Ask Liz Weston

Get smart with your money

Retirement Savings

Q&A: How to start an IRA for your new Gen Z college graduate

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Dear Liz: My son is about to graduate from college and, as a present, I want to use $10,000 to start an IRA for him. But which is better? A Roth or a standard IRA?

Answer: Congratulations to both of you! Starting a retirement account is a great idea, but you should be aware of the numerous rules that limit who can contribute and how much.

Let’s start with the annual contribution limit, which for 2022 is $6,000 for people under 50. (People 50 and older can make an additional $1,000 “catch up” contribution.) Also, your son needs to have earned income — such as wages, salary or self-employment income — that is at least equal to the size of the contribution you want to make. In other words, he needs to earn $6,000 for you to contribute $6,000. If he’s about to start a full-time job, that probably won’t be an issue, but if he’s not working, or working only part time before starting graduate school, that might further limit how much you can contribute.

For all of those reasons, a Roth IRA contribution may be best. He won’t get an upfront tax deduction but withdrawals in retirement will be tax free. He can withdraw Roth contributions at any time without taxes or penalties, so the Roth can serve as a de facto emergency fund. Obviously, it’s better to leave the money alone to grow, but having access to the cash could be helpful while he builds a regular emergency fund.

Q&A: Leaving IRAs to charity

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Dear Liz: In responding to the reader who asked how to plan around the tax consequences of leaving a traditional IRA to a family member, I wish you had mentioned the tax benefit of naming a charity as the beneficiary of a traditional IRA. There is no tax on the distribution of a traditional IRA to a charity. The consequence is that the income is never taxed (on the front end or back end) and a charity benefits from the IRA owner’s generosity.

Answer: The reader was primarily concerned with bequeathing assets to children and grandchildren after the Secure Act of 2019 did away with “stretch IRAs” for most non-spouse beneficiaries. One way to do that while also benefiting a charity is the charitable remainder trust that was mentioned in the column. These trusts require some expense to set up and aren’t a good option if the IRA owner isn’t charitably minded.

If someone’s primary goal is to benefit the charity, however, then qualified charitable distributions or outright bequests are certainly an option. Qualified charitable distributions, which can begin at age 70½, allow someone to donate required minimum distribution amounts directly to a charity; the distribution isn’t counted as taxable income to the donor.

Q&A: Retirement account distribution rules

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Dear Liz: My husband is 71 and retired. We have started withdrawing from one of his retirement funds but I am unsure if there is a minimum amount that needs to be withdrawn per year. We have a few retirement funds in different places. Do we have to withdraw from each or just a minimum per year no matter where?

Answer: Required minimum distributions from most retirement accounts typically must begin when someone turns 72. The withdrawals must be made by Dec. 31 each year, but your first one can be delayed until April 1. If your husband turns 72 next year, for example, then the first withdrawal wouldn’t be due until April 1, 2024. Your husband would need to take a second distribution by Dec. 31, 2024.

Required minimum distributions are calculated using the tables in IRS Publication 590-B, Distributions From Individual Retirement Arrangements (IRAs). IRA owners have to calculate the minimum withdrawal separately for each IRA they own, but they’re allowed to draw the total amount from one or more of the IRAs. People who have 403(b) accounts are also allowed to take the total amount from one or more 403(b) contracts after calculating the amount separately for each one.

The rules are different for other types of retirement plans. People who have 401(k) and 457(b) plans must calculate and take minimum withdrawals separately from each of those plan accounts. No distributions are required for Roth IRAs during the owner’s lifetime.

Your brokerage typically can help you calculate required minimum distributions, or you can talk to a tax pro. A tax pro or fee-only financial planner also could help you decide if it makes sense to consolidate your accounts. At your stage of life, you probably could benefit from simplifying your finances and having fewer accounts to monitor.

Q&A: The rules have changed on inherited IRAs. Here’s what you need to know

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Dear Liz: My husband and I have a combination of traditional and Roth IRAs naming our children and grandchildren as beneficiaries. With the passage of the Secure Act requiring distribution of inherited IRAs within 10 years, we want to revise our plan of leaving all of the investments to our children, as such inherited income would affect their tax bracket also. Do you have recommendations to alter the inherited IRAs to avoid this issue? Our annual fixed income puts us at the top of our tax bracket, meaning we usually cannot manage a traditional IRA to Roth conversion.

Answer: The Secure Act dramatically limited “stretch IRAs,” which allowed people to draw down an inherited IRA over their lifetimes. Now most non-spouse inheritors must empty the accounts within 10 years if they inherited the IRA in 2020 or later.

There are some exceptions if an heir is disabled, chronically ill or not more than 10 years younger than the IRA owner, says Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. These “eligible designated beneficiaries” can use the old stretch rules, as can spouses. Minor children of the IRA owner can put off withdrawals until age 21. At that point, the 10-year rule applies.

If you had a potential heir who qualifies, you could consider naming them as the beneficiary of a traditional IRA and leaving the Roth money to the other heirs. (The IRA withdrawals will be taxable while the Roth withdrawals won’t.) Or you could leave the IRA to the children in lower tax brackets and the Roth to those in higher tax brackets.

If you’re trying to divide your estate equally, though, these approaches could vastly complicate matters because the balances in the various accounts could be quite different. Plus, predicting anyone’s future tax brackets can be tough.

Another approach is to name your children along with your spouse as the primary beneficiary of your IRA. That way, the children would get 10 years to spend down this first chunk of your IRA money after you die. When your survivor dies, they would get another 10 years to spend down the remainder, giving them 20 years of tax-deferred growth.

Alternately, you could focus on spending down the IRA to preserve other assets for your kids. The stretch IRA rules encouraged people to preserve their IRAs, but now it may make more sense to focus on passing down assets such as stock or real estate that would get a valuable “step up” in tax basis at your death.

Converting IRAs to Roths is another potential strategy for those willing and able. In essence, you’re paying the tax bill now so your heirs won’t have to pay taxes later (although they’ll still have to drain the account within 10 years). It may be possible to do partial conversions over several years to avoid getting pushed into the next tax bracket.

There are a few other approaches that involve costs and tradeoffs, such as setting up a charitable remainder trust that can provide beneficiaries with income. These are best discussed with an estate planning attorney who can assess your situation and give you individualized advice.

Q&A: Here’s a strategy to avoid going broke in retirement

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Dear Liz: A lot has been written about how much can safely be withdrawn from a balanced investment portfolio so that it will last a lifetime. A popular strategy is to withdraw a percentage, say 4%, in the first year and then increase that withdrawal each subsequent year by the rate of inflation.

What are your thoughts on an alternate strategy of withdrawing a fixed percentage, say 4%, at the beginning of each year? This has the disadvantage of providing a more variable income stream year to year but has the advantages of simplicity and it can never deplete the portfolio to zero.

Answer: Many retirees would find it hard to cope with incomes that swing wildly from one year to the next. One way to address that volatility is to ensure that retirees have enough guaranteed income — through Social Security, pensions and annuities — to cover their basic, must-have expenses. Retirement plan withdrawals then would provide for their “wants,” such as travel, meals out and so on.

Cutting back on the nice-to-haves isn’t easy, but it’s better than not having enough money to pay the mortgage or buy groceries.

This approach is the core of the “Spend Safely in Retirement Strategy,” created by retirement researchers Wade Pfau, Joe Tomlinson and Steve Vernon with the help of the Society of Actuaries and the Stanford Center on Longevity.

The strategy suggests maximizing Social Security and basing withdrawals on the IRS’ required minimum distribution percentages. Reports detailing the strategy and the research behind it are available on both organizations’ websites, and Vernon’s book “Don’t Go Broke in Retirement” explains the strategy in detail.

Of course, trying to eliminate any possibility of running short means that you may die with a whole lot of unspent money. That may be great news for your heirs, but sad for you if you denied yourself excessively while you were alive. Finding the right balance between security and spending is tough, to say the least.

Q&A: Where to park cash?

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Dear Liz: I turned 72 in December and took my first required minimum distribution. With the goal of purchasing property next year, should I put the funds — $6,000 — in my Roth IRA or just put it in my bank savings account? Also, should I convert my traditional IRA to a Roth or just leave it alone?

Answer: To contribute to an IRA or Roth IRA, you must have earned income such as wages, salary or self-employment income. If you don’t have earned income, your contribution would be considered an excess contribution that could incur a 6% penalty for each year the money remained in the account.

You don’t have to be working to convert a traditional IRA to a Roth, but there’s typically not much reason to do so at this point unless you intend the money to go to your heirs and want to pay the income taxes rather than have them do so. Even then, you should run this idea past a tax pro or a financial planner since conversions can create other problems, such as higher Medicare premiums.