Apache is functioning normally
Our goal here at Credible Operations, Inc., NMLS Number 1681276, referred to as “Credible” below, is to give you the tools and confidence you need to improve your finances. Although we do promote products from our partner lenders who compensate us for our services, all opinions are our own.
Apache is functioning normally
Our goal here at Credible Operations, Inc., NMLS Number 1681276, referred to as “Credible” below, is to give you the tools and confidence you need to improve your finances. Although we do promote products from our partner lenders who compensate us for our services, all opinions are our own.
Apache is functioning normally
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.
SOIN0124032
Source: sofi.com
Apache is functioning normally
Our goal here at Credible Operations, Inc., NMLS Number 1681276, referred to as “Credible” below, is to give you the tools and confidence you need to improve your finances. Although we do promote products from our partner lenders who compensate us for our services, all opinions are our own.
Apache is functioning normally
Key takeaways
- Jumbo loans are large-amount mortgages, generally used to buy more expensive properties.
- The size of a jumbo varies by geographic location, but it generally means a loan of more than $766,550 in most parts of the U.S. (as of 2024).
- The interest rates on jumbo loans are different (usually higher) than those on regular, conforming mortgages.
- Jumbo loans have stricter criteria for borrowers: a higher credit score, larger income/assets, and bigger down payments.
A jumbo loan is a mortgage for an amount that exceeds the standard loan size, as set by the federal government. If you’re buying a mansion — or just a regular home in a highly pricey neighborhood — you’ll need an extra amount of financing to get it.
It’s not just the principal amount, though: Everything on these mortgages can be super-sized. Let’s look at what jumbo loans are, and when you need one.
What is a jumbo loan?
As the name implies, a jumbo loan covers a larger-than-normal loan amount. More specifically, a jumbo loan is any mortgage that exceeds an area’s conforming loan limits, which are set yearly by the Federal Housing and Finance Agency (FHFA).
Many mortgage lenders offer jumbo loans up to $3 million or $5 million. You might be able to find jumbo loans in even higher amounts, especially if you work with a mortgage broker who specializes in them.
Jumbo loans can be used for primary residences, investment properties and vacation homes.
How do jumbo loans work?
Despite their “nonconforming” status, jumbo loans aren’t much different from traditional mortgages when it comes to the way they work. The payment schedules and other details are generally the same. Borrowers can get fixed- or adjustable-rate jumbo mortgages with various term options.
However, the interest rates on jumbo loans often differ from their conforming loan counterparts. Historically, they’ve been higher; however, the gap has closed of late. As of April 1, 2024, the 30-year jumbo rate was 7.06 percent, according to Bankrate’s survey of national lenders, vs. 6.93 percent for the traditional 30-year fixed loan. Part of the reason for this is an increase in guaranteed fees charged on conforming loans to lenders by Fannie Mae and Freddie Mac.
The maximum size of a jumbo loan varies by your mortgage lender and location, as does the exact qualifying guidelines. Because the market for jumbo loans is smaller, you might need to shop around a bit more to find one. It’s usually beneficial to work with a mortgage lender who specializes in them.
Jumbo loans vs. conforming loans
Most loans are conforming loans, meaning they conform to, or follow, specific criteria followed by Fannie Mae and Freddie Mac, the government-sponsored enterprises that buy most U.S. home loans. Jumbo loans do not adhere to these criteria; hence, they fall into the financing category of nonconforming loans.
You’ll have more buying power with a jumbo loan than with a conforming loan, but you’ll pay more in interest since your balance is bigger. To qualify for a jumbo loan, you’ll need a higher credit score — and possibly a higher income, down payment or more assets — than you would for a conforming loan. For example, U.S. Bank calls for a minimum 740 credit score to be considered for a jumbo loan versus 620 for a conforming loan.
Jumbo loan limits
You need a jumbo loan if you want to finance a property that costs more than a certain amount the FHFA sets for your state each year. If a mortgage exceeds the FHFA’s conforming loan limit, market-makers Fannie Mae and Freddie Mac won’t back or purchase it, thus making it a riskier proposition for a lender.
For 2024, the limit for conforming loans for most of the continental U.S. is $766,550. In Hawaii, Alaska and certain counties where median home prices are significantly higher than average, the conforming loan limit goes up, too — as high as $1,149,825.
Because homes that cost above these sums require a jumbo loan, these ceilings are often referred to as “jumbo loan limits” — though technically, they’re the starting points for jumbos.
Loan limits by state
The table below provides state-by-state conforming loan limits for 2024. In many states, the limits vary by county, depending on how high-cost the real estate market is there.
How to qualify for a jumbo loan
Jumbo lenders typically impose stricter underwriting guidelines than conforming mortgage lenders do. Because the loans aren’t backed by Fannie or Freddie, jumbo mortgages pose more risk to the lender. Overall, if you want to take out one of these hefty loans, you will need to make sure your financial profile is very good or excellent.
There are three common hurdles borrowers must clear to get approved for a jumbo loan: income, credit score and cash reserves (for making a down payment).
Jumbo loan income requirements
Yes, it’ll help if you have a large income — and, just as importantly, if you have a low-debt-to-income (DTI) ratio, the percentage of your monthly income that goes to debt payments. If your outgo is a significant part of your incoming — like more than one-third — you might not qualify for a jumbo loan unless your credit score is excellent or you have a sizable amount of reserves or liquid assets.
Jumbo loan credit score
Higher credit scores are needed to qualify for a jumbo versus a conforming loan. You will need, at the very least, a minimum score of 700 (most likely) to qualify for one. “The average is around 740, although I have seen some as low as 660,” says Robert Cohan, president of Carlyle Financial based in San Francisco. “[But] if you’re high-leveraged and you have a low credit score, it’s going to be hard to get a jumbo loan.”
Keep in mind:
Most jumbo loans are conventional loans (offered by private lenders, vs. a government agency). One exception is the VA jumbo loan. Active military or veterans can qualify with a significantly lower credit score, like in the mid-to-low 600s.
Jumbo loan down payment
You may have to make a significant down payment to qualify for the jumbo loan. The down payment on a jumbo loan is typically 10 percent to 20 percent (and sometimes more). “Anything lower than a 10 percent down payment and you’re probably going to pay for it in higher rates,” says Cohan (assuming you can get the loan at all). Be prepared to show enough reserves, or liquid assets, to cover between six and 12 months’ mortgage payments.
Is a jumbo loan right for me?
Jumbos are meant for buyers with a substantial stable income and ample resources. You’ll need strong credit, a low debt-to-income ratio and at least six months of cash reserves to qualify.
Research the conforming loan limits in your region. If the homes you’re interested in buying do not fall within conforming loan guidelines, a jumbo loan might be an appropriate alternative — in fact, your only alternative, if you want to live in a high-cost county.
That said, a jumbo loan is not for you if it means you must stretch your finances to the brink to get one. Or if it means you’ll end up being house broke or house poor, meaning your homeownership costs squeeze out everything else in your budget.
Pros and cons of a jumbo loan
Jumbo loans can help you finance a large home purchase, however, you’ll pay more in interest over time than with a conforming loan. Here are some additional pros and cons:
Pros
- Allows you to borrow more than a traditional mortgage
- Competitive interest rates
- Opportunity to buy a more expensive home/live in a high-cost region
Cons
- A higher credit score is required to qualify, plus a larger annual income
- Must have cash reserves to cover 6 to 12 months of payments
- Higher interest rates
There may also be situations in which a jumbo loan loan makes sense. For instance:
- If you have to live in a more expensive part of the country
- If you see a good deal on a luxury piece of property
- If the jumbo loan rates are close to conforming loan rates (why not get more bang for your financing buck)
- If you have gotten, or expect to soon get, a windfall or big rise in income, so the cash reserve requirement is no problem (real estate isn’t the worst investment in the world)
Jumbo loan FAQ
-
If you would like to take out a jumbo mortgage, you’ll need to make sure your credit is very good to excellent, as a strong credit score is crucial for getting the best rates. Like any home loan, it is worth shopping around with lenders to see who might offer you the best rate. If you can put down a larger down payment — above and beyond the standard 20 percent — it may help you qualify for a lower rate as well.
-
The closing costs for a jumbo loan are similar to its conforming loan counterpart — 2 to 5 percent of the home’s purchase price. But while the percentage is the same, the property’s higher price means you’ll end up paying more in fees. For example, with 2 to 5 percent in closing costs, a loan on a $1 million dollar property could cost $20,000 to $50,000 in closing costs alone. For a $500,000 property, your costs would be half that range.
-
There are reduced tax benefits with a jumbo loan compared to a standard mortgage. For mortgages taken out after Dec. 16, 2017, the IRS allows for deducting home mortgage interest on the first $750,000 of mortgage debt, or $375,000 if you are married and file separate tax returns. So, taking out a jumbo loan could mean you will not be able to write off the entirety of your mortgage interest on federal tax returns each year. There are higher mortgage interest deductions, however, for homeowners whose mortgage was established before December 16, 2017. In that case, mortgage interest up to $1 million or $500,000 for those who are married filing separately, can be deducted on tax returns.
-
Yes, the Department of Veterans Affairs (VA) guarantees (it technically doesn’t offer) jumbo loans. The minimum financial requirements the VA sets are more lax than a conventional jumbo loan: you’ll need a 620 credit score and no cash reserves are required (though lenders may set higher requirements). If you’re a qualified buyer with your full VA entitlement, you may also not need a down payment. Bear in mind, though, that lenders may set their own stricter requirements.
-
You can refinance your jumbo loan, but it may be more difficult than refinancing a conforming loan. That’s largely because lenders have different financial requirements when it comes to jumbo mortgages, potentially limiting the pool of lenders you can work with. On top of that, jumbo loans come with higher closing costs, which makes your break-even period longer than it would with a conforming loan.
Additional reporting by Mia Taylor
Source: bankrate.com
Apache is functioning normally
A Roth IRA can be used to pay for college expenses, and it is possible to do so without incurring taxes or penalties. However, there are disadvantages of using a Roth IRA for college, and it’s important to weigh the pros and cons.
A Roth IRA is designed to help individuals save for retirement. While you can also use a Roth IRA for college expenses, you’ll want to understand the potential ramifications.
Here’s what you need to know about using a Roth IRA for college, plus other college savings options, to help make the best decision for your situation.
Can You Use a Roth IRA for College?
You can use a Roth IRA to help pay for college. However, as mentioned, a Roth IRA is primarily a vehicle for saving for retirement. You contribute after-tax dollars to the account (meaning you pay taxes on the contributions in the year you make them), and the money in the Roth IRA grows tax-free. You can generally withdraw the funds tax-free starting at age 59 ½. However, if you withdraw the money early, you may be subject to a 10% penalty.
But there are some ways to make early withdrawals from your Roth IRA to help pay for college without being penalized. Because you contribute to a Roth IRA with after-tax dollars, you can withdraw the contributions (but not the earnings) you’ve made to a Roth at any time without paying a penalty. You could then use those contributions to help pay for college.
Just be aware that there are annual contribution limits to a Roth IRA. In tax year 2023, you can contribute up to $6,500 (or $7,500 if you’re 50 or older), and in 2024 you can contribute up to $7,000 ($8,000 for those 50 or older). How much you’ve contributed will affect how much you have in contributions to withdraw, of course.
Another way to use a Roth IRA to pay for college without being penalized is by taking advantage of one of the Roth IRA exceptions that allow you to withdraw money from your account early. One of the exceptions is for qualified higher education expenses.
💡 Quick Tip: Did you know that you must choose the investments in your IRA? Once you open a new IRA and start saving, you get to decide which mutual funds, ETFs, or other investments you want — it’s totally up to you.
Do You Have To Pay Penalties if You Use a Roth IRA for College?
Typically, if you take out money from your Roth IRA before age 59 ½ , you will be subject to taxes and penalties. However, IRA withdrawal rules grant a few exceptions to this rule, and one of the exceptions is for qualified higher education expenses.
If you pay qualifying higher education expenses to a qualified higher education institution for your child, yourself, your spouse, or your grandchildren, you won’t have to pay the 10% penalty for withdrawing funds from a Roth IRA. Qualified higher education expenses include things like tuition, fees, books and supplies. However, you will still have to pay taxes on any earnings you withdraw from your Roth IRA.
Get a 2% IRA match. Tax season is now match season.
Get a 2% match on all your SoFi IRA contributions* through Tax Day (up to the annual contribution limits). Plus, you can still contribute to your 2023 IRAs until April 15th.
*Offer lasts through Tax Day, 4/15/24. Only offers made via ACH are eligible for the match. ACATs, wires, and rollovers are not included.
Pros and Cons of Using a Roth IRA for College
Whether using a Roth IRA for college is right for you depends on your particular situation. Here are the pros and cons you’ll want to consider.
Pros of Tapping Into a Roth IRA for College
Advantages of using a Roth IRA for college expenses include:
• You might not have to borrow as much money to pay for college. Using a Roth IRA for college expenses may reduce the need for student loans. And for some students, using money from a Roth IRA might make the difference between being able to afford to attend college or not.
• You won’t be penalized for withdrawing the money. Because of the exception for qualified higher education expenses, you can take out the money to pay for those expenses without having to pay the 10% penalty.
• If you withdraw just your contributions, you won’t owe taxes on that money.
Cons of Tapping Into a Roth IRA for College
These are the drawbacks of using a Roth IRA to pay for college:
• Your retirement savings will take a hit. This is the biggest disadvantage of using the money in a Roth IRA for college. While there are other ways to help cover the cost of college, there are generally fewer options to help you save for retirement if you spend your Roth IRA funds on college expenses.
• Because of possible compounding returns, even a few thousand dollars withdrawn from your Roth IRA today might mean missing out on tens of thousands of dollars of potential growth by the time you’re ready to retire years from now.
• Eligibility for financial aid could be affected. Another possible downside of using a Roth IRA for college is that the money you withdraw generally counts as income on the FAFSA (Federal Application for Federal Student Aid). That may limit financial aid you could receive, including grants and loans.
Roth IRA vs 529 for College
Before you decide to use a Roth IRA for college savings, you might want to consider a 529 plan. With a 529, you can save money for your child to go to college and withdraw the funds tax-free as long as they’re used for qualified higher education expenses.
A 529 plan has more generous contribution limits than a Roth IRA does, and other extended family members may also contribute to the plan. In addition, while 529 contributions aren’t deductible at the federal level, many states provide tax benefits for 529s.
💡 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 College Expenses Can a Roth IRA Be Used For?
According to the IRS, a Roth IRA can be used to pay for qualified higher education expenses. These qualified expenses include tuition, fees, books and supplies, and equipment required for enrollment or attendance.
The Takeaway
It’s possible to use a Roth IRA to help pay for qualified higher education expenses, and you typically won’t be subject to a penalty for doing so. However, taking funds out of your Roth IRA means you won’t have that money available for retirement. You’ll also lose out on any gains that may have compounded throughout the years. That could impact your retirement savings or even delay your retirement date.
Instead of using a Roth IRA for college, you may want to consider other ways to save for college that might better fit your financial needs, such as a 529 plan. That way you can save for both college and retirement.
Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
Help grow your nest egg with a SoFi IRA.
FAQ
Can you use a Roth IRA for college?
Yes, it is possible to use a Roth IRA for college expenses. If you withdraw money from a Roth IRA for qualified higher education expenses, you generally will not be subject to the 10% early withdrawal penalty. Tuition, fees, books, supplies, and equipment needed for enrollment or attendance are usually considered qualified expenses.
Is a Roth IRA better than a 529 for college?
Deciding whether to use a 529 plan or a Roth IRA for college will depend on your specific financial situation. In many cases, a 529 plan may make more sense than a Roth IRA for college savings. You can generally contribute more to a 529 plan each year than you can to a Roth IRA, there are tax advantages to the plan, and other relatives can also contribute to it. Plus, by using a 529, you won’t be taking money from your retirement savings.
Can I withdraw from my IRA for college tuition without penalty?
Yes, you can use a Roth IRA to pay for college tuition without penalty in most cases because tuition is generally considered a qualified higher education expense. However, to avoid taking money from your retirement savings, you may want to consider other college saving options instead, such as a 529 plan.
Photo credit: iStock/Tempura
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.
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.
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.
SOIN0224027
Source: sofi.com
Apache is functioning normally
Americans Believe They Will Need $1.46 Million to Retire Comfortably According to Northwestern Mutual 2024 Planning & Progress Study People’s ‘magic number’ for retirement rises faster than inflation, jumping 15% in just a year and a whopping 53% since 2020; while retirement savings falls to $88K The ‘Silver Tsunami’ is here: 11,000 Americans will turn 65 … [Read more…]
Apache is functioning normally
Grella filed a complaint against Kortas and his wife, Edna Montijo, in Maricopa County (Arizona) on March 19.
In total, Grella claims he discovered over $1.5 million worth of “secret, unauthorized” aircraft purchases and jet hangar lease payments – “and all of which Kortas purchased for himself or his wholly owned entities.”
The document claims breach of the operating agreement, breach of fiduciary duties, unjust enrichment, and conversion, among others allegations. It says Kortas’s “misconduct also supports his removal from the company as a member.”
Grella is asking for attorney fees and punitive damages. He also claims that Kortas converted NEXA funds and made unauthorized credit card purchases, which “have reduced Kortas’ membership percentage interest to below Grella’s membership percentage interest, such that Grella is now the majority owner of Nexa.”
The lawsuit states that Kortas had 50.5% of the company and Grella had a 49.5% share.
NEXA’s businesses
America’s largest mortgage brokerage, NEXA originated $6.29 billion in mortgage loans in 2023, according to Kortas. As of Monday, the company had 2,391 sponsored mortgage loan officers, per the Nationwide Multistate Licensing System (NMLS).
Grella told HousingWire that the mortgage business is profitable despite a challenging market. But that’s not the case for the aviation business. NEXA’s affiliated companies include AXEN Mortgage, a non-delegated correspondent shop, as well as a charter flight business – the latter of which was the source of disagreement between the partners.
The venture started in February 2022 when Kortas “persuaded” Grella to purchase two jets for NEXA’s corporate use and business purposes, per the lawsuit. The jets would be used to fly executives around the country as needed. However, there were also tax benefits to depreciating those assets, which would justify the investment. Another jet acquisition was made one month later.
Then, according to the lawsuit, in late 2022, Kortas “convinced” Grella to acquire an FAA-licensed charter company called Fly Dreams, LLC. The justification was that it would help charter the third jet and “dry-lease it, which would help defray NEXA’s aircraft expenses.”
“After NEXA closed on the purchase of Fly Dreams in early 2023, due to regulatory hurdles that Kortas had failed to flag or explain, NEXA was unable to charter the new jet with Fly Dreams,” the lawsuit states.
After that, specifically in 2023, Grella said Kortas tried to convince him to purchase an airplane flight school due to a pilot shortage (which he ended up doing independently), invest in an aircraft hangar, and purchase another jet.
Grella refused and claimed he faced retaliation, with Kortas treating him as an employee rather than a partner, depriving him of the use of the jets, and ceasing the payment of wage for both of them despite NEXA having millions in retained earnings.
Regarding the $24 million airplane-hangar leasehold, the lawsuit that “Grella informed the seller of the truth of Kortas’ inability to bind Nexa.” Then, through his legal counsel, Kortas “asserted that the aviation business is a legitimate business of Nexa and “Grella had consented to some aviation related purchases.” Therefore, according to Kortas, he was authorized to make the purchase on Nexa’s behalf without Grella’s consent, per the lawsuit.
The split
According to Grella, his “abrupt” termination occurred on March 20, after months of frustration related to what he calls a “serious breach of NEXA’s operating agreement, which requires profits to be distributed equally and for both partners to consent to activities not directly related to NEXA’s mortgage brokerage purposes.”
The lawsuit states that Kortas controls the company, bank accounts, and profit distributions. However, the operating agreement says that if the company engages in any other activity that is unrelated to the purpose of mortgage brokerage, it “requires unanimous member consent.”
“But after Kortas developed an aviation hobby, he began spending millions of dollars of company money for his own aircraft, without Grella’s consent, and, in many cases, without his knowledge,” the document states.
Grella, who started the business with Kortas in 2017 after leaving Equity Prime Mortgage, was responsible for handling the operations, including managing relationships with partners and lenders, overseeing production and supporting loan officers and the management team.
Kortas announced during a weekly Town Hall on Tuesday that Grella had been terminated. This means he will not be involved in the company’s daily operations or strategic decisions for the growth of the business. However, he remains a partner until the conclusion of a buyout negotiation.
According to Kortas, the buyout depends on NEXA’s appraisal. Despite his sadness at hearing what he called Grella’s “harmful rhetoric,” Grella appears to be motivated more by his unhappiness with the terms of his agreed-upon buyout than by concerns he claims to have about the related airplane business, Kortas added.
“Of course, Mr. Grella’s ongoing interference with NEXA’s business relationships and expectancies, which appears to be a blatant effort to pressure NEXA into relenting on those contractual rights that Mr. Grella is actually upset about, are doing nothing but causing the type of harm… harm that is irreparable in nature … that Mr. Grella professes to be taking issue with.”
“NEXA will not be bullied or blackmailed into foregoing its legal rights by a former employee who had himself already agreed to no longer be an owner of NEXA.”
Source: housingwire.com
Apache is functioning normally
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.
Source: crediful.com
Apache is functioning normally
After a few real-life conversations and my running the math, I’ve decided that a “50/50” rule for college saving achieves the best of both worlds.
The rule is:
- ~50% of your college savings goals should be saved via a 529 plan.
- The other ~50% should be saved via a taxable brokerage account.
Why is that the case? Let’s discuss what we do and don’t want from our college savings plan.
PS – if you want further background reading on 529 plans, here are some other useful articles…
What We Do and Don’t Want from College Savings
- We do want to save for college. Ground-breaking stuff.
- We do want to reduce our income taxes.
- We do want our investments to grow tax-free.
- We do want flexibility while we save, in case life throws us a curveball.
- We don’t want to end up with permanently frozen assets. We don’t want “leftover” 529 dollars.
529 College Savings Plans offer some of these ideals. But not all.
In fact, 529 plans are terrible at achieving some of the abovementioned goals.
Reducing Income Taxes
Many states offer income tax deductions on 529 contributions. In New York, for example, the first $10,000 contributed to 529s per year is exempt from state tax. That’s a ~$600 annual savings (depending on tax bracket).
Tax-Free Growth
529 investments grow tax-free, just like 401(k) or IRA assets. There’s no annual tax on dividends and interest. This leaves more dollars behind to compound.
Let’s Measure That Tax Savings
If we apply these two tax advantages to a reasonable scenario**, it’s realistic to expect a 529 account to result in 15-20% more dollars for college than a taxable brokerage account.
**see this Google sheet for detail.
But taxable brokerage accounts have distinct advantages on our other ideals.
Flexibility & “Frozen” Assets
Taxable accounts are very flexible. You can withdraw from them anytime (e.g. during an unexpected emergency). 529 dollars, on the other hand, must be spent on educational expenses and cannot be withdrawn for other reasons.
What if your kid decides to skip college? Unused funds in a 529 can be impossible to withdraw without taxes and penalties. Taxable accounts avoid this situation.
What’s the 529 Withdrawal Penalty?
Every 529 withdrawal—whether for education purposes or not—is made pro rata between your contributions and your earnings. The contributions are never taxed and never penalized, but the earnings can be if your withdrawal is not for a qualified educational expense.
For example:
- Your 529 plan has $100,000 of contributions and $50,000 of earnings. (Two-thirds and one-third)
- You make a $30,000 withdrawal. You have no choice in that $20,000 will come from contributions and $10,000 will come from earnings (Two-thirds and one-third)
- If your withdrawal is not for qualified education expenses, the $10,000 earnings portion will be taxed as income (more marginal tax dollars, ouch!) and will suffer a 10% penalty.
If you run the math, you’ll see this penalty eats away at all the 529’s tax benefits. You do not want to suffer this penalty.
Finding Balance Between 529 and Taxable
The question is how to balance these various pros and cons. The 50/50 Rule does so!
Let’s say you aim to gift your children $100,000 over their four years of college. How generous! I submit you should aim to have:
- $50,000 of that gift coming from a 529
- And $50,000 from a taxable brokerage
You know it won’t be a perfectly ideal scenario. Whatever reality throws at you, you’ll wish you had decided to go all-in on the 529 or all-in on the taxable.
But you don’t know the future! This fact – that we’re more mortals without a crystal ball – is one of the fundamental frustrations in financial planning. If we knew the future, we could make a perfect financial plan. But we don’t, so we can’t. Our best solutions, therefore, involve hedging our bets. We’d rather know we’re 50% correct than be surprised later we’re 100% wrong.
The 50/50 Rule guarantees a middle-of-the-road solution. You’ll capture tax benefits and retain flexibility.
If Johnny gets a little scholarship and only needs 70% of your saved money, great! Use the 529 dollars completely. Dip into the taxable account when needed, and keep the remaining taxable dollars for other goals in life. You’ll be confident your 529 account will be completely drained, avoiding frustrating taxes and penalties.
Does It Have to Be 50/50?
I’ll admit: dividing the two accounts down the middle, 50/50, is an easy shorthand. You can choose a different fraction. But when thinking it through, my primary concerns are:
- You need to be confident you’ll drain the 529s. If Johnny’s college will cost $200,000 and you aim to have all $200,000 in a 529, I don’t like that. There’s no margin for error.
- You want to have a large enough portion in the taxable account to provide “just in case” flexibility.
Maybe 75/25 makes more sense for you. I can get on board with that. But I wouldn’t go much higher than 75% from the 529.
Working Backward
You can work backward from your future goal to discover what today’s saving rates need to be. In our hypothetical scenario of $50K in a 529 and $50K in a taxable (for college in ~15 years, we’ll say), a reasonable starting point is to put $2000 per year (or ~$170 per month) into each account. That’s how the math shakes out.
Depending on your timeline and assumed rate of compound growth, a simple spreadsheet or question to your financial planner will inform what your savings plan should be.
Thank you for reading! If you enjoyed this article, join 8000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.
-Jesse
Want to learn more about The Best Interest’s back story? Read here.
Looking for a great personal finance book, podcast, or other recommendation? Check out my favorites.
Was this post worth sharing? Click the buttons below to share!
Source: bestinterest.blog