May 26, 2020 By

Q&A: When a Roth IRA makes sense

Dear Liz: I have some money saved in a brokerage account, over and above my maximum 401(k) contribution. I just turned 60. Is it advantageous to move that money into a Roth IRA or should I keep it in the brokerage account?

Answer: If you suspect you’ll need this money within five years, then you probably should leave it in the brokerage account (and move it to cash, since money needed within the next few years should not be in the stock market). Otherwise, there’s little downside to moving some of the money to a Roth IRA, if you can, and plenty of upside.

Having money in a Roth gives you “tax diversification,” or a potentially tax-free bucket of money to draw from or leave alone as you see fit. That’s in contrast to 401(k)s, regular IRAs and other retirement plans, which typically require withdrawals to begin at age 72.

You can always withdraw an amount equal to your contributions without paying taxes or penalties. Once the account is at least 5 years old and you’re over 59½, whichever comes later, you also can withdraw any earnings without tax or penalty.

You can contribute up to $7,000 to a Roth this year, assuming you have earned income of at least that amount and your modified adjusted gross income is less than $124,000 if you’re single or $196,000 if you’re married filing jointly. (The contribution limit is $6,000 for people under 50.) If your income is above those limits, your ability to contribute to a Roth starts to phase out. The ability to contribute directly to a Roth ends when your modified adjusted gross income is over $139,000 for singles and $206,000 for married couples.

Filed Under: Q&A, Retirement Tagged With: , , ,
May 11, 2020 By

Q&A: What to do if an employer messes up your 401(k) coronavirus hardship withdrawal

Dear Liz: I used the Coronavirus Aid, Relief, and Economic Security (CARES) Act to cash out my 401(k). My ex-employer waived the 10% penalty but withheld 20% for federal taxes. It seems unconscionable to keep $20,000 of my money for at least eight months instead of sending it to me. The law states I have three years to pay the taxes and I need that hard-earned money now. Is there anything I can do to make my former employer release my money?

Answer: Please contact your former employer immediately. It sounds like what you got was a regular distribution, which can be penalized as well as taxed and which can’t be paid back. Your employer can’t waive an IRS penalty — it either applies to the distribution by law or it doesn’t — and the 20% withholding indicates this was not a coronavirus hardship withdrawal, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting.

Coronavirus hardship withdrawals allow qualified people to withdraw as much as $100,000 of their balances from 401(k)s and IRAs, but these withdrawals aren’t available to everyone. You must have been affected physically or financially by the pandemic.

Plus, if you want to take the distribution from a 401(k), check if your employer is offering the option. A majority of employers now offer coronavirus hardship withdrawals, according to a Willis Towers Watson survey, but some are opting not to do so.

If you qualified for a coronavirus hardship withdrawal from a 401(k) plan offering that option, the distribution should not have been subject to withholding.

You would owe income taxes but not the usual 10% federal early withdrawal penalty, and you would have three years to pay the income taxes on the withdrawal. You also would have the option to pay the money back within three years and then amend your tax returns to get the taxes you paid refunded.

If your former employer did not offer coronavirus hardship withdrawals but you otherwise qualified, you had the option of rolling your 401(k) money into an IRA and then taking a coronavirus hardship withdrawal from the IRA. (You can typically roll money out of only a former employer’s plan. If you’re still working for that employer, such rollovers usually aren’t allowed.)

If your employer won’t release the withheld money, you still have a way to limit the damage. You can put the rest of what you received into an IRA, as long as you do so within 60 days, and then take a coronavirus hardship withdrawal from the IRA.

Unless you can come up with the $20,000 that was withheld, however, you’ll have to pay taxes and penalties on that $20,000 and you won’t be able to pay that money back. That’s unfortunate, but it’s better than having the entire $100,000 penalized and not having the option to pay any of it back.

Filed Under: Coronavirus, Q&A, Retirement Tagged With: , ,
April 27, 2020 By

Q&A: Withdrawing after-tax retirement funds

Dear Liz: I have been contributing to retirement accounts for many years, starting back in the early 1980s. Back then, there were no deductions for contributions. I made about $50,000 of after-tax contributions, meaning I’ve already paid taxes on that money. Later I switched to before-tax contributions. Now that I am retired and approaching 65, in my feeble mind, I believe I should be able to withdraw that $50,000 without having to pay any taxes on it. However, things that I’ve read indicate that it may not be that easy. Can you help with this question, or at least point me in the right direction?

Answer: You will escape taxes on a portion of any withdrawal you make from a retirement plan that has after-tax money in it, said Mark Luscombe, principal analyst at Wolters Kluwer Tax & Accounting. However, only Roth IRAs allow you to make totally tax-free withdrawals of your contributions at any time.

With a Roth IRA, any withdrawals are considered first to be a return of contributions. For example, if you contributed $50,000 to an account that’s now worth $200,000, the first $50,000 you withdraw would be tax- and penalty-free, regardless of your age, Luscombe said. If you were under 59½, additional withdrawals could be subject to taxes and penalties.

With regular IRAs and 401(k)s, the tax treatment is different. Withdrawals are considered to be a proportionate return of your after-tax money, Luscombe said. If you contributed $50,000 after tax and then withdrew the same amount from an account now worth $200,000, only one quarter of the money would escape tax.

Filed Under: Q&A, Retirement, Taxes Tagged With: , ,
April 27, 2020 By

Q&A: Coronavirus aid law lets you more easily tap retirement savings. That doesn’t mean you should

Dear Liz: You recently mentioned that a person can withdraw money from their 401(k) and spread the taxes over three years. If 401(k) is paid back, they can amend their tax returns to get those taxes refunded. Because of some major home repairs, I asked our accountant about this before we proceeded. He said that he hasn’t read anything official about the above. Would you please provide where you obtained your information, so we can decide if that’s an avenue we can use?

Answer: It’s possible you had this conversation before March 27, when the Coronavirus Aid, Relief, and Economic Security (CARES) Act became law.

Otherwise, it’s kind of hard to imagine an accountant anywhere in the U.S. who hasn’t heard of the emergency relief package that created the stimulus checks being sent to most Americans, as well as the Paycheck Protection Program’s forgivable loans for businesses and the new coronavirus hardship withdrawal rules for 401(k)s and IRAs.

Those rules allow people who have been affected financially or physically by COVID-19, the disease caused by the novel coronavirus, to get emergency access to their retirement funds if their employers allow it.

Even if you do have access to such a withdrawal, you should consider other avenues first.

The income taxes on retirement plan withdrawals can be substantial, even when spread over three years. Perhaps more importantly, you probably would lose out on future tax-deferred returns that money could have earned because few people who make such withdrawals will be able to pay the money back.

A home equity loan or line of credit is typically a much better option for home repairs, if you can arrange it.

Filed Under: Coronavirus, Q&A, Retirement, Taxes Tagged With: , , , , ,
April 20, 2020 By

Q&A: Here’s why taking money from retirement accounts to pay bills is dumb

Dear Liz: I do not qualify for a coronavirus hardship withdrawal, but I have debt on several credit cards with interest rates above 23%. In 2019, I paid nearly $2,500 in interest charges. I would like to remove $10,000 from my IRA and use it to pay off the debt. I would then put the money that would normally go toward the credit card debt ($500 a month) to pay back the IRA. Would this repayment mitigate some of my tax charges from the withdrawal, and how long do I have to replace the funds, if any?

Answer: Coronavirus hardship withdrawals are available to a large group of people, including those who have lost their jobs or suffered other financial setbacks because of the pandemic, as well as people actually diagnosed with COVID-19, the disease caused by the novel coronavirus.

Coronavirus hardship withdrawals allow people to take out up to $100,000 from individual retirement accounts or 401(k)s without paying early withdrawal penalties or facing mandatory withholding. Income taxes must be paid on the withdrawal, but that bill can be spread over three years.

People who take such withdrawals would have the option of putting the money back within three years. If they can repay the money, they could amend their previous tax returns to get a refund of the taxes they paid on them.

If you don’t qualify for a coronavirus hardship withdrawal, then the rules on taking money from your IRA haven’t changed. You cannot take a loan from an IRA, and any money you withdrew would have to be returned to a qualifying retirement account within 60 days or it’s considered a withdrawal.

You would have to pay income taxes on the withdrawal, plus the 10% federal penalty if you’re under 59½. Most states also tax and penalize such withdrawals.

Even if you could qualify for a coronavirus hardship withdrawal, though, it would be a bad idea to raid your retirement account to pay credit card bills.

Not only is the tax cost high, but you’re also losing the future tax-deferred returns that money could have earned. A $10,000 withdrawal now could mean $100,000 less in retirement funds 30 years from now.

Also, you shouldn’t use an asset that would be protected from creditors to pay debts that could otherwise be erased in case you have to file for bankruptcy.

Too many people drain their 401(k)s and IRAs trying to pay their bills, only to find out too late that their retirement accounts are protected in bankruptcy. Meanwhile, the bills — including credit card balances, medical bills and most other unsecured debts — could have been wiped out.

If you can make your credit card payments but want to reduce your interest costs, you could consider a personal loan to consolidate your debt if your credit is good. If your credit is not good or you are struggling financially, you could contact a credit counselor about a debt management plan that would allow you to pay off your cards over time at lower rates.

You can get referrals from the National Foundation for Credit Counseling.

Another option for people struggling to pay off their credit card debt is to ask the issuers about hardship programs. Many are willing to offer forbearance, which allows cardholders to skip payments, or to temporarily reduce required payments.

If you’re struggling, though, you also should make an appointment with a bankruptcy attorney about your options. You can get referrals from the National Assn. of Consumer Bankruptcy Attorneys.

Filed Under: Q&A, Retirement, Saving Money Tagged With: , ,
April 6, 2020 By

Q&A: Volatile markets and retirement

Dear Liz: With the tumult in the stock market, I’ve been thinking of a strategy which may be safe but not prudent. I have about $315,000 in a trust account which pays me about $9,000 a year in dividends. I’m 81. If I sell all the stocks in my trust account, I could draw the same $9,000 for over 10 years, not counting about 2% growth on the $315,000. What are your thoughts?

Answer: Many people have discovered they’re not as risk tolerant as they thought they were. The volatile stock market has unnerved even seasoned retirement investors. Most, however, should continue investing because they won’t need the money for decades, and even retirees typically need the kinds of returns that only stocks can deliver long term.

There’s no reason to take more risk than necessary, however. If all you need from your trust account is $9,000 a year, you’d be unlikely to run out even if your money is sitting in cash. But you may need more than $9,000 in the future — to adjust for inflation, for example, or to cover long-term care costs.

One option to consider is a single-premium immediate annuity. In exchange for a lump sum, you’d get a guaranteed stream of monthly checks for the rest of your life. At your age, you could get $9,000 a year by investing about $100,000 in such an annuity. Because your payments would be guaranteed by the annuity, you might be more comfortable leaving at least some of the rest of your account in stocks for potential growth.

Filed Under: Investing, Q&A, Retirement Tagged With: , , ,
March 23, 2020 By

Q&A: Reducing taxes in retirement

Dear Liz: I agree with this concept of delaying Social Security to lessen overall taxes and have a further suggestion. My spouse and I are gradually converting our traditional IRA account funds to Roth IRAs. The converted funds are immediately taxable but could continue to gain in value and future distributions would not be taxable. Also, Roth accounts don’t have required minimum distributions.

Answer: Conversions make the most sense when you expect to be in the same or higher tax bracket in retirement.

That’s not the case for most people because they’re in a lower tax bracket when they stop working. Some older people, however, do face higher tax rates in retirement — typically because they’ve been good savers, and required minimum distributions from their retirement accounts will push their tax rates higher.

When that’s the case, they may be able to take advantage of their current lower tax rate to do a series of Roth conversions.

The math can be tricky, though, so it’s advisable to get help from a tax pro or financial planner. You don’t want to convert too much and push yourself into a higher tax bracket, or trigger higher Medicare premiums.

If your intention is to leave retirement money to your heirs, Roth conversions may also make sense now that Congress has eliminated the stretch IRA.

Stretch IRAs used to allow non-spouse beneficiaries — often children and grandchildren — to take money out of an inherited IRA gradually over their lifetimes. This spread out the tax bill and allowed the funds to continue growing. Now inherited IRAs typically have to be drained within 10 years if the inheritor is not a spouse.

To compensate, some people are converting IRAs to Roths — essentially paying the tax bill now, so their heirs won’t have to do so later. Heirs would still have to withdraw all the money in an inherited Roth IRA within 10 years, but taxes would not be owed.

Filed Under: Q&A, Retirement Tagged With: , , , ,
March 16, 2020 By

Q&A: Which to tap first: IRA or Social Security?

Dear Liz: I retired in 2015 but have not started Social Security. My wife and I are living on a pension and savings. I read an article saying that taking early IRA withdrawals and holding off on Social Security can help minimize the so-called tax torpedo, which is a sharp rise and fall in marginal tax rates due to the way Social Security benefits are taxed.

I made a spreadsheet to compare the cumulative income we could expect by starting IRA withdrawals now and delaying Social Security until age 70, versus starting Social Security now and delaying the IRA withdrawals. The spreadsheets indicate that by taking early IRA distributions and delaying Social Security, we would get a significant increase in total cumulative income as the years go by.

We feel we need a professional to verify our results and perhaps advise us as to which might be our best route, as well as getting an assessment of our income tax implications for the next five years or so. My wife thinks we should ask a Certified Public Accountant and is concerned about the price of a fee-only advisor.

Answer: Your findings are similar to what researchers reported in the July 2018 issue of the Journal of Financial Planning. The tax torpedo increases marginal tax rates for many middle-income households. One solution is to delay Social Security until age 70 and tap IRAs instead. That maximizes the Social Security benefit while reducing future required minimum distributions.

It’s always a good idea to get an objective second opinion on retirement distributions, however. Mistakes can be costly and irreversible. A fee-only certified financial planner should have access to powerful software that can model various scenarios to help confirm your results and guide your next steps.

Filed Under: Q&A, Retirement, Social Security Tagged With: , , ,
March 9, 2020 By

Q&A: Worried about stocks? Why you shouldn’t try to time the market

Dear Liz: I’m a federal employee with a Thrift Savings Plan account. I’m 35 and have put about $125,000 into my TSP. However, I never changed it from the low-risk G fund so it’s not gaining as much interest as it should. Should I wait for the market to tank before moving it around or is it OK to move it now due to my age and amount of time I have before retirement? I’m worried I’ll move it and I’ll lose the value in a downturn, so maybe I should wait for a downturn to act.

Answer: You sent this question a few weeks ago, before the recent correction. Did you use the downturn as an excuse to hop into the market? Or did you stay on the sidelines, worried it might drop further?

Many people in your situation get cold feet. You’re better off in the long run just diving in and not trying to time the market.

Waiting for a downturn sounds good in theory, but in reality there’s no sure way to call the bottom of any stock market decline. And when the stock market recovers, it tends to do so in a hurry. If you delay too long, you risk missing much of the upside.

It won’t feel good if the market plunges a day, a week or a year after you invest your money, but remember that you’re investing for the long term. The day-to-day or even year-to-year gyrations of the stock market don’t matter. What matters is the trend over the next 30 years — and long term, stocks outperform every other asset class.

Filed Under: Investing, Q&A, Retirement Tagged With: , , ,
March 2, 2020 By

Q&A: When should retirees stop actively investing?

Dear Liz: I am retired. My income is from a small pension, Social Security and dividends and interest from investments. I’ve made some bad investments, but I’m still earning a satisfactory return. Is there some kind of formula that I can use to determine whether I should sell a stock, take the loss and seek another investment or keep the stock, enjoy the dividend and worry the stock might drop further?

Answer: One approach is to ask yourself if you’d buy the same stock today. If not, then it may be time to sell these shares. Be sure to consult with a tax pro first because you may be able to use losses on one investment to offset taxable gains on another.

You also might ask yourself if it’s time to transition away from active investing and individual stocks. Most people aren’t able to buy the stock of enough companies to be truly diversified. Then there’s the daunting task of staying up to date on the fortunes and prospects of each company and industry. That’s way more work than most people can handle. Even if you’re up for the task now, you might not be in the future.

Also, most people don’t do well with active investing. Trying to figure out when to buy and sell for maximum gain usually results in excess trading costs that lower your returns. It’s also too tempting to hang on to a losing stock rather than admit you made a mistake, or to chase “hot” stocks that have already had their biggest gains.

A better approach would be a portfolio of mutual funds or exchange traded funds that’s regularly rebalanced, either by a financial advisor or a computer algorithm. If you opt for funds that mimic a market benchmark, you’ll be assured of matching the market and getting a better return than most active investors can achieve.

Filed Under: Investing, Q&A, Retirement Tagged With: , ,