Q&A: At retirement, should you roll your 401(k) into your IRA? Think about these factors

Dear Liz: I turned 70 last week and therefore I am leaving my part-time job after about 13 years. No big deal, but now that I am retiring I have a 401(k) worth about $60,000 and an IRA that is somewhere around $50,000. Should I roll my 401(k) account into my IRA or just let it sit there collecting dust? I do understand that at age 70½ I am supposed to start withdrawing some of the funds, but am not sure how much. It seems 70 years creeped up on me.

Answer: Years have a nasty habit of doing that.

You mentioned that you’re retiring because you’ve achieved a certain age. Few jobs have mandatory retirement ages, though. If you don’t retire, you can continue putting off required minimum distributions from your 401(k). You would still have to take minimum distributions from your IRA, unless your employer allows you to roll that money into your 401(k) plan.

But we’ll assume you’re happy with your decision. Rolling your 401(k) into your IRA isn’t necessarily the best option. What you should do next depends on the details of both accounts.

Most large-company 401(k)s allow retirees to take regular distributions, including required minimum distributions, from the plans. These plans also tend to offer low-cost institutional funds that may be a much better deal than those you can access as a retail investor with an IRA. If you’ve got a good 401(k) that allows retirement distributions, there may be no need to move your money.

If your employer’s plan doesn’t allow such distributions, don’t automatically assume your current IRA provider is the best choice, especially if it’s a full-service brokerage or insurance company. Compare the fees of the investment options with what’s available from a discount brokerage. Transferring all your retirement money to a lower-cost provider can help you keep more money in your pocket.

Calculating your required minimum distributions isn’t difficult. The IRS has tables on its website, and in Publication 590, to help you figure out how much money to withdraw. Various sites have calculators as well.

One caveat: If you keep your IRA and 401(k) separate, you’ll have to calculate required minimum distribution separately for each account and withdraw those amounts from each account, says Mark Luscombe, principal analyst for taxes and accounting at Wolters Kluwer. That’s different from the rules when you have multiple IRAs. When you have more than one IRA, you calculate the required minimum distribution based on the total of all your IRAs but are allowed to take the distribution itself from any one of them.

Q&A: Can creditors get your IRA funds?

Dear Liz: You recently wrote that workplace retirement plans offer unlimited protection from creditors but that IRAs are protected only up to $1,283,025. When I transferred my 401(k) to a rollover IRA, the advisors at the brokerage assured me that the rolled-over money also enjoys the unlimited protection. Your article seems to imply otherwise. Can you clarify what is the correct rule?

Answer: Two sets of rules apply, which causes a fair amount of confusion.

In bankruptcy court, your transferred money would be protected. Money rolled into an IRA from a workplace plan such as a 401(k) enjoys unlimited protection from creditors in bankruptcy filings. Outside of bankruptcy court, however, creditor protection is determined by your state’s laws, which may not be as generous. If someone successfully sues you and wins a judgment, for example, your IRA could be at risk.

Wednesday’s need-to-know money news

Today’s top story: How debt settlement can make a bad money situation worse. Also in the news: Using an IRA as a legal, last-minute way to lower your taxes, 4 reasons why it’s smart to buy a used cell phone, and how to budget as a freelancer.

Debt Settlement Can Make a Bad Money Situation Worse
Not the perfect solution.

An IRA Is a Legal, Last-Minute Way to Lower Your Taxes
There’s still time for 2017 taxes.

4 Reasons It’s Smart to Buy a Used Cell Phone
Saving on new-to-you tech.

How to Budget as a Freelancer
Budgeting when income isn’t reliable.

Q&A: When rolling your 401(k) into an IRA isn’t a good idea

Dear Liz: I have just retired. I have a 401(k) from work. Do I keep it as is or do I roll it over into an IRA?

Answer: Investment companies and their representatives like to push the idea of rollovers as the best option, but that may profit them more than it does you.

Leaving your money in your employer’s 401(k) has several potential advantages. Many 401(k)s offer access to institutional funds, which can be much cheaper than the retail funds available to IRA investors. Workplace retirement plans also offer unlimited protection from creditors if you’re sued or forced to file bankruptcy. An IRA’s bankruptcy exemption is limited to $1,283,025, and protection from creditors’ claims varies by state. (In California, for example, only amounts “necessary for support” are out of reach of creditors.)

If you retired early, you can access your 401(k) without penalty at age 55. The typical age to avoid penalties from IRA withdrawals is 59½.

You may opt for a rollover if your 401(k) offers only expensive or poorly performing options. Even if you decide to roll over the rest of your 401(k), though, get a tax pro’s advice before you roll over any company stock. You may be better off transferring the stock to a taxable account now so you can let future appreciation qualify for capital gains rates. Ask your tax pro how best to take advantage of this “net unrealized appreciation.”

Q&A: IRA distributions and the tax man

Dear Liz: I am 79, in fairly good health and fortunately have almost $600,000 in my IRA account. My minimum required distribution is currently about $30,000 a year, which means my IRA funds will last until I am well over 100! I realize that I can pay a penalty and draw down some of the funds but I don’t want to be pushed into a higher income bracket. Any suggestions on how I can enjoy the money while I am able?

Answer: You won’t pay a penalty for pulling more than the minimum from your IRA. That early withdrawal penalty disappeared 20 years ago, after you turned 59½. You will owe income taxes, of course, but a visit with a tax pro can help you determine how much more you can withdraw before you’re pushed into a higher tax bracket.

Q&A: Don’t get tripped up by invalid Roth IRA contributions

Dear Liz: A friend told me that when he takes out his required minimum distribution from his traditional IRA and pays the tax, he then puts the money in his Roth IRA. I believe since this was not earned income, this was wrong. Who’s right?

Answer: The money contributed to an IRA doesn’t have to be earnings, necessarily, but your friend or his spouse must have income earned from working to make an eligible contribution. Earned income includes wages, salary, tips, bonuses, professional fees or small business profits. Earned income does not include Social Security benefits, pension or annuity checks and distributions from retirement accounts.

Another restriction is that contributions can’t be greater than the amount of earned income. If your friend or his spouse earned $3,000 last year, that’s all he’d be allowed to contribute — not the $6,500 maximum allowed for people 50 and over.

The ability to contribute to a Roth begins to phase out when someone’s modified adjusted gross income exceeds certain amounts. In 2017, single filers’ ability to contribute phased out between $118,000 and $133,000. For married couples filing jointly, the phase out began at $186,000 and ended at $196,000.

The penalty for ineligible contributions is 6% of the ineligible amount. The penalty is owed each year the taxpayer allows the lapse without correcting the oversight. If your friend has been doing this for several years, the penalty will be pretty painful.

He could cross his fingers and hope the IRS doesn’t notice, but the error isn’t that hard for the agency to catch. The IRS would simply need to compare Form 5498, which IRA custodians issue to report contributions, to your friend’s income and the sources of that income to know whether he was eligible to put money in an IRA.

Q&A: Retirement can bring some complex tax questions

Dear Liz: I was in the twilight of my career when the Roth became available, and I contributed the maximum for those few years before retirement. After retirement, I dropped to the 15% tax bracket, so I did Roth conversions of my regular IRA to fill out that tax bracket until I was age 70½. My reasoning was that I would likely be in the 25% tax bracket when I started my required minimum distributions from my IRA, and that turned out to be true.

The scary part is that the tax-deferred money in the rollover IRA has continued to increase each year in total in spite of the required minimum distributions. My tax preparer says he has clients who would be happy with my problem, so I should tread softly with my tax complaints.

One thing I regret is funding a nondeductible IRA for a few years before the availability of the Roth IRA. The nondeductible contributions only represent about 1% of the total. That means I can’t access that money I have already paid taxes on unless I have depleted all of my tax-deferred monies. Do you have any suggestions?

Answer: Absolutely. Listen to your tax preparer. Most retirees would love to have these problems-that-aren’t-really-problems.

You were smart to “fill out” your tax bracket by converting portions of your IRAs. For those who aren’t familiar with the concept, it involves converting just enough from an IRA to make up the difference between someone’s taxable income and the top of his or her tax bracket.

The top of the 15% bracket is $75,900 in 2017, so a married couple with a $50,000 taxable income, for example, would convert $25,900 of their IRAs to Roths. They would pay a 15% tax on the amount converted (plus any state and local taxes), but the Roth would grow tax-free from then on and no minimum distributions would be required.

These conversions can be a great idea if people suspect they’ll be in a higher tax bracket in retirement.

Now on to your complaint about getting back the already taxed contributions to your regular IRA. Withdrawals from regular IRAs are taxed proportionately.

The amount of your after-tax contributions is compared to the total of all your IRAs, and a proportionate amount escapes tax. So if nondeductible contributions represent 1% of the total, you’ll pay tax on 99% of the withdrawal. You’re accessing a tiny bit of your after-tax contributions with each withdrawal.

If you don’t manage to withdraw all the money, that’s not the worst thing in the world. It means you didn’t outlive your funds. Your heirs will inherit your tax basis so they’ll access whatever you couldn’t.

Q&A: Why tapping retirement cash early shouldn’t be done lightly

Dear Liz: I’m reaching out on behalf of my father, who does not know how to write emails. He was wondering if he pulls his money out of his IRA, how much will he get charged? Also, how much would he be able to give to his granddaughters without being charged?

Answer: Withdrawals from IRAs and most other retirement accounts are taxable. The tax bill will depend on his tax bracket and whether his contributions were pre-tax (deductible) or after-tax (non-deductible). If he withdraws money before age 59 1/2, he also may face tax penalties. A premature withdrawal can easily trigger a tax bill of 25% to 50%. Once the money is withdrawn, it also loses all the future tax-deferred returns it could have earned.

If he gives the money to his granddaughters, it’s unlikely he would face an additional tax bill. He would be required to file a gift tax return if the amount exceeded $14,000 per recipient in a year, but he would only have to pay gift taxes if the total amount he gives away in his lifetime over that limit exceeds $5.49 million.

Clearly, taking money out of a retirement account is a big deal and something that shouldn’t be done lightly. At the very least, your dad should consult a tax pro who can estimate the bill he’s likely to face. He’d be smart to consult a fee-only financial planner as well so he understands the potential effect this withdrawal could have on his future standard of living.

Wednesday’s need-to-know money news

Today’s top story: Don’t get taken by government grant scams. Also in the news: When you should and shouldn’t tap your Roth IRA, using your credit cards to pay for child care, and a report that finds many American teens lack basic financial skills.

Don’t Get Taken by Government Grant Scams
The government doesn’t want to give you money.

When You Should — and Shouldn’t — Tap Your Roth IRA
Let your interest rate be your guide.

Should You Use Credit Cards to Pay for Child Care?
Depends on the card.

Report finds many American teens lack basic financial skills
Not a good sign.

Make your teen a millionaire this summer

Gary Sidder set up Roth IRAs for his sons when they turned 13. Each year, the Littleton, Colorado, certified financial planner and his wife, Francie Steinzeig, a school psychologist, contributed an amount equal to whatever the two boys earned cutting lawns, shoveling snow and doing odd jobs. As the sons’ earnings increased, so did the parental contributions.

“Initially we started with $400, and now we do $5,500 for each,” the annual maximum allowable contribution, says Sidder, whose sons are 32 and 27. “Now that their accounts are worth more than $100,000 and $65,000, respectively, they do see the value of saving and starting early.”

Even if no further contributions are made, both sons could see their accounts top $1 million by retirement age, assuming conservative 7 percent average annual returns.

In my latest for the Associated Press, how setting up your kids with an IRA could pay off big dividends for their future.