Q&A: Retirement saving after layoff

Dear Liz: My husband and I are both in our early 50s and have been contributing the full amount to each of our 401(k) plans, plus the catch-up amounts since we turned 50. I was laid off in February 2020 and had only contributed $3,000. I had assumed I’d get a new job quickly, but as of now, I still have not. Fortunately, my husband still has a good job and has been able to make his full contribution plus the catch-up. Is there any way we can increase my contribution to retirement savings at this point? Can I fund an IRA if I already contributed to a 401(k)? We don’t want to lose any more ground.

Answer: The fact that you were both contributing the maximum amount — $26,000 each, or $52,000 total — is impressive. That, plus the fact that you’re still able to contribute given your unemployment, indicates your household income could affect your ability to deduct your IRA contributions.

You can still make the contributions, however. Anyone with earned income can contribute as much as $6,000 to an IRA (or $7,000 if you’re 50 or older) even if they’re covered by a workplace plan such as a 401(k). There used to be an age limit for IRA contributions, but that’s been eliminated. You have to earn at least as much as you contribute in the form of wages, salary or self-employment income. If you only earned $4,000 in 2020, for example, that’s the maximum you could contribute to an IRA.

Unemployment insurance doesn’t count as compensation, so you can’t use that — or interest, dividends, pension payments and other such nonwage income — to determine your contributions.

If you were covered by a workplace plan at any point in 2020, the ability to deduct your contribution phases out for modified adjusted gross incomes between $104,000 and $124,000 for married couples filing jointly for 2020. (The phaseout range rises to $105,000 to $125,000 for 2021.)

If you can’t deduct your contribution, consider putting the money instead into a Roth IRA if possible. You don’t get an upfront tax deduction, but withdrawals are tax-free in retirement. The ability to contribute to a Roth IRA starts to phase out with a modified gross income of $196,000 in 2020 (and $198,000 in 2021).

If your income is too high and you don’t already have a large IRA, you could use the “back door Roth” maneuver by contributing to a regular IRA and then converting it to a Roth, since there are no income limits on conversions. (You have to pay taxes on any pretax money that’s converted this way, which is why this might not be an ideal approach for those with big IRAs.)

You also can open up a taxable brokerage account and invest an unlimited amount of money. Again, there’s no upfront deduction, but investments held for at least a year can qualify for favorable capital gains tax rates.

Investing in accounts with different tax treatments is a good idea in general, since it can help you better control your tax bill in retirement.

Q&A: Survivor vs. retirement benefits

Dear Liz: I was 21 and my husband was 69 when we got married. He died in 1992 after 13 years of marriage. Our young son and I received survivor benefits for years. I got remarried in 2000 and divorced in 2008. When I reach my full retirement age of 66 years and 8 months, could I still claim survivor benefits from my first husband?

Answer: Yes, although you may want to start them sooner.

If your second marriage had lasted, you wouldn’t have been eligible for survivor benefits based on your first husband’s earnings record. Widows and widowers who remarry before age 60 aren’t eligible for survivor benefits.

Since that marriage ended, though, you were eligible to begin benefits at age 60. You are also free to remarry at 60 or later without losing those benefits.

Starting before your full retirement age for survivor benefits, however, means your check would be reduced and also subject to the earnings test, which reduces your benefit by $1 for every $2 you earn over a certain amount ($18,960 in 2021).

As mentioned in a previous column, your full retirement age for survivor benefits is different from your full retirement age for retirement benefits. Since you were born in 1958, your full retirement age for survivor benefits is four months earlier, or 66 years and 4 months.

In most cases, starting a Social Security benefit early locks you into a smaller check permanently. With survivor benefits, though, you also have the option of switching to your own retirement benefit later, if it’s larger. The ability to switch benefits is severely limited with Social Security, but survivor benefits remain the exception.

Being eligible for survivor benefits complicates claiming decisions, so consider using a more sophisticated claiming calculator such as Maximize My Social Security or Social Security Solutions to determine how best to file.

Q&A: Retirees and mobile home parks

Dear Liz: I’ve been following the discussion of the reader who was 70 and trying to decide between renting in a senior living facility versus buying a second-floor condo with no elevator. There is a third choice for people who are older and cannot stay in their present residence. We moved to a senior citizen manufactured-home park. It has a clubhouse, and before the COVID epidemic the park had all kinds of activities. It is a great place for seniors.

Answer: That’s a good suggestion and actually just one of many choices people have to age safely. Many mobile home parks are “naturally occurring retirement communities,” a term for areas that weren’t necessarily created for seniors but that nonetheless have a high concentration of older folks. At their best, these organic retirement communities provide services and activities that benefit seniors, including opportunities for socializing and the sense that their neighbors are looking out for them.

Q&A: What to consider when deciding whether to buy or rent a home

Dear Liz: I’m just turning 70 and am on my own for the first time in my life. In the last three years I took care of both my 100-year-old mother and my husband as their health failed. My daughter and son-in-law live in Colorado and are going to have a baby, and I plan on moving there in the near future.

I had originally planned to move into a senior living apartment complex. Then my children said I should buy a condo for the freedom, privacy and potential investment. They found a condo building under construction with units I could afford, plus a mortgage company willing to take me on and help with the down payment.

I’m torn about what to do. Because of both bad luck and bad decisions, currently I have only about $18,000 in savings. Between my pension and Social Security I make about $47,000 a year.

Do I invest in the condo and use up a good chunk of my savings? It’s on the second floor (the steps aren’t very steep, fortunately) and I’m strong and in good shape, but I’m also 70 and things can go south quickly. But, as the kids have said, I could live there for 10 years and make a good profit from the sale.

Or do I move into the senior living apartment and keep my savings but face regular increases in rent (thus “throwing my money away”)? The senior complex has amenities and activities and elevators but lots of people around all the time (thus sacrificing some privacy). Having a place of my own would be so wonderful, but I need to be smart about this decision.

Answer: Younger people often don’t understand about stairs. No, they’re not a big deal now, but even a few steps can become a huge barrier if you have mobility issues — and those issues become more likely the older you get. Having an elevator or a unit on the ground floor, preferably with a zero-step entry, is a good insurance policy against the vicissitudes of aging.

Besides, you aren’t necessarily throwing money away when you rent. You’re buying freedom. You don’t have to worry about paying for repairs and other unpredictable costs, and you can move more easily if your circumstances change. People are often advised to rent first when they move to a new area, just so they can get a better idea of the advantages and disadvantages of various neighborhoods before they commit. Renting also could give you a chance to build up your reserves so that if you do decide to buy, you won’t be quite so
house poor.

Having more people around isn’t necessarily a bad thing, either. You’re newly widowed, and moving to an area where you presumably don’t know many people. The senior complex could make it a lot easier to make friends. A good social network is essential to staying mentally and physically healthy as we age.

Q&A: Managing retirement savings

Dear Liz: I’m considering converting an old 401(k) to a Roth IRA. Will the gains from the 401(k) account be treated as capital gains? And can you only convert 401(k) plans you no longer participate in, or can you convert both current and former 401(k) plans?

Answer: You’ll pay income taxes on the conversion. Retirement plans, including 401(k)s and IRAs, don’t qualify for capital gains tax rates. You may be able to convert your current 401(k) as well. Ask your plan administrator if “in plan Roth conversions” are allowed.

Q&A: Backdoor Roth IRA contributions

Dear Liz: You mentioned in a previous column that a backdoor Roth contribution could be expensive if you have a large pretax IRA. I was in that situation, and opted to first roll my IRA into my employer’s 401(k). I then made a nondeductible contribution to a new IRA and shortly afterward converted it to a Roth. This allowed me to get money into a Roth without a big tax bill.

Answer: That’s a great solution for those who have access to 401(k) plans that accept such transfers, and many do.

For those who don’t know, backdoor Roths are a two-step process for people whose incomes are too high to contribute directly to a Roth. Instead, they contribute to a regular IRA and then convert that money to a Roth because there’s no income limit on conversions.

Taxes are usually owed on Roth conversions, based on how much pretax money you have in IRAs. But the conversion can be tax free if the contribution was nondeductible, you convert shortly after the contribution and you don’t already have a pre-tax money IRA.

Some questioned the legality of this particular loophole, but Congress blessed it in 2017 as part of the Tax Cut and Jobs Act of 2017.

Q&A: Retirement funds and creditors

Dear Liz: I keep reading conflicting things about 401(k)s and IRAs. If I roll over my 401(k) from my previous employer into an IRA, is it still protected from creditors? I’ve left it in the old 401(k) plan for now because I’ve read IRAs can be seized in lawsuits or bankruptcy, or alternatively that only $1 million is protected and the rest could be at risk. I’ve read that if I leave it in the 401(k), the whole amount is protected. Can you please help clear up this confusion so I can make a wise decision?

Answer: Your 401(k) is protected from creditors, full stop. Federal law bans creditors from taking money in a pension plan that was set up under the Employee Retirement Income Security Act (ERISA), and that includes 401(k)s as well as traditional pensions.

Your IRA is protected in bankruptcy court up to a certain amount, currently $1,362,800. Whether creditors outside of bankruptcy court can access your IRA funds depends on state law. In California, for example, there’s no specific dollar amount.

If a creditor wins a judgment against you and goes after your IRA, a court would decide how much of the account was necessary for your support and protect that. The rest could go to the creditor.

Q&A: Here’s why two 401(k) accounts aren’t better than one

Dear Liz: I changed jobs more than three years ago and did not roll over my 401(k) when I started a 401(k) account with my new employer. I’m perfectly happy having separate accounts. However, I’ve read some IRS rules that I cannot understand about being penalized for not contributing to a 401(k) for five years. So my question: After turning 59½, will I face any sort of penalty or loss when I begin withdrawing funds from a 401(k) account that has been sitting idle?

Answer: There’s no penalty for not contributing to an old 401(k). In fact, you cannot contribute to an old 401(k). Once you leave the employer that sponsored the plan, you generally can’t put any more money into it.

What you may have stumbled upon are IRS rules that apply to employers who sponsor 401(k) plans that have a profit-sharing component.

Employers aren’t required to make contributions to these plans every year — there may be years when there’s no profit to share — but their contributions have to be “recurring and substantial.” If the employer hasn’t made contributions in three of the past five consecutive years, the plan could be terminated, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting.

That obviously doesn’t apply to your situation, and if you want to continue managing two 401(k) accounts, you’re welcome to do so. But consider rolling the money into your new employer’s plan, if it’s a good one and accepts such transfers. That would mean one fewer account you need to track and also could give you access to more money if you wanted to take out a loan.

Q&A: IRA confusion leads to disappointment

Dear Liz: Many years ago, I read in a personal finance magazine about a mutual fund company that paid $1 million to a customer who had an IRA for 40 years. So I started an IRA at that company in December 1992 and paid $10,000. As of today, that account is worth only $80,000. What happened to the high payoff?

Answer: First things first. The maximum you were supposed to contribute to an IRA in 1992 was $2,000. If you were able to contribute more, you may have opened a different type of account, such as a regular taxable brokerage account. Either that or you have some explaining to do to the IRS.

Also, IRAs hadn’t been around for 40 years in 1992. They were created in 1974 by the Employee Retirement Income Security Act. So what you probably read in the magazine was a hypothetical example of what someone might accumulate over time in an IRA. Someone who contributed $2,000 a year to an IRA for 40 years could wind up with $1 million, but only with returns in excess of 10%.

Actual returns historically have been closer to 8%, but that’s an average. Some years it’s less, some years it’s more. There are no guarantees. What you end up with depends on how you invested the money and what fees you paid, among other factors. If your investment had done as well as the broader stock market, as measured by the Standard & Poor’s 500, you would have over $100,000 by now.

If your money is in an IRA, you could move it to be a better investment, such as a low-cost, broad-market index fund, without tax consequences. If it’s not in an IRA, then selling the investment to buy another could generate a tax bill, so consult a tax pro before taking any action.

Q&A: Side effects of IRA conversions

Dear Liz: I thought your readers would benefit from additional knowledge about Roth conversions. I started converting our IRAs to Roth IRAs when my wife and I turned 60 years old. Years later, I realized that our premiums for Medicare Part B and D were higher because our income in those years exceeded $174,000.

Answer: Triggering Medicare’s income-related monthly adjustment amount (IRMAA) is just one of the potential side effects of a later-in-life Roth conversion.

That’s not to say these conversions are a bad idea.

People with substantial amounts in traditional retirement accounts might benefit from transferring some of that money to Roth IRAs, particularly if the required minimum withdrawals that start at age 72 would push them into a higher tax bracket. They may have a window after they retire, when their tax bracket dips, to convert money and pay the tax bill at a lower rate.

Roths also don’t have the required minimum distributions that apply to other retirement accounts, so people have more control over their future tax bills.

Converting too much, however, can push people into higher tax brackets. Many financial advisors suggest their clients convert just enough to “fill out” their current bracket.

For example, the 12% bracket for married people filing jointly was $19,401 to $78,950 in 2019. A couple with income in the $50,000 range might convert $28,000 or so, because a larger conversion would push them into the 22% tax bracket.

But there are other considerations, as you discovered.

People with modified adjusted incomes above certain levels pay IRMAA adjustments that can add $144.60 to $491.60 each month to their Medicare Part B premiums for doctor visits and $12.20 to $76.40 to their monthly Part D drug coverage premiums. Higher income could reduce or eliminate tax breaks that are subject to income phaseouts, and conversions can subject more of your Social Security benefits to taxation.

At the very least, you should consult a tax pro before any Roth conversions to make sure you understand the ramifications. Ideally, you’d also be talking with a fee-only, fiduciary financial planner to make sure conversions, and your retirement plan in general, make sense.