Ask Liz Weston

Get smart with your money

Retirement

Q&A:Don’t make this mistake with your retirement savings

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Dear Liz: My wife and I are in our mid-40s and planning to buy what likely will be the last house we’ll purchase. I’ve decided to withdraw around $15,000 from my IRA to buy down the rate, which will guarantee returns in the form of interest savings, even if those will be less than the returns I would earn if I left the money in the account. My real question is about our current house. We owe around $77,000 on a house that could likely fetch in the low $200,000 range. I’ve looked at it up, down and sideways. Would it make more sense to rent, sell, or rent then sell after a couple of years to avoid the capital gains tax?

Answer: Sometimes it can make sense to buy down a mortgage interest rate by paying more upfront if you plan to stay in the home for many years. The deals vary by lender, but you might pay 1% of the loan amount (one point) to get a rate that’s 0.25% lower, or 2% (two points) to get the rate reduced by 0.5%. For example, paying two points on a $200,000 mortgage, or $4,000, could lower the rate from 4.5% to 4%. You would drop the monthly payment about $59, and it would take you nearly six years for the slightly lower monthly payments to offset what you paid upfront.

You complicate the math, though, when the money used to buy down the rate comes out of a retirement account. That money is taxed as income and would likely be penalized as well because you aren’t yet 59½. (There’s an exception to the penalty for first-time home buyers who withdraw up to $10,000, but they’ll still owe income tax on the withdrawal.) The tax bill varies according to your tax bracket and your state, but you can expect it to equal roughly one-quarter to one-half of the amount withdrawn.

In addition to the tax bill, you’ve also given up future tax-deferred returns on the money. And because most people’s incomes drop in retirement, you’re probably paying a higher tax rate than you would if you withdrew the money later.

A good rule of thumb is to consult a tax pro before you take any money out of a retirement account. The rules can be complex and it’s easy to make an expensive mistake. A tax pro also could advise you about the tax implications of renting vs. selling, although you might also want to talk to anyone you know who’s a landlord about what’s involved with renting out a property.

The simplest solution may be to sell your current home and use the equity to reduce the size of the loan you’ll need on the next residence, rather than raiding a retirement fund to get a slightly lower rate.

Q&A: New Secure Act changes some retirement rules

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Dear Liz: At age 70½, when I must withdraw money from my IRA, may I donate those dollars to a charitable organization without paying tax on the withdrawn funds?

Answer: The short answer is yes, but you should know there have been some recent changes to retirement plan rules.

Required minimum distributions now start at 72, thanks to the recently enacted Setting Every Community Up for Retirement Enhancement (Secure) Act. If you turned age 70½ in 2019 and started your required minimum distributions, you should generally continue, but talk to a tax pro.

Also, you can now make contributions to your IRA after age 70½, as long as you’re still working. You must have earned income at least equal to the amount you contribute.

The law didn’t change when you can begin making qualified charitable distributions from your IRAs. Once you reach 70½, you can donate up to $100,000 each year directly from your IRA and the donated amount will not be included in your income.

If you make IRA contributions after age 70½, though, those contributions are deducted from the amount you can donate.

Q&A: Your retirement plans require lots of decisions. Get help

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Dear Liz: We are a working couple in our late 50s. We live a comfortable lifestyle, have no mortgage, no debt, and we enjoy our careers. Through luck and diligence we have built a sizable net worth of $4.5 million (37% equity in our primary residence, 37% IRAs, 25% taxable equities). The investments are being managed by a family member. We plan to wait as long as possible before taking Social Security but would like to quit working within the next five years. As we look to retirement, we are undecided about where we’d like to live. We could stay in our current large house in Los Angeles, or we could move to a just-as-expensive nearby beach town and opt for a much smaller condominium.

I’d like to purchase the condo before retirement (paying cash, as we are debt-averse at this stage of our lives). This plan could improve our current lifestyle by providing a weekend retreat. Once retired, we might then have the luxury of deciding which home to keep and which to sell.

However, my partner is rightfully concerned about having too much exposure to real estate and missing out on the portfolio growth we’ve enjoyed by staying in the stock market as long as we have. What should we do?

Answer: It’s not a bad idea to test drive your planned retirement community before you give up your current home. But your partner is right to be concerned about having too much money tied up in real estate. Most people need to keep a substantial portion of their portfolios in stocks even in retirement. Plus, any money you pull from your investments could incur a rather substantial tax bill.

One solution could be to purchase the condo using a mortgage. Interest rates are quite low, and it sounds like your finances are in good-enough shape to pass the extra scrutiny lenders often give second-home purchases. If you eventually decide to sell your current home, the proceeds could be used to pay off the loan.

This would be a good time to hire a comprehensive financial planner who can help you figure out how this next phase of your life will work. The planner also could help you with all the other retirement issues you’ll face, such as picking a Medicare supplement plan, managing required minimum distributions and paying for long-term care.

You can get referrals to fee-only planners from a number of organizations, including the National Assn. of Personal Financial Advisors, the Garrett Planning Network, the XY Planning Network and the Alliance of Comprehensive Planners.

Q&A: This retiree got a big surprise: taxes

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Dear Liz: I’m 76 and retired. During the decades I worked, I contributed to my IRA yearly using my tax refund or having money deducted from my paycheck. No one told me I would have to pay taxes on this when I turned 70. For the past six years, I have been required to withdraw a certain percentage of this IRA money and pay taxes on it. Is there ever going to be an end to this? Do I have to keep paying taxes on the same money every year? And what about when I pass away, do my children have to keep paying?

Answer: Ever heard the expression, “There’s no such thing as a free lunch”?

You got tax deductions on the money you contributed to your IRA over the years, and the earnings were allowed to grow tax deferred. Those tax breaks are designed to encourage people to save, but eventually Uncle Sam wants his cut.

Also, you aren’t “paying taxes on the same money every year,” because the money you withdraw has never been taxed. Plus, you’re required to take out only a small portion of your IRA each year starting at 70½. The required minimum distribution starts at 3.65% and creeps up a bit every year, but even at age 100 it’s only 15.87% of the total. You can leave the bulk of your IRA alone so it can continue to grow and bequeath the balance to your children.

Your heirs won’t get the money tax free. They typically will be required to make withdrawals to empty the account within 10 years and pay income taxes on those withdrawals. Previously, they were allowed to spread required minimum distributions over their own lifetimes. Congress recently changed that to require faster payouts because the intent of IRA deductions was to encourage saving for retirement, not transfer large sums to heirs.

The Roth IRA is an exception to the above rules. There’s no tax deduction when you contribute the money, but the money can be withdrawn tax-free in retirement or left alone — there are no required minimum distributions. Your children would be required to start distributions, but wouldn’t owe taxes on those withdrawals.

Q&A: When savings are meager, it might be time to unretire

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Dear Liz: I’m 67, retired and have $83,000 in a 401(k) that I left with my employer. Should I see a certified financial planner? Based on my current income, I either need a job, or I have to start pulling $10,000 from my 401(k) each year, which will clean out my account in eight years.

Answer: You definitely need a job.

You could burn through your nest egg even faster than you expect if the stock market drops or an unexpected expense crops up. And retirement is loaded with surprise expenses, from healthcare bills to home repairs to long-term care. Even in a best-case scenario, you’re likely to run short of money long before you run out of breath.

A planner could have warned you about this and suggested that a few more years of working, saving and delaying Social Security could have given you a far more comfortable retirement.

It may not be too late.

If you can return to work full-time, you could suspend your Social Security benefit. That would allow it to grow by 8% each year until you turn 70. If you’re married and the higher earner, that also would increase the survivor benefit that one of you will have to live on once the other dies.

Even if you can’t work full time, a part-time job could ease the drain on your 401(k). If you’re a homeowner, you also could consider a reverse mortgage that would allow you to turn your home equity into a lifetime stream of monthly checks, a line of credit or a lump sum.

A fee-only advisor — one who is paid only by clients’ fees, rather than by commission — could help you review your options. The Garrett Planning Network offers referrals to fee-only planners who charge by the hour.

Another option for people on a budget: accredited financial counselors or financial fitness coaches. These folks aren’t certified financial planners, but they can help with budgeting, debt management and retirement planning. You can get referrals from the Assn. for Financial Counseling & Planning Education.

Q&A: A surprise pension creates investment concerns

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Dear Liz: Before my husband died, I encouraged him to find out if he had a pension. He worked for his company for more than 10 years and was vested, but he didn’t think he qualified. A few months after he died, I found an unopened letter stating he would receive a pension after he reached his retirement date. I contacted the benefit plan service center and submitted the required documents. I now have two options for receiving the money as his beneficiary: a lump sum or a single-life annuity that would pay a monthly benefit for my lifetime only. The lump sum could be rolled over into an eligible employer plan or traditional IRA, neither of which I have, or paid directly to me, in which case the whole amount is taxable. I am 65 and my only income is his Social Security survivor benefit and a small pension from my company when I retired. So what is the best thing for me to do?

Answer: Thank goodness you found that letter. It’s unfortunate your husband didn’t understand that “vested” meant qualified to receive a pension.

You don’t have to have an employer plan or an existing IRA to keep the lump sum from being taxed right away. You can open an IRA for the sole purpose of receiving the rollover. A bank or brokerage can help you set this up.

Any withdrawals would be taxed, but you wouldn’t be required to start taking withdrawals until you turn 70½. Even then, you would be required to withdraw only a small portion each year (a little less than 4% to start). You can always take more if you want.

Your income is low enough that taxes shouldn’t be driving your decision. Instead, consider whether you’d rather be able to tap the money at will or have more guaranteed income for the rest of your life.

If you don’t have other savings, you may want to have this pool of money standing by to use for emergencies and other spending. On the other hand, an annuity is money that you don’t have to manage and that you can’t outlive or lose to fraud, bad investments or bad decisions. If you have enough emergency savings, adding more guaranteed income could help you live a bit more comfortably.