
Take advantage of higher IRA contribution limits when you’re 50+.
Audit your accounts every year.
Consolidate multiple accounts (like IRAs) to reduce fees.
Put your end-of-year bonus into a retirement account.
Bottom Line
Investing in your retirement is really investing in yourself. Taking advantage of your employer’s 401(k) is an important part of the equation. In addition to making regular contributions, be sure to explore all of your options for financing your retirement. A healthy portfolio mix isn’t difficult to develop, and there are plenty of resources available to help you get started.