Investopedia

Avoid paying too much in mortgage fees by learning about potential junk fees

Reviewed by Somer Anderson

The homebuying process can be complex with paperwork to sign, industry jargon to decipher, and real estate agents and mortgage brokers to meet. It’s important to take time to understand all the costs, including what may be unnecessary costs.

Many costs associated with a mortgage include closing costs such as loan origination fees and appraisal fees. Knowing these costs before you get to the closing table can help you understand where your money is going and whether you are paying junk fees.

The Consumer Financial Protection Bureau (CFPB) determined that consumers are indeed paying unlawful junk fees related to mortgages in various ways, including through excessive late fees, unnecessary inspection fees, fake mortgage insurance premium charges, and fees paid despite financial loss mitigation options.

Key Takeaways

• The CFPB found consumers can pay illegal fees for unnecessary inspections and mortgage insurance as well as excessively high late fees.
• Some consumers may pay fees that could be waived with financial loss mitigation options.
• Junk fees can include excessively high fees for application, underwriting, mortgage rate lock, loan processing, and broker rebates.
• Recurring closing costs are expenses that you pay at closing and each month thereafter, such as real estate taxes.
• Nonrecurring closing costs are one-time payments, such as points, loan fees, and home inspection fees.

What Are Junk Fees?

Junk fees are unnecessary fees that add costs but little to no value. Consumers are paying billions of dollars in junk fees on various financial products, including with mortgages, according to the CFPB.

Homebuyers may unknowingly pay illegal fees with several costs related to mortgages, They include:

• Excessive late fees: The CFPB found that mortgage servicers may charge the highest level of late fees allowed by law even when the buyer’s mortgages caps it at a lower amount.
• Unnecessary inspections: Buyers are also vulnerable to paying for unnecessary inspections if servicers pay inspectors to go to an incorrect address and then pass the charge on to buyers. The fees can range from $10 to $50.
• Mortgage premiums: The CFPB also found cases where servicers charged private mortgage insurance (PMI) premiums when buyers did not owe them.
• Fees during financial hardship: A servicer may fail to waive fees for buyers who are entering loss mitigation options such as charging late fees while the mortgage was under forbearance under the CARES Act when those fees should have been waived.

Many junk fees related to mortgages are associated with closing costs, which are the fees related to closing on a mortgage. They can include recurring and non-recurring expenses like mortgage insurance, loan origination fees, and appraisal fees.

Recurring Costs

Recurring costs are paid at closing, then monthly thereafter. These include real estate taxes, homeowners insurance, and—if you’re putting down less than 20% of the purchase price—private mortgage insurance (PMI).

These expenses must be funded in advance at the time of purchase, which is done by putting funds into an escrow account to cover the next year’s obligations.

Nonrecurring Costs

Nonrecurring costs are also paid at closing. They may include:

• Points
• An application fee (profit for the lender)
• A series of loan fees (these may include an origination fee, appraisal fee, credit report fee, tax service fee, underwriting fee, document preparation fee, wire transfer fee, office administration fees, et al.)
• A broker’s service fee (if you are working with a mortgage broker)
• Any lender-required home inspections (e.g., pest inspection)
• The cost of a lender-required home appraisal (in which someone is paid to verify that the property is worth at least as much as the selling price)

Other Costs at Closing

Closing costs may also include:

• Federal Housing Administration (FHA) fees
• Veterans Affairs (VA) fees
• Rural Housing Service (RHS) fees associated with mortgages guaranteed by the government
• A flood determination fee, to investigate whether the property is in an area prone to flooding
• A land survey to verify the property’s boundaries
• Title charges (which may include a title settlement fee, title search fee, title examination fee, closing service letter fee, deed preparation fee, notary fees, title insurance fee, and any attorney fees)

Other miscellaneous costs may include a courier/delivery fee, endorsements, recording fee, transfer tax, and an optional home warranty.

How Much Are Closing Costs?

As a general rule, you can expect to spend 3% to 6% of the purchase price in closing costs. Fees vary widely based on the lender, the geographic location of the property, and the price of the home. Consult the CFPB’s Your Home Loan Toolkit, which is a guideline for evaluating fees.

All-In-One Closing Cost Pricing

Consumers who are overwhelmed by fees may want to consider an all-in-one, flat-rate fee that includes all closing costs. Use caution when shopping for these products, making sure that you purchase the one that applies strictly to mortgage closing costs and not to other banking relationships or products.

Reducing Mortgage Costs

If the real estate market in your area is favorable to buyers, then you may be able to negotiate with the seller about paying closing costs.

Comparison shopping is another way to get competitive rates with mortgage costs. Ask several lenders to provide loan estimates, then compare the results. This will help you understand the range of closing fees in your area.

Can I Negotiate Mortgage Fees?

You can negotiate many mortgage fees, including negotiating the closing costs with the seller. Closing costs can include loan origination fees, title search fees, and appraisal fees, among many others.

How Do I Avoid Loan Origination Fees?

Loan origination fees cannot be entirely avoided as either the buyer or seller must pay them. If you are buying a home and want to avoid loan origination fees, you can try to negotiate with the seller regarding who will be responsible for paying loan origination fees. You could potentially ask your lender to lower the amount of their loan origination fee as well.

What Are Points in a Mortgage?

Points in a mortgage are used to reduce the interest rates in a mortgage. They are fees that they buyer pays the lender to lower the interest rate. Mortgage points are also called discount points.

The Bottom Line

The official form that includes a breakdown of all closing costs is called a closing statement or closing disclosure. You have a right to see this document at least three business days in advance of closing. Request it and compare it with the loan estimate. If the numbers aren’t reasonably close, then ask questions.

By comparison shopping and to carefully reviewing all documentation in advance, you can minimize the expense of closing costs.

Reviewed by Lea D. Uradu
Fact checked by Vikki Velasquez

Buying a home is expensive, but purchasing through auctions, government programs, or with rental income can provide a free or almost free option. However, reducing the cost in these ways comes with requirements, risks, and challenges that should be understood before committing to any purchase.

Key Takeaways

• Reliable, long-term tenants can help pay off a mortgage loan.
• The U.S. Department of Housing and Urban Development sponsors homeownership and assistance programs for qualified individuals.
• Foreclosed homes may sell through an absolute auction where the highest bidder wins regardless of the bid amount.

Use Rental Income

Investors commonly obtain a mortgage on a property and then rent it by charging a competitive amount that provides enough money to meet the monthly payments. It is possible that reliable, long-term tenants can pay off the entirety of a mortgage. Be aware, however, that this approach can impact your taxes in multiple ways. Rental income is taxable, and there also is the possibility that the additional income could push you into a higher tax bracket.

You also are likely to face higher property taxes, depending on the state and local municipality where the property is located. It’s a good idea to familiarize yourself with IRS Publication 527, which details residential rental properties, and speak with a financial advisor before becoming a landlord.

Buying properties for use as an Airbnb also is popular. Over the long run, it can provide a steady, passive income. These rentals typically are short-term. According to AirDNA, which analyzes data for the short-term rental industry, the average daily rate for an Airbnb in Los Angeles for the year ending in February 2025 was approximately $274, with units typically occupied 54% of the year.

Making a profit from renting out property is not simple. In addition to taxes, other factors to consider include the neighborhood, schools, and area crime statistics. These factors and more will impact your ability to attract tenants.

Home Ownership Programs

The U.S. Department of Housing and Urban Development sponsors programs for qualified individuals that include:

• Law enforcement officers, teachers, firefighters, and emergency medical technicians may qualify for the Good Neighbor Next Door Sales Program. HUD offers a discount of 50% off the list price if the eligible buyer commits to living in the property for 36 months as their principal residence, among other criteria.
• A local Public Housing Authority (PHA) may offer public housing units to residents and other eligible low-income families in their communities. A PHA can also use Capital Funds for homeownership activities, including financial assistance for closing costs, downpayment, and mortgage loans to public housing residents.
• The Federal Housing Administration (FHA), part of HUD, insures loans so lenders can offer buyers incentives like low down payments and closing costs.

Auctions and Tax Sales

Homes may end up in auction due to a mortgage default or foreclosure, or a homeowner’s failure to pay taxes. Foreclosed properties are seized by a mortgage lender after a borrower fails to make mortgage payments over some time. When an owner doesn’t pay property taxes, the local tax authority may seize the property. Auctions can be conducted in person or online and are deployed in one of three ways:

• Absolute Auction: The highest bidder wins regardless of the amount of the bid.
• Minimum Bid: A minimum dollar value is required to bid for the property
• Reserve Auction: Bids are treated as offers that can be rejected by the seller.

Properties purchased through auctions and tax sales typically are sold as is, meaning the cost for renovations and repairs is unpredictable.

How Do I Contact HUD for Assistance?

HUD.gov offers federal homeownership and home-buying assistance programs. Additionally, there may be programs sponsored by state or local governments.

How Can I Get a House I Can’t Afford?

There are several sources of help available to buy houses. You can apply for homebuyers’ assistance programs, try a rent-to-own option, or look into alternative loans.

Where Can I Find Houses Selling at Auction?

Local realtors and banks may carry listings of foreclosed homes and offer information regarding the date and time of auctions. Auction.com provides subscribers access to daily updates on available homes.

The Bottom Line

Three affordable or low-cost housing options include local auctions, government-sponsored programs, or receiving rental income. Potential homebuyers can visit the U.S. Housing and Urban Development website for assistance or online auction sites for listings.

Fact checked by Vikki Velasquez

What Happens to Your Crypto When You Die?

When you die, your cryptocurrency assets may be lost forever if you haven’t properly planned for their transfer. The key to ensuring your digital assets are inherited by your crypto beneficiaries lies in estate planning.

Without a will or a transfer plan that details clear instructions, your heirs might never gain access to your crypto holdings, as cryptocurrencies are stored in wallets that require private keys or recovery phrases. If these aren’t passed on, your crypto holdings will be inaccessible. By some estimates, about 20% of all Bitcoin tokens are lost and unrecoverable.

To avoid this, it’s crucial to take steps now to guarantee that any of your digital holdings can be safely transferred to your heirs.

Key Takeaways

• Estate planning for cryptocurrency is essential to ensure smooth transfer to your heirs after your death.
• It’s important to make clear in a will who the intended beneficiaries of your crypto holdings are.
• You should provide your beneficiaries with instructions for accessing your crypto holdings, including crypto wallets, custodial services, private keys, and other crucial information.
• While many crypto investors are hesitant about custodial services, they offer strong security and established processes for transferring ownership to beneficiaries.

Cryptocurrency As a Digital Asset

In the U.S., cryptocurrencies are considered by the IRS to be digital assets, and more specifically, convertible virtual currencies—that is, the government treats crypto tokens as property rather than as currency. This has a variety of tax implications and also impacts the way that cryptocurrencies are treated in issues involving inheritance and transfer of ownership.

Given their status as digital assets, the U.S. government views cryptocurrency tokens in a manner more similar to stocks or to tangible property like artworks and jewelry than to cash. This means that crypto holdings are potentially subject to capital gains tax.

Essential to planning the transferral of ownership of crypto holdings is understanding the use of wallets. These applications help secure digital assets and facilitate transactions between crypto investors. They are typically secured using both an address or a public key (a way in which the wallet can be publicly identified so that other wallets can transfer in tokens, for example) and a private key (a secure password usually available only to the holder of the wallet).

In many cases, wallets are provided by crypto custodians, such as digital asset exchanges, and can be accessed through their interfaces. Otherwise, one can access non-custodial wallets using the private key or a mnemonic seed phrase.

Why Crypto Beneficiaries Are Essential

Consider naming a trusted person, such as a family member or lawyer, who is tech-savvy enough to handle digital wallets and crypto transactions.

Without naming crypto beneficiaries or providing them with the necessary information, your digital assets might be lost forever. Since crypto is classified as personal property rather than traditional currency, estate planning and inheritance related to digital tokens can be more complicated.

Crypto may be subject to different estate and transfer taxes. When beneficiaries inherit crypto holdings and use them as a payment method or convert them to fiat currency, it may trigger a tax event that requires calculating capital gains or losses.

Crypto may also be subject to different estate and transfer taxes. When the beneficiaries of your crypto holdings use those tokens as a payment method or go to exchange them for fiat currency, it will likely trigger a tax event, and they will need to calculate capital gains or losses, for example. If you give crypto as a gift, it won’t be recognized as income until it’s sold or exchanged.

Important

When crypto investors die without a will, their investments pass according to their state’s intestacy laws. Depending on location, this likely means ownership of the assets will transfer to a spouse or children, although the exact mechanism for this distribution varies.

Steps to Ensure Your Crypto Is Passed to Your Beneficiaries

While a will and a detailed, written plan for transferral of ownership of digital assets is extremely helpful for your next of kin, it’s crucial to remember that this is not enough. While a will may make it legally clear that, say, your children own your crypto holdings, this is no guarantee in and of itself that they will be able to access and use those holdings.

Chris and Charles Brooks, the CEO and CTO of CryptoAssetRecovery.com, explained that there are several other steps investors should take to facilitate a smooth and complete transfer of cryptocurrency ownership. These steps include:

1. Inform Your Heirs

“Make sure that your loved ones—or at least your lawyers—know that you have crypto.” The father-and-son team that runs the digital asset recovery service suggested that communication is an essential first step, as beneficiaries will be helpless without knowing that you have crypto holdings and in which wallets they are stored.

2. Document (and Secure!) Backup

“Record seed phrases or other forms of backup, store them safely, and share with people you trust.” Documenting the ways to access your wallets is essential as well. However, keep in mind that anyone with this information can access these tokens, so it’s vital to keep the documentation secure.

3. Test Your Recovery Seeds

While you still have access to your digital wallets, test the recovery seeds to ensure that they will work for your next of kin and that they are linked to the appropriate wallet containing the assets you wish to transfer.

4. Build in Redundancy

“Consider upgrading your plans using secret sharing and/or multi-signature techniques to share partial backups with multiple people.” Building redundancy into your cryptocurrency management practices will help to protect them against theft during the process of transfer to a beneficiary.

5. Consider Using a Custodial Service

The Brookses said that, while some crypto investors shy away from custodial services due to the history of hacks targeting these companies, “the benefits are that these custodians have extremely robust security practices and existing systems for transferring assets to your estate after death.” When working with a custodian, the beneficiaries should be prepared to provide documentation including a copy of your will, probate documents, and proof of identification.

6. Don’t Count on Current Technology

The Brookses suggested that crypto investors avoid using mobile phones as a backup method, as the phone you utilize may be dead or the wallet app you use may be non-functional by the time a transfer is needed. Similarly, some of the most popular crypto wallets of today may no longer be supported by the time of your passing.

Estate planning for cryptocurrency investments should also include preparations for someone in a fiduciary or executor role who is appointed to safeguard the control of those tokens for a period. Suzy Walsh, American College of Trust and Estate Council Fellow, explained that crypto investors should be particularly careful when selecting a fiduciary. 

“Fiduciaries are supposed to keep things safe and manage them…they’re not supposed to be holding volatile assets” like crypto tokens, she said. She added that fiduciaries are not equipped to handle and retain cryptocurrency securely.

A fiduciary familiar with cryptocurrency can help you navigate security issues.

On the other hand, investors can make use of the volatility inherent to the crypto market when it comes to taxes. By gifting tokens at a time when values are low, for example, investors can minimize transfer taxes. Ideally, a fiduciary should also be comfortable with this aspect of crypto management.

What Happens to Unclaimed Cryptocurrency?

If your beneficiaries cannot access your crypto holdings, there may be no way to recover them. If you do not have a will and beneficiaries, your digital assets could be disposed of by your estate, potentially triggering a tax event for your estate.

Can You Lose Your Cryptocurrency?

Unfortunately, yes. It’s easy to lose access to cryptocurrencies by losing a wallet, private key, or other critical information. This can result in permanent loss, so secure storage and planning are vital.

Does Crypto Have to Go through Probate?

Yes, cryptocurrencies go through the probate process, similar to real estate or tangible assets, because they are classified as property by the IRS. A properly documented will can help streamline the probate process.

The Bottom Line

The security measures that protect cryptocurrency holdings can make it difficult for your heirs to access your assets after your death. To safeguard your assets and ensure a smooth transfer, it’s important to include your crypto in your will, designate beneficiaries, and clearly communicate how to access your holdings.

Secure your documentation (such as wallet addresses, private keys, and custodial passcodes) and consider using custodial services for added security. Lastly, ensure your fiduciary or executor is equipped to handle your digital assets and understands the volatility of the crypto market.

Fact checked by Vikki Velasquez

What Is a Traditional IRA?

A traditional individual retirement account (IRA) is a retirement savings account that lets you invest pre-tax income to save for retirement. The key feature of this account is its tax advantages: contributions to a traditional IRA are tax-deductible, meaning you don’t pay taxes on the money you contribute in the year you make the deposit. Taxes are paid when you withdraw funds during retirement, ideally when you’re in a lower tax bracket.

You don’t need to be sponsored by an employer to open a traditional IRA. It’s an individual account that you can open with various financial institutions such as Vanguard, Fidelity, or Charles Schwab.

Key Takeaways

• Traditional IRAs allow you to invest pre-tax income toward your retirement.
• Contributions to a traditional IRA may be tax-deductible.
• Taxes are paid upon withdrawal of funds, typically during retirement.
• Early withdrawals may be subject to penalties, with some exceptions.
• Alternatives to traditional IRAs include Roth IRAs, SIMPLE IRAs, and SEP-IRAs.

How Traditional IRAs Work

Traditional IRAs allow you to direct your contributions to a variety of investment options such as stocks, bonds, or mutual funds. These investments grow tax-deferred, meaning you won’t owe any taxes on dividends, interest, or capital gains as long as the funds remain in the account.

Once you reach your retirement age and begin to withdraw funds, they are subject to ordinary income taxes. If you withdraw money before age 59½, you’ll typically incur a 10% early withdrawal penalty, in addition to paying the relevant income taxes on the distribution.

Tax Treatment of Traditional IRAs

Contributions to a traditional IRA are made from pre-tax income. In some cases, contributions may be tax-deductible. Typically, investors without access to employer-sponsored retirement plans are more likely to be able to deduct contributions to a traditional IRA.

Contribution Limits for Traditional IRAs

If you are under age 50, you may contribute a total of $7,000 to traditional and Roth IRAs in 2024 and 2025. If you are age 50 and above, you may contribute an additional $1,000 in catch-up contributions for a total of $8,000 per year. These limits include all contributions, meaning that the total contribution to all IRA accounts cannot exceed $7,000 or $8,000, depending on your age.

Note

In 2024, you may make IRA contributions until April 15, 2025.

Early Withdrawals: Rules, Penalties, and Exceptions

Traditional IRA withdrawals are subject to income tax for the year in which they are disbursed. Additionally, the IRS levies a 10% early withdrawal penalty for investors who take a distribution before age 59½.

There are exceptions for which the 10% penalty tax does not apply. These include but are not limited to:

• Birth or adoption expenses for a new child (up to $5,000)
• Death or disability of the account holder
• Expenses for recovery from a federally recognized disaster (up to $22,000)
• Cases of domestic abuse
• Qualified higher education expenses
• Emergency family expenses (typically up to $1,000 per year)
• First-time homebuying expenses (up to $10,000)
• Unreimbursed medical expenses equal to greater than 7.5% of the taxpayer’s AGI
• Health insurance costs while unemployed

Required Minimum Distributions

The IRS requires investors to take regular distributions from traditional IRAs once they reach a certain age. If you turn 72 before Dec. 31, 2022, you’ll need to take these required minimum distributions (RMDs) by age 72; if you turn 72 after that date, you’ll need to take RMDs by age 73.

Tip

The amount of these minimum withdrawals is calculated based on the account balance at the end of the previous year and your life expectancy.

Having a Traditional IRA and a 401(k)

If you have an employer-sponsored retirement plan like a 401(k), you may also invest in IRAs. However, if you have a 401(k) as well as an IRA, depending on your income, you may be unable to deduct IRA contributions.

Pros and Cons of Contributing to a Traditional IRA

Benefits of a Traditional IRA

• Ability to set up a traditional IRA separate from (and in addition to) employer-sponsored retirement accounts like 401(k)s
• May provide tax advantages at retirement if you expect to be in a lower tax bracket then than you are now
• Contributions may be tax-deductible

Drawbacks of a Traditional IRA

• Lower annual contribution limit compared to 401(k) accounts
• Must pay taxes on distributions in the year they are made
• Early withdrawal penalties in most cases for individuals under 59½ 

Traditional IRAs vs. Other IRAs

Traditional IRA vs. Roth IRA

Traditional and Roth IRAs are very similar, except that Roth IRAs make use of post-tax income for contributions. This means that Roth IRA distributions are generally not taxed. The 10% early withdrawal penalty tax is only levied on distributions of Roth IRA earnings; investors may typically withdraw their contributions without penalty so long as the fund has been active for at least five years.

Traditional IRA vs. SIMPLE IRA

SIMPLE IRAs allow both employees and employers to contribute. These accounts are offered by employers who may be unable to provide other retirement plans.

Traditional IRA vs. SEP-IRA

Simplified Employee Pension Plan IRAs (SEP-IRAs) function similarly to traditional IRAs, except they provide employers a way to contribute toward an employee’s retirement. The contribution limits are higher for a SEP-IRA than a traditional IRA, but typically only employers are allowed to make contributions.

Here’s a comparison of how the four main types of IRAs compare with one another: 

	Traditional IRA	Roth IRA	SIMPLE IRA	SEP-IRA
Account holders are…	Individuals	Individuals	Employees	Employees (or self-employed individuals)
Contributions come from…	Pre-tax income	Post-tax income	Pre-tax income	Pre-tax income
Annual contribution limits (2024 and 2025)	$7,000	$7,000	$16,000 (for 2024) $16,500 (for 2025)	$69,000 or 25% of compensation up to $345,000 (for 2024) $70,000 (or 25% of their compensation up to $350,000 (for 2025)
Income cap	None	2024 phaseout range: single filers, $146,000-$161,000; joint filers, $230,000-$240,000 2025 phaseout range: single filers, $150,000-$165,000; joint filers, $236,000-$246,000	None	None
Who is eligible?	Anyone earning at least the contribution amount	Anyone earning at least the contribution amount	Employers not offering other retirement accounts	Individuals 21+ earning at least $750 annually from a business they’ve worked for during at least 3 of the previous 5 years

How to Open a Traditional IRA

Opening a traditional IRA is a straightforward process:

1. Select an IRA provider. Major providers include TIAA, Vanguard, Fidelity, and more.
2. Apply through the provider. You’ll need to provide personal information and financial details and specify the type of IRA you want to open.
3. Fund the account. Make a contribution from an existing bank account or set up a rollover from a previous retirement account.
4. Select investment options. Specify any investments you would like the account to target. This may mean particular stocks, mutual funds, bonds, and so on, or it may be a broader breakdown of stocks vs. bonds.

Is a Traditional IRA Right for You?

Traditional IRAs are a good option if you’re looking to contribute pre-tax dollars to a retirement account separate from an employer-sponsored plan. They are particularly appropriate if you anticipate being in a lower tax bracket at the time of retirement when you will pay taxes on distributions.

What Happens if I Contribute More Than the Annual Limit to a Traditional IRA?

Over contributing to a traditional IRA incurs a 6% penalty tax. In order to correct the situation, you must withdraw any excess contributions or apply them to the next year’s limit.

How Much Tax Will I Pay on a Traditional IRA?

The amount of tax you pay on a traditional IRA depends on your income tax bracket when you withdraw the funds. Contributions to a traditional IRA are made with pre-tax income, and taxes are deferred until you begin taking distributions. At the time of withdrawal, the amount you take out is taxed as ordinary income. If you withdraw funds before age 59½, you may face a 10% early withdrawal penalty.

At What Age Can You No Longer Open a Traditional IRA?

There is no maximum age for opening a traditional IRA. As long as you have earned income (such as from a job or self-employment), you can contribute to a traditional IRA at any age.

The Bottom Line

Traditional IRAs are individual-directed retirement accounts that use pre-tax dollars for investment. They have lower contribution limits than 401(k)s but do not require employer sponsorship. While investors can direct how their contributions are invested, often the best approach is to determine an appropriate level of risk, target a broad range of assets through a mutual fund or similar option, and hold for the long term.

Reviewed by Thomas Brock
Fact checked by Suzanne Kvilhaug

Revenue is the amount of money a company receives in exchange for its goods and services or, conversely, what a customer pays a company for its goods or services. The revenue received by a company is usually listed on the first line of the income statement as revenue, sales, net sales, or net revenue.

Aside from the bottom line (net income), companies pay more attention to this single line item than any other. It is the greatest factor that determines how their business is doing. It tells a company clearly how much money it is bringing in from the sale of its product.

Changes in revenue can be analyzed to determine if marketing strategies are working, how price changes affect the demand for the product, and a multitude of other insights.

Key Takeaways

• Revenue is another word for the amount of money a company generates from its sales.
• Revenue is most simply calculated as the number of units sold multiplied by the selling price.
• Because revenues do not account for costs or expenses, a company’s profits, or bottom line, will be lower than its revenue.

How To Calculate Revenue

There is a standard way that most companies calculate revenue. Regardless of the method used, companies often report net revenue (which excludes things like discounts and refunds) instead of gross revenue.

For example, a company buys pairs of shoes for $60 and sells each pair for $100. They offer a 2% discount if the customer pays with cash. If the company sells two pairs of shoes to a customer who pays with cash, then the gross revenue reported by the company will be $200 ($100 × 2 pairs). However, the company’s net revenue must account for the discount, so the net revenue reported by the company is $196 ($200 × 98%). This $196 is the amount that would normally be found on the top line of the income statement.

The most simple formula for calculating revenue is:

• Number of units sold × average price

Also:

• Number of customers × average price per unit provided

Expenses and other deductions are subtracted from a company’s revenue to arrive at net income.

Other Revenue

In a financial statement, there might be a line item called “other revenue.” This revenue is money a company earns or receives for activities that are not related to its original business. For example, if a clothing store sells some of its merchandise, that amount is listed under revenue. However, if the store rents a building or leases some machinery, the money received from this business activity is filed under “other revenue.”

Recording Revenue

Revenue is recorded on a company’s financial statements when it is earned, which might not always align with when cash changes hands. For example, some companies allow customers to buy goods and services on credit, which means they will receive the goods or services now but will pay the company at a later date.

In this case, the company will record the revenue on the income statement and create an “accounts receivable” account on the balance sheet. Then, when the customer pays, the accounts receivable account is decreased; revenue is not increased because it was already recorded when it was earned (not when the payment was received).

What Revenue Reporting Is Used for

Revenue is very important when analyzing gross margin (revenue minus cost of goods sold) or financial ratios like gross margin percentage (gross margin divided by revenue). This ratio is used to analyze how much profit a company has made after the cost of the merchandise is removed but before accounting for other expenses.

As you can imagine, companies can become almost artistic with how they handle their top line. For example, if they wanted to lower the cost of their merchandise so that their top-line margins would appear larger, they could lease the merchandise or offer it at a premium. Using such a method would incur a higher net revenue than if they were to simply sell the product or service at its base cost.

What’s the Difference Between Gross Revenue and Net Revenue?

The difference between gross revenue and net revenue is:

• When gross revenue (also known as gross sales) is recorded, all income from a sale is accounted for on the income statement without consideration for any expenditures from any source.
• When net revenue (or net sales) is recorded, any discounts or allowances are subtracted from gross revenue. Net revenue is usually reported when a commission needs to be recognized, when a supplier receives some of the sales revenue, or when one party provides customers for another party.

How Do Businesses Report Revenue on Their Tax Returns?

Businesses report revenue on their tax returns by listing all sources of income—including sales, investments, and other revenue streams—and then subtracting allowable business expenses to arrive at taxable income.

Corporations use Form 1120, including Form 1120 for C corps and Form 1120-S for S corps, to file tax returns. Sole proprietorships and single-member limited liability companies (LLCs) use Schedule C (Form 1040). Partnerships and multiple-member LLCs use Form 1065.

What’s the Largest Company in Terms of Revenue?

The largest company in the world ranked by revenue is Walmart (WMT). The largest non-U.S. company ranked by revenue is Saudi Aramco.

The Bottom Line

The process of calculating a company’s revenue is rather straightforward. However, accountants can adjust the numbers in a legal way that makes it necessary for curious parties to dig deeper into the financial statements to get a better understanding of revenue generation than just looking at a cursory figure. This is especially true for investors, who need to know not just a company’s revenue, but what affects it from quarter to quarter.

Sidestep these 7 issues to make the most of your account

Reviewed by Anthony Battle
Fact checked by Vikki Velasquez

Over the past quarter of a century, the 401(k) plan has evolved into the dominant retirement savings vehicle for most U.S. employees.

While many improvements have been made to the structure and features of 401(k) plans since their creation, they’re not perfect. But there are ways to mitigate the impact of these problems, making 401(k)s ultimately worth your time and money.

Here’s a look at seven issues that you may have to face with your 401(k) plan, as well as ways to temper their effects.

Key Takeaways

• A 401(k) plan turns long-term savings for retirement into a habit for American workers.
• A 401(k) can postpone the taxes due on some earnings for decades.
• Some employers match part of employee savings, effectively a bonus.
• Administrative and record-keeping costs can be high.
• Investing options can be limited.

Dollar-Cost Averaging

At its heart, the 401(k) plan maximizes a common investment strategy known as dollar-cost averaging. That is, an investor deposits a certain amount of money every month in an investment such as a stock or a mutual fund. Depending on the vagaries of the markets, that set amount buys more or fewer shares from month to month.

In the end, proponents say, the investor’s price per share averages out at a lower level than a more active strategy would have yielded. The total return is better.

Those less enthusiastic about dollar-cost averaging say it’s simply a convenient justification for the 401(k) system that channels money from your paycheck to the investment funds in your plan. Your funds may be fully valued or even overvalued at the time the contributions are made.

If this is a concern, you’re best option might be to put your contributions into a conservative investment option offered in your plan. The share price should be relatively steady from month to month. Eventually, you might transfer some of the gains into a more aggressive fund for better growth.

It’s up to you to determine when the switch looks attractive from an investment standpoint.

Long Investment Time Horizon

Your 401(k) plan is supposed to provide you with a long-term savings plan for retirement. Given this premise, you may believe that you should develop a long-term strategic asset allocation based on a time horizon of a decade or several decades.

Unfortunately, it’s highly unlikely that the portfolio managers who are currently managing the mutual funds available through your plan will be managing them 10 or more years from now.

That means you could be better off bypassing actively managed funds and choosing index funds for your 401(k). This will remove any mismatch between the short-term tenure of fund managers and your long-term investment holding period.

Actively Managed Funds vs. Index Funds

Most active mutual funds do not outperform their index or benchmark, and they come with higher fees. You are better off putting your money into an index fund. A 1% saving can mean tens of thousands of extra dollars at retirement.

Your fund may not offer index funds as an option. That’s up to your employer.

If index funds aren’t offered in your 401(k) plan, consider developing a tactical asset allocation contingency plan in the event that one of your portfolio managers relinquishes responsibility.

Or, you could consider putting some of your savings into a traditional IRA or Roth IRA instead of your 401(k). You can contribute to both up to the maximum annual combined limit.

401(k) Fees

Your returns from your 401(k) plan are reduced by the fees you will be paying, and they include charges unique to 401(k) plans.

A 401(k) plan is government-approved because it affects your taxes, and that means your company has to take on many compliance issues as well as administrative tasks, employee education, and communication services.

You’re probably paying your share of these costs through charges such as:

• Participant fees
• Supplemental asset-based charges
• Itemized costs for services such as loans, hardship withdrawals, and qualified domestic relations orders
• Higher fund expenses

Costs are particularly steep for smaller employers and plans where a lack of economies of scale fosters higher expenses.

How to Offset Expenses

First and foremost, you should always invest in your 401(k) plan up to the point where you receive 100% of your employer’s matching contribution. Not all employers offer this match, but many do.

Then, you could open a traditional IRA or a Roth IRA and contribute up to your combined annual maximum. This will get you an enormous range of investing options and lower fees than your company 401(k) can offer.

One warning, though—if you or your spouse is covered by an employer-sponsored retirement plan, and your income exceeds certain levels, you may not be able to deduct your entire contribution.

Lackluster Recordkeeping

Recordkeeping for assets in your 401(k) plan is complex and time-consuming, even with today’s technology. Therefore, few retirement plan providers distribute investor-friendly statements. Instead, they generate only what the law requires, which is not sufficient for you to make a useful financial assessment of your investment strategy.

To successfully plan for retirement, you need to know on a monthly basis your beginning account balance, how much you and your employer contributed, the number of transfers or withdrawals you made, the amount of any gains or losses, and your ending balance.

Unfortunately, your record-keeper probably doesn’t provide this information in a user-friendly way. To get the data, you may have to extract the information from your monthly or quarterly statements and build a spreadsheet to track the details.

Know Your Rate of Return

Once you have properly compiled the information, you should manually calculate your annualized rate of return. It’s worthwhile seeking outside advice to get an accurate view of how your investments are performing.

“Often, it is difficult to go through your quarterly statement and decipher how well your investment strategy is working,” says Carlos Dias Jr., founder and managing partner of Dias Wealth LLC in Lake Mary, FL.

“By consulting with an outside fee-only advisor,” Dias adds, “you can see how your 401(k) investments are really performing and what modifications can be made without having to transfer to an IRA.”

Important

Most active mutual funds, on which 401(k) plans are based, don’t outperform their index or benchmark. You’re better off putting your money into an index fund.

Limited Investment Options

The conventional wisdom in the 401(k) plan investment industry is that “less is more.” A retirement plan will offer investment options that cover roughly five asset class categories. These categories, in order of theoretical risk, are as follows:

• Money-market funds or stable value funds
• Core bond funds
• Large-capitalization funds
• Small-capitalization funds
• International funds

The concept behind “less is more” is to minimize the complexity of your investment choices. You can develop a diversified portfolio by investing in funds that fall into these five asset-class categories.

That may do it for many investors. If you’re more aware of the variety of investment choices out there, you might want access to Treasury Inflation-Protected Securities (TIPS) funds, high-yield funds, real estate investment trust (REIT) funds, mid-capitalization equity funds, emerging markets funds, and commodity funds to build a comprehensive portfolio for your long-term financial needs.

Widening Your Choices

“When I find a client’s 401(k) has limited (or subpar) investment choices, I always look to see if they have a self-directed brokerage window available to them,” says Carol Berger, a retired CFP® in Peachtree City, GA.

“This allows them to open an account on the ‘brokerage window’ side and opens up many more investment choices,” Berger adds. “The client then has their regular contributions go into this account versus the ‘regular’ 401(k) choices.”

The quality of the investment options offered in your plan may be well below average, particularly if you are a participant in a small retirement plan.

As with any investment, you should conduct a thorough due diligence analysis before making any type of investment. If you’re dissatisfied with your choices, you can contact your human resources department to request changes.

In addition, you could offset any 401(k) plan deficiencies by investing in index funds through an individual IRA.

Advisor Insight

Kirk Chisholm, Wealth Manager at Innovative Advisory Group, Lexington, MA

One frequently overlooked option for an investor who has a poor selection of fund choices is to speak to your employer.

Frequently, employers are not deliberately trying to provide you with poor choices. Many times they are given these choices by the advisor on the plan.

If you request different or additional options, it is possible your employer will say yes. Many employers are looking for this type of feedback.

Tax Implications

The most highly touted 401(k) plan attribute is the pre-tax treatment of invested cash flows. In a traditional plan, the money you pay in is not taxed. It doesn’t count towards your income that year. You won’t pay the taxes due until years down the road after you retire.

However, that money will be taxed at your personal income tax rate, not at the (usually lower) capital gains rate. (This is not relevant to Roth accounts, for which taxes are pre-paid.)

This tax treatment may compare unfavorably to the capital gains taxes you would have owed on investments outside the 401(k) system.

A true comparison is nearly impossible because your tax status will change over time, and the tax laws may well change too. Just bear in mind that what looks like a good deal today may very well be a bad deal tomorrow.

Investment Risk

The 401(k) plan has largely replaced the employee pension plan in the American workplace. In government-speak, the 401(k) plan is a defined contribution pension plan and a pension is a defined benefit plan.

That means that you, not your employer, bear all of the investment risk.

The amount that’s in the fund when you retire is what you will receive as a pension. The fund may lose all (or a substantial part) of its value in the markets just as you’re ready to start taking distributions.

While that’s true of any financial investment, the risk is compounded by the relative inaccessibility of 401(k) money throughout your working years.

“The final problem is that your 401(k) assets are not liquid,” says Dan Stewart, CFA®, president of Revere Asset Management, Inc. in Dallas, TX. “Make sure that you still save enough on the outside for emergencies and expenses you may have before retirement. Do not put all of your savings into your 401(k) where you cannot easily access it, if necessary.”

What Are the Advantages of a 401(k)?

A 401(k) has many advantages as a long-term savings vehicle.

• The contributions are made on a pre-tax basis, lowering your yearly taxable income.
• Your employer may match a portion of your contributions, increasing your savings.
• They are a relatively easy, steady way to compile a stash of cash for your future.
• 401(k)s are protected from most creditors.

Is It Better to Have a 401(k) or an IRA?

Many investors choose to have both as they each offer advantages for saving. An individual retirement account (IRA) will have a greater variety of investment options, but only a 401(k) has the potential for employer matching funds.

A 401(k) also allows for greater contributions than an IRA. Here are the current contribution limits:

• For 2024, the 401(k) contribution limit is $23,000 (plus a $7,500 catch-up for people aged 50 and older).
• For 2024, IRA contributions are $7,000 (plus a $1,000 catch-up for those aged 50 and older.)
• For 2025, the 401(k) limit is $23,500 and the catch-up stays at $1,000.
• The 2025 limit for IRAs remains at $7,000, and the catch-up remains at $1,000.

Do You Need a 401(k) and a Savings Account?

A 401(k) and a savings account serve entirely different purposes.

A savings account is a necessity to take care of unexpected expenses. The interest you’ll earn on the account is abysmally low but the money will be there when you need it.

It is difficult and expensive, if not impossible, to take money out of a 401(k) before you reach retirement age. But it has the potential to grow into a substantial sum that you can rely on for living expenses after you retire.

The Bottom Line

The 401(k) plan has become the cornerstone of retirement planning for most U.S. wage earners. They can be of great benefit to you. But move cautiously and consider how you can make the most of your 401(k) and even take advantage of some other available options such as an IRA.

Fact checked by Vikki Velasquez

A traditional individual retirement account (IRA) is one of the most common ways to save for retirement due to its tax advantages. These accounts are also commonly used because they are easy to open and maintain. 

The tax advantages of a traditional IRA are simple. Yearly contributions are tax-deductible, and your investments grow tax-deferred while in the IRA. Then, withdrawals during retirement are taxed according to your income tax rate during retirement.

If you’re looking to open a traditional IRA, this guide will walk you through what you need to know to open and manage your traditional IRA, from choosing the right provider to understanding the rules that govern contributions and withdrawals.

Key Takeaways

• Opening a traditional IRA is straightforward and can be done through online brokers, robo-advisors, or financial institutions.
• Contributions to a traditional IRA are tax-deductible, and your investments grow tax-deferred.
• Choose the right IRA provider based on fees, investment options, and customer service.
• Stay informed about contribution limits, required minimum distributions (RMDs), and potential early withdrawal penalties.

1. Understand What a Traditional IRA Is

Before you start the process of opening a traditional IRA, it’s important to understand what this type of account offers. A traditional IRA is a retirement account that allows you to make tax-deductible contributions, with investments growing tax-deferred until you start making withdrawals in retirement.

Keep in mind the IRS imposes rules and limits on the contributions you can make each year, otherwise a penalty may be applied.

2. Consider Your Investing Style

One benefit of traditional IRAs is that they can be invested in various investments, such as mutual funds, stocks, and bonds, similar to a brokerage account. Company-sponsored 401(k) plans often limit your investment options, and if these options do not agree with your investment priorities, you may be dissatisfied with your investment outcomes. 

On the other hand, with the wide variety of investment options available through a traditional IRA, you will have to decide how much time and energy you can and want to devote to managing your IRA. 

Opening a traditional IRA with a robo-advisor instead of a traditional broker is a great option for individuals who want to take a more passive approach to investing. Opening a traditional IRA at a brokerage with the help of a financial advisor could also be a compelling option for more hands-free investors. However, these services both charge fees, which can be unappealing to some people. 

“If you don’t have the time and energy, or if the idea of parsing through different investment options makes you anxious or nervous, I think it makes a ton of sense, at a minimum, to consider using a robo-advisor, because robo-advisors are usually way cheaper than the typical 1% in-person advisor fee,” said Taylor Jessee, CFP, CPA, founder of Impact Financial.  

Note

Mutual funds and ETFs are popular investment choices in long-term retirement accounts like traditional IRAs because of their low risk over extended investment periods. Therefore, independently investing in an IRA may seem more approachable than independently investing in a brokerage account. 

3. Choose an IRA Provider

Once you have decided whether to open your traditional IRA with a robo-advisor or a traditional broker, you will need to decide which provider to open your account with. 

Not all robo-advisor and traditional broker providers are created equal. These are some key considerations when comparing different products:

• Fees or commissions: Some brokers or robo-advisors impose fees or commissions on traditional IRAs. Research fee schedules and rates to find the right account for yourself. 
• Investment options: Traditional IRAs can generally be invested in stocks, bonds, mutual funds, and ETFs. However, if you are interested in alternative investments or real estate products, you should make sure that your account provider offers those options.
• Account or investment minimums: Some traditional IRA providers may have an account or investment minimums. Research this factor in advance to avoid any potential friction in your contribution schedule. 
• Customer support: Quality customer service can be key to an enjoyable and successful investment experience. 
• Educational resources: The availability and quality of investment education resources at your account provider can be a crucial factor when opening a traditional IRA, especially for inexperienced investors. 

4. Open a Traditional Account

Opening a traditional IRA is a straightforward process, often done entirely online. After selecting your provider, you’ll need to provide personal identification and financial information.

“Lots of mobile apps have it where you can open up an IRA or an investment account straight through your mobile phone,” Jessee said. “It’s not like how it was in the 70s, 80s, like before, the internet, where your only choice was to go to a stockbroker to open the account.”

Necessary materials vary by provider, but here are some common requirements: 

• Personal identification information (Social Security number and driver’s license or another form of personal identification) 
• Personal financial information (statement of assets or cash) 
• Employer information (if applicable)
• Beneficiary information

When you are actually opening the account, you will likely need to perform the following: 

• Create login credentials and answer security questions 
• Select account features
• Provide necessary information 
• Decide how to fund the account 

Nowadays, opening a traditional IRA account is a simple process. If you run into any roadblocks, customer service will likely be able to help you work through the issue. 

5. Fund Your IRA 

The final step to opening a traditional IRA is to fund the account. There are three main ways to fund a traditional IRA from an existing financial institution, and they are not unique from other kind of investment account: 

• Electronic funds transfer (EFT): It can be very convenient to transfer funds from an external account to your traditional IRA through an EFT. Creating this link between accounts can make it easier to fund your traditional IRA from that external account in the future. 
• Wire transfer: Wire transfers can also facilitate fund cash transfers from an existing financial account to your traditional IRA. These transfers are similar to EFTs but generally require more time than EFTs. 
• Check deposit: Checks from your existing financial institution can be mailed or deposited into your traditional IRA in person. 

Important

For 2024 and 2025, you can contribute up to $7,000 per year ($8,000 if you’re 50 or older). If your income is below the contribution limit, you may be able to contribute a lesser amount.

Important Considerations Before Opening a Traditional IRA

Before you open a traditional IRA, make sure that you understand the full terms of the account and how it compares to other retirement products. 

Choosing a Traditional IRA Over Other Retirement Accounts

A traditional IRA is just one mechanism to support retirement savings. When opening or considering opening a traditional IRA, you should consider other investment options to ensure that this is the right decision for you. 

You may want to explore other IRA options, like Roth IRAs, SIMPLE IRAs, and SEP IRAs, in order to determine if the tax advantages of the traditional IRA best suit your personal budget and career trajectory. For example, a SEP IRA is designed for self-employed individuals, and Roth IRAs have an annual income limit, while traditional IRAs do not. 

You may also want to contribute to a traditional IRA in addition to other retirement products. 

“The vast majority of employers these days offer a 401(k), so usually if you’re just starting out in your retirement savings journey, a 401(k) is almost always going to be the easiest and most efficient place to start,” Jessee said. “Once you check the box of putting money into your 401(k), then I think it can make sense to branch out and say, ‘I’m going to do a 401(k) and an IRA because I still have money that I want to save’.” 

Contribution Limits

Traditional IRAs, like Roth IRAs, have annual contribution limits. Therefore, you may want to consider investing sooner rather than later to maximize your return on investment during retirement. 

For 2024 and 2025, you can contribute up to $7,000 to your traditional IRA. To help older adults catch up on retirement savings, adults over age 50 can contribute up to $8,000 in 2024.

If your taxable compensation or total income for the year is less than $7,000, you can contribute up to the whole of this compensation. 

Early Withdrawal Penalties

Because traditional IRA investments are tax-advantaged and intended to remain in accounts until retirement, the IRS imposes early withdrawal penalties on these accounts. 

Withdrawals before the age of 59½ years old from a traditional IRA are subject to income tax in addition to a 10% penalty unless you have a specific extenuating circumstance. Exceptions to the 10% penalty include certain medical reasons, first home purchases, births, and adoptions. 

Similar restrictions apply to other kinds of retirement accounts, and considering this limitation may affect your retirement strategy. 

“Investments don’t have to just be retirement,” said Kevin Lao, CFP, founder of Imagine Financial. “It could also be investing into yourself, investing into education, investing into a skill or a trade because that’s going to add value to your earning potential, and more earning potential in your 30s, 40s, and 50s will pay more dividends than just saving 10% or 50% of your salary for the next 30 to 35 years.”

Warning

Be aware of early withdrawal penalties on traditional IRAs.

Required Minimum Distributions (RMDs)

Required minimum distributions are the amount of money that you must withdraw from your traditional IRA after you reach age 73 (age 72 if you reached that age before Dec. 31, 2022). 

Required minimum distributions for traditional IRAs vary depending on marital status, spouse age, and beneficiaries. For specific information, consult the IRS website. 

If You Are Rolling Over a 401(k)

If you are specifically rolling over a 401(k) from a former employer to a traditional IRA, you will likely want to roll over your retirement plan distribution. By rolling over, you generally will not have to pay tax on your investments until you withdraw from your new plan, and you will not incur any penalties if your distribution is given to you before age 73. 

“The traditional IRA is more for folks that are doing a rollover,” Lao said. “Let’s say [you] have a 401(k) plan from a previous employer, and [you]’ve built up a couple million dollars and want a little bit more control over [your] investments, but don’t want to go through the whole corporate bureaucracy of tapping into [your] 401 k plan… [You] can roll those funds into a traditional IRA and control the investments a little bit more.”

To complete a distribution rollover, you will need to deposit the distribution within 60 days of receiving it, and generally, you can only complete one rollover per year. To learn more about specific situations, consult the IRS website. 

Can I Open a Traditional IRA on My Own?

Yes. Traditional IRAs can be easily opened through many different brokers and robo-advisors by providing personal identification and financial information. To ensure that you are opening an account that fits your personal goals and investment style, you may want to compare different accounts’ fees or commissions, investment options, account or investment minimums, customer support, and educational resources. 

How Much Money Do You Need To Open a Traditional Ira?

The amount of money required to open a traditional IRA depends on the provider. Many brokers and financial institutions allow you to open an IRA with no minimum deposit, but some may require an initial contribution, often ranging from $100 to $1,000.

Can I Open a Traditional Ira at a Bank?

Yes, you can open a traditional IRA at many banks. However, bank IRAs typically offer fewer investment options (like certificates of deposit or savings accounts) compared to brokerage firms or robo-advisors, which offer a wider range of stocks, bonds, and mutual funds.

The Bottom Line

You can open a traditional IRA in a few simple steps. When opening a traditional IRA, evaluating your investment style, provider fees, and contribution limits in advance is crucial. This accessible retirement tool offers tax-deductible contributions and tax-deferred growth through diverse investment options.

To effectively manage your IRA after opening it, regularly review your investment strategy, take advantage of employer-sponsored plans, and stay informed about retirement savings options to maximize your long-term benefits.

Reviewed by Somer Anderson
Fact checked by Timothy Li

The U.S. central bank, the Federal Reserve (the Fed), has a dual mandate: to work to achieve low unemployment, and to maintain stable prices throughout the economy. During a recession, unemployment rises, and prices sometimes fall in a process known as deflation.

The Fed, in the case of steep economic downturns, may take dramatic steps to suppress unemployment and bolster prices, both to fulfill its traditional mandate and to provide emergency support to the U.S. financial system and economy.

Key Takeaways

• The Federal Reserve has a dual mandate from Congress to maintain full employment and price stability in the U.S. economy.
• To help accomplish this during recessions, the Fed employs various monetary policy tools to suppress unemployment rates and reinflate prices.
• These tools include open market asset purchases, reserve regulation, discount lending, and forward guidance to manage market expectations.
• Most of these tools were deployed in a big way starting in the spring of 2020 in response to the economic challenges imposed by a global pandemic.

The Impact of a Recession

At the onset of a recession, some businesses begin to fail, typically due to some combination of real economic shocks or economic bottlenecks caused by the incompatibility of production and consumption activities resulting from previously distorted interest rate and credit conditions. These businesses lay off workers, sell assets, and sometimes default on their debts or even go bankrupt. All of these things put downward pressure on prices and the supply of credit to businesses in general, which can spark a process of debt deflation. 

Deflation, in the form of falling prices, is not generally a harmful process for the economy or a problem for most businesses and consumers by itself. It is, however, widely feared by central banks and the broader financial sector, especially when it involves debt deflation because it increases the real value of debts and thus the risk to debtors. Banks and related institutions are typically among the largest debtors in any modern economy. To protect its constituent banks from defaulting on their overextended debts, the Federal Reserve does not hesitate to take action in the name of stability.

The Federal Reserve has a number of tools to attempt to re-inflate the economy during a recession in pursuit of these goals. These tools largely fall into a handful of categories, which we will look at below.

Open Market Operations

The Fed can lower interest rates by buying debt securities on the open market in return for newly created bank credit. Flush with new reserves, the banks that the Fed buys from are able to lend money to each other at a lower federal funds rate, the rate at which banks lend to each other overnight. The Fed hopes that a drop in interest rates spreads throughout the financial system, reducing rates charged to businesses and individuals.

When this works, the lower rates make it cheaper for companies to borrow, allowing them to continue going into more debt rather than defaulting or being forced to lay off staff. This helps to both keep employees in their current jobs and suppress the rise in unemployment when a recession hits. Lower interest rates also enable consumers to make more purchases on credit, keeping consumer prices high.

There are times when interest rates won’t go any lower because banks simply hold on to the newly injected reserve credit for their own use as liquid reserves against their debt obligations. In these cases, the Federal Reserve may choose to simply continue open market operations, buying bonds and other assets to flood the banking system with new credit. This is known as quantitative easing (QE)—the direct purchase of assets by the Federal Reserve to inject more money into the economy and expand the money supply. 

The Fed has used quantitative easing on several occasions since 2008, including in March 2020, when the central bank launched an initial $700 billion QE plan aimed at propping up the debts of the financial system on top of most of the nearly $4 trillion in QE that it created during the Great Recession.   

Important

The Fed purchases mostly Treasury securities in its normal open market operations but extends this to include other government-backed debt when it comes to quantitative easing.

Lowering Capital Requirements

The Fed also can regulate banks to ensure that they are not required to hold capital against potential debt redemption. Historically, the Fed was charged with regulating the banks to make sure they maintained adequate liquid reserves to meet redemption demands and remain solvent. During recessions, the Fed could also lower requirements to allow banks greater flexibility to run their reserves down, at the risk that this may increase banks’ financial vulnerability.

However, after the 2007–08 financial crisis, the Fed’s campaign of quantitative easing resulted in banks holding massive ongoing balances of reserves in excess of the required reserve ratio. In part because of this, as of March 2020, the Fed eliminated all reserve requirements for banks. This leaves the Fed no further room to use this tool to loosen credit conditions for any impending recessions.

Note

The Fed does not currently require banks to hold any minimum reserves against their liabilities, but many banks hold large excess reserves with the Fed anyway.

Discount Lending

The Fed can directly lend funds to banks in need through what is called the discount window. Historically, this type of lending was carried out as an emergency bailout loan of last resort for banks out of other options—and it came with a hefty interest rate to protect the interests of taxpayers, given the risky nature of the loans.

However, in recent decades, the practice of discount lending by the Fed has shifted toward making these risky loans at much lower interest rates to favor the interests of the financial sector as much as possible. It has also rolled out a host of new lending facilities similar to discount lending, targeted at supporting specific sectors of the economy or the prices of specific asset classes.

As of March 2020, the Fed dropped its discount rate to a record low 0.25% to give extraordinarily favorable terms to the riskiest of borrowers. However, by March 2025, a series of assertive rate increases enacted by the Fed to cool high inflation had returned the discount rate to 4.5%.

Note

With discount lending, the Fed is acting in its function as a lender of last resort for banks.

Expectations Management

Expectations management is also known as forward guidance. Much of the economic research and theory on financial markets and asset prices acknowledge the role that market expectations play in the financial sector and the economy more broadly, and this is not lost on the Fed. Doubt as to whether the Fed will act to bail out banks and keep asset prices inflated can lead to pessimism among investors, banks, and businesses on top of the real problems facing the economy. 

Fighting Inflation and the Specter of a Recession

Inflation occurs when prices rise in the economy and the purchasing power of the dollar erodes. The Fed targets around 2% inflation per year, and during a recession, inflation may indeed remain well below this target, allowing the central bank to maintain expansionary monetary policy.

However, expansionary monetary policy also can eventually lead to inflation. If the economy is operating near capacity and there are not enough workers to fill all the jobs available, or if wages are rising faster than productivity growth, then more people will want to borrow money to fund additional consumption.

The supply of labor will not expand quickly enough to accommodate the increased demand for labor, leading to rising wages relative to productivity growth and a wage-price spiral in which firms are forced to raise wages to match the cost of borrowing. The availability of cheap credit to individuals and firms may also lead to increased borrowing, spending, and investing, which can lead to both economic growth and higher prices. These factors, when combined, can cause an inflationary rise in asset prices in the economy.

In periods of high inflation, central banks must aggressively fight price pressures by raising interest rates and/or implementing contractionary policies such as reducing bank reserve requirements or selling off assets. When inflation rises above the target level for too long, this can push the economy into stagflation, a situation in which high unemployment and high inflation occur at the same time.

This dual problem is untenable for the central bank, which can end it only by tightening policy aggressively to bring price pressures down and slash aggregate demand in the economy. This, however, can trigger another recession.

What Tools Does the Federal Reserve Have to Fight a Recession?

The Fed has several monetary policy tools it can use to fight off a recession. It can lower interest rates to spark demand and increase the amount of money in circulation via open market operations, including quantitative easing, through which additional types of assets may be purchased by the Fed. Other measures include making loans to troubled financial institutions or buying assets from them directly. These policies can be particularly useful during a financial crisis or economic slump, when firms and investors may be unwilling to lend as they worry about their future.

Why Does the Fed Raise Interest Rates When Unemployment Falls?

The Fed does not always raise interest rates in response to low unemployment. However, low unemployment can lead to an overheated economy. Higher interest rates reduce demand by making borrowing more expensive, which slows economic growth and damps price pressures in the economy. Interest rates should rise when unemployment falls because consumers are likely to start borrowing more and spending more with high employment and faster wage growth. 

What Is Loose Money?

Loose money (or easy money) refers to expansionary monetary policy by the Fed. When money is “loose,” it means it is abundant and easy to obtain. When money is “tight,” it is scarce and more expensive to borrow. During a recession, loose monetary policy can help the economy recover by sparking aggregate demand because individuals and firms are able to borrow more to spend and invest.

What Is the Difference Between Fiscal Policy and Monetary Policy?

Monetary policy is enacted by a country’s central bank and seeks to influence the money supply in a nation. Fiscal policy is enacted by a country’s government through spending and taxes to influence a nation’s economic conditions. To help fight a recession, fiscal policy may aim to lower taxes and increase federal spending to increase aggregate demand.

The Bottom Line

During recessions, the Fed generally seeks to credibly reassure market participants through its actions and public announcements that it will prevent or cushion its member banks and the financial system from suffering too-heavy losses, using the tools discussed above.

Reviewed by Somer Anderson

Gross profit margin and operating profit margin are two metrics used to measure a company’s profitability. Gross profit margin includes the direct costs involved in production, while operating profit margin accounts for operating expenses like overhead.

Both metrics are important in assessing the financial health of a company.

Key Takeaways

• Gross profit margin and operating profit margin are two metrics used to measure a company’s profitability.
• Gross profit margin includes the direct costs involved in production.
• Operating profit margin accounts for operating expenses like overhead.

Gross Profit Margin

Gross profit margin shows how well a company generates revenue from direct costs like direct labor and materials used in production. Gross profit is first calculated by subtracting the cost of goods sold from total revenue. Gross profit margin is the difference divided by total revenue and shown as a percentage.

$begin{aligned} &text{Gross Profit Margin} = frac { text{Revenue} – text{COGS}}{ text{Revenue}} times 100 \ &textbf{where:} \ &text{COGS} = text{Cost of goods sold} \ end{aligned}$​Gross Profit Margin=RevenueRevenue−COGS​×100where:COGS=Cost of goods sold​

Important

The cost of goods sold (COGS) is the amount a company spends to produce the goods or services it sells.

Operating Profit Margin

Operating profit is derived from gross profit. Operating profit or operating income takes gross profit and subtracts all overhead, administrative, and operational expenses. Operating expenses include rent, utilities, payroll, employee benefits, and insurance premiums. The operating profit calculation excludes interest on debt and the company’s taxes.

Operating profit margin is calculated by dividing operating income by total revenue. Like gross profit margin, operating profit margin is expressed as a percentage.

$begin{aligned} &text{Operating Profit Margin} = frac { text{Operating Income} }{ text{Revenue}} times 100 \ end{aligned}$​Operating Profit Margin=RevenueOperating Income​×100​

Comparing Gross Profit Margin and Operating Profit Margin

Below is a portion of an income statement for JCPenney. In this example, JCPenney earned only $3 million in operating income after earning $2.67 billion in revenue.

Although the gross profit margin appeared healthy at 38%, after taking out expenses and selling, general, and administrative expenses (SG&A), the operating profit margin tells a different story. The disparity between the numbers shows the importance of using multiple financial metrics in analyzing a company’s profitability.

• Total revenue is highlighted in green as $2.67 billion, while the COGS is beneath revenue, coming in at $1.7 billion.
• Gross profit margin was 36%, or $begin{aligned} frac { $2.67 text{ Billion} – $1.7 text{ Billion COGS} }{ $2.67 text{ Billion} } = .36 times 100 = 36$$2.67 Billion$2.67 Billion−$1.7 Billion COGS​=.36×100=36%​
• Operating income, which is further down the statement, totaled $3 million for the period and is further down the statement, highlighted in blue.
• Operating profit margin was 0.11%, or $begin{aligned} frac { $3 text{ Million} }{ $2.67 text{ Billion} } = .0011 times 100 = .11$$2.67 Billion$3 Million​=.0011×100=.11%​
• Although JCPenney had a 36% gross profit margin, after taking out operating expenses and overhead, listed as SG&A, the company earned less than 1% in operating profit margin.

What Expenses Are Included in COGS?

Cost of goods sold (COGS) is the cost to manufacture the products or finished goods a company sells. Costs included in the measure are directly tied to the production of the products, including the labor, materials, and manufacturing overhead.

What Are Overhead Costs?

Overhead costs include all of the expenses to run a business, like rent, insurance, and utilities.

How Often Do Companies Report Earnings?

Publicly traded companies must submit quarterly reports to the U.S. Securities and Exchange Commission (SEC). They must also file annual reports.

The Bottom Line

The gross profit margin can show a company’s financial health. However, when accounting for additional operating costs like rent or payroll, the operating profit margin may be lower than the gross profit margin. The difference between the numbers proves how important it is for investors and analysts to use multiple financial metrics in analyzing a company’s financial position.

Reviewed by Ebony Howard
Fact checked by Yarilet Perez

What Is Marginal Propensity to Save?

Marginal propensity to save (MPS) is used by economists to quantify the relationship between changes in income and changes in savings. It refers to the proportion of an increase in disposable income that a household saves rather than uses for consuming goods and services.

Key Takeaways

• Marginal propensity to save (MPS) is an economic measure of how savings change, given a change in disposable income.
• It is calculated by dividing the change in savings by the change in disposable income.
• A larger MPS indicates that small changes in disposable income lead to large changes in savings, while a small MPS indicates that large income changes lead to small savings changes.

Understanding Marginal Propensity to Save

The marginal propensity to save is the portion of each extra dollar of a household’s income that’s saved. The MPS indicates what the overall household sector does with extra income—specifically, the percent of extra income that is saved.

As saving and consumption complement each other, the MPS reflects key aspects of a household’s saving and consumption habits. The MPS reflects leakage, the portion of disposable income that’s not put back into the economy through purchases of goods and services. The higher the changes in disposable income for an individual, the higher the MPS, as the ability to satisfy needs increases with income.

Disposable income is the amount of income left over after paying bills and other recurring expenses, income that is not intended to be used for living expenses. Disposable income can increase for various reasons, such as a pay raise without an increase in expenses or paying off a car loan, mortgage, or credit card.

In other words, each additional dollar is less likely to be spent as an individual becomes wealthier. Studying MPS helps economists determine how wage growth might influence savings.

MPS is expressed as a percentage. For example, if the marginal propensity to save is 10%, it means that out of each additional dollar not used for expenses, $0.10 is saved.

How Marginal Propensity to Save Is Calculated

MPS is most often used in Keynesian economic theory. It is calculated simply by dividing the change in savings observed given a change in income: 

MPS = ΔS/ΔY

Where:

• Δ represents change
• ΔS is the change in savings
• ΔY is the change in income

If income changes by a dollar, then saving changes by the value of the marginal propensity to save. The marginal propensity to save is actually a measure of the slope of the savings line when graphed. The graph is created by plotting the change in income on the horizontal x-axis and the change in savings on the vertical y-axis. The slope of the savings line is depicted by the change in savings and the change in income, or a change in the y-axis, divided by the change in the x-axis.

So, if consumers saved $0.20 for every $1 increase in income, the MPC would be 0.20 (0.20 / $1). The value of the marginal propensity to save always varies between zero and one, where zero indicates that changes in income had no effect on savings whatsoever.

Example

Assume an engineer has a $100,000 change in income from the previous year due to a pay raise and bonus. The engineer decides that they want to spend $50,000 of the increase in income on a new car and save the remaining $50,000. The resulting marginal propensity to save is 0.5, which is calculated by dividing the $50,000 change in savings by the $100,000 change in income.

Therefore, for each additional $1 of income, the engineer’s savings account increases by $0.50.

What Is MPC and MPS?

Marginal propensity to save (MPS) is a measurement of a consumer’s increase in savings relative to a change in income. Marginal propensity to consume (MPC) is the opposite of MPS, a measurement of an increase in spending in proportion to an increase in income.

How do You Calculate MPC to Save?

Marginal propensity to consume (MPC) is a measurement of a consumer’s increase in consumption regarding an increase in disposable income.

What Is Meant by Marginal Propensity to Save?

Marginal propensity to save is the measured proportion of savings following an increase in income.

The Bottom Line

Marginal propensity to save is a measurement of a worker’s proportional increase in savings following an increase in income. It is a metric generally used by economists to describe and quantify consumer saving tendencies.