Ask Liz Weston

Get smart with your money

Investing

Q&A: How to dump your broker and invest your own money

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Dear Liz: I have a mutual fund and a Roth IRA that are actively managed by a broker. The accounts have not done well. I would like to withdraw them from the broker and reinvest them on my own. How do I safely and securely withdraw them from the broker? What paperwork and fees should I expect?

Answer: Look through your records to find the agreement you signed with the brokerage when these accounts were opened. The agreement may include the steps for closing the account along with any fees. You also could try searching for the name of the brokerage and “account closure fees” to see what, if anything, you might owe.

The brokerage may give you the option to manage the account on your own, or you may want to set up accounts at a new, less expensive discount brokerage. Once the accounts have been opened, your new brokerage will help with the transfers. If any of your money is invested in “proprietary funds” — that is, investments offered only at the old brokerage — those investments probably would have to be sold first. Such a sale wouldn’t incur any tax consequences with your Roth IRA. If your mutual fund is proprietary, though, its sale may incur capital gains taxes.

Q&A: Tax consequences of annuity conversion

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Dear Liz: Several years ago my wife inherited an IRA when her mother died. Her banker suggested rolling the IRA into an annuity with an insurance company. That company is difficult to deal with and not forthcoming about how the annuity is invested. She wants to convert the IRA into a certificate of deposit so it is insured by the FDIC. What are the tax consequences of doing that?

Answer: There are many different types of annuities. If your wife purchased an immediate annuity, which offers a stream of payments in return for a lump sum, then she probably can’t change her mind since those transactions are effectively irreversible.

If she purchased a deferred annuity, though, she has more options. Deferred annuities allow people to defer the stream of payments until later — often years or even decades in the future. In the meantime, the annuity may pay a fixed rate, a variable rate based on the performance of underlying investments, or an indexed rate based on a market benchmark.

Your wife won’t face taxes if she switches from a deferred annuity to a CD, since changing investments within an IRA isn’t considered a taxable event. The annuity itself may have surrender charges, however. Because annuities often pay advisors substantial commissions, surrender charges help discourage investors from withdrawing the money before insurers can recoup those fees.

These charges and high expenses in general make deferred annuities a poor fit for many investors, and many financial planners especially dislike seeing them in IRAs. A deferred annuity’s primary advantage is tax deferral, which an IRA already offers.

If your wife feels she was misled about this investment, she can make a complaint with her state insurance regulator.

Q&A: Whether to close elderly mom’s CDs

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Dear Liz: I have the power of attorney for my 92-year-old mother, who has dementia. She has numerous financial accounts including money market, checking and savings accounts and certificates of deposit. When she passes, would it be easier to settle her estate if I start closing her CDs now and put that money into, say, her money market? I am the sole beneficiary for all of this.

Answer: If your mom has multiple accounts at different institutions, then consolidating those accounts now can save time and hassle later. You’ll want to review the rules for FDIC insurance, though, to make sure her accounts would remain adequately covered.

There’s probably less urgency if all her accounts are already at the same institution and under FDIC limits. Closing CDs prematurely could mean losing some interest, which may not make sense unless she urgently needs the money.

If you haven’t already, consider checking in with an estate planning attorney who can give you suggestions about what you can do now to ease the transition later.

Q&A: Should your retirement savings plan include life insurance? Here are some pros and cons

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Dear Liz: Are indexed universal life insurance products worthwhile, and how do they compare to a Roth IRA?

Answer: Both offer the potential for tax-free distributions in retirement, but indexed universal life insurance is a complex product with high expenses that’s not a good fit for most investors.

With a Roth IRA, virtually all of your money can go toward your retirement investment. (Most investments have fees of some kind, but you can minimize those by using exchange traded funds or low-cost index funds.) With permanent life insurance, some of your money goes toward paying premiums for the death benefit and other administrative expenses, including commissions for the person who sells you the policy. The remaining cash can be invested in accounts that are tied to the performance of a stock market index. Your principal is guaranteed, but the amount you earn is subject to caps.

Financial planners generally recommend that you first max out other retirement savings options, such as 401(k)s and IRAs, before considering investing through a life insurance policy. Also, you should be someone who needs permanent life insurance — the kind that is meant to cover you for the rest of your life. (Term insurance, by contrast, is a much less expensive option meant to cover you for a set term, such as 20 years.)

Some people do need permanent coverage. Their estates may be large enough to incur estate taxes that they want to pay with insurance, for example. Or they may have a special needs child who will require ongoing support. If you need permanent coverage, consider hiring a fee-only financial planner to help you sort through your options.

Q&A: Roth IRA or traditional IRA? Here’s why one might be a better choice for young workers

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Dear Liz: My mid-20s nephews and I discussed financial planning for them. After recommending they check with their employers for a 401(k) or equivalent program, we spoke about traditional versus Roth IRAs. Would younger investors benefit more from a Roth IRA because the length of time the money would be invested is so long that the eventual tax-free withdrawal of the earnings outweighs the initial tax benefits of a traditional IRA? At this time, we cannot determine if my nephews will have a higher tax rate post-retirement than now (even assuming income tax rates stay the same).

Answer: The usual advice has been that people should contribute to a Roth IRA rather than a traditional IRA if they expect to be in the same or higher tax brackets in retirement. (Contributions to Roths are not tax-deductible but withdrawals in retirement are tax-free. By contrast, contributions to traditional IRAs are often deductible, but withdrawals are taxed as income in retirement.)

Of course, you can’t predict future tax rates with any certainty. But it’s a pretty good bet that 20-somethings who are at the beginning of their careers will earn more — and thus face higher tax rates — down the road. In other words, your nephews’ current tax rates may be the lowest they’ll ever be. Your nephews may not get much benefit from a tax deduction now but could get huge benefits from tax-free withdrawals in the future.

Also, premature withdrawals from traditional IRAs are usually taxed and penalized, but you can always withdraw the amount you contribute to a Roth without paying taxes or penalties. That flexibility often appeals to young people who worry about “locking up” their money or who don’t yet have a substantial emergency fund.

Q&A: Taxes on account withdrawals

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Dear Liz: We have two large expenses that need to be paid this year. I’m in my late 60s. My wife is in her 50s. I think that we should pull the money from our brokerage account (which is taxable) and protect the money in our IRA and Roth IRA accounts so that it can continue to grow tax deferred (and tax free in the case of the Roth). My wife feels that the withdrawal should come from the IRA or Roth IRA, saying that the money used from the brokerage account would be “double taxed.” Which account would you pull the money from?

Answer: There should be no double taxation when you sell investments in a brokerage account. You pay taxes only on the growth in value of the investments you bought.

She may be confused if you’ve paid taxes in the interim on dividends and capital gains distributions. If those were paid out to you, they’re no longer part of your investment and won’t be taxed again when you sell. If the dividends and capital gains were reinvested, those amounts should be added to the original purchase price to determine your tax basis, or the amount you can deduct from the sales proceeds to determine your capital gains.

You typically benefit from favorable capital gains rates if you sell investments in a taxable brokerage account that you’ve held for at least a year. By contrast, withdrawals from traditional IRAs are typically taxed at higher income tax rates. A large enough withdrawal from a traditional IRA could throw you into a higher tax bracket. And withdrawals from either the brokerage account or the traditional IRA could increase your Medicare premiums.

Qualified withdrawals from a Roth may not affect your taxes or premiums, but as you noted you’d be giving up future tax-free compounding, which could be an even stiffer price to pay.

It also matters who owns the retirement accounts. For example, a withdrawal from your wife’s IRA could be penalized as well as taxed if she’s not yet 59½.

There are enough moving parts to this decision that you’d be smart to consult a tax pro who can model how the various transactions will affect the rest of your finances.