Ask Liz Weston

Get smart with your money

Retirement

Q&A: IRMAA is not your friend

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Dear Liz: My wife and I retired in 2019 and ran into IRMAA — Medicare’s income-related monthly adjustment amount, which increased our monthly premiums. I thought I’d done such a good job budgeting for retirement but missed this. A lot of couples have their best income years at the end of their career and then get blindsided by the cost of Medicare and the adjustment based on their previous income. I will say that the folks at the local Social Security office were very helpful, and they supplied us with forms for an exception based on our new income.

Answer: IRMAA can boost premiums substantially for singles with yearly income above $87,000 and married couples with incomes above $174,000. The increases for Medicare Part B, which covers doctor’s visits, range from $57.80 to $347 a person per month. The surcharges for Part D, which pays for prescription drugs, start at $12.20 and top out at $76.40 a person per month.

The adjustments are based on your income two years prior (so 2018 income determines 2020 premiums). You can appeal the increase if you’ve experienced a life-changing event. Retirement with a subsequent drop in income can be one such event. So can other work stoppages or reductions, marriage or divorce, the death of a spouse, loss of income-producing property or loss of pension income.

Even without IRMAA, healthcare costs can catch many newly retired people by surprise, especially if they previously had generous employer-subsidized coverage. Medicare doesn’t cover everything; it has deductibles and co-pays in addition to premiums, and excludes most vision, hearing and dental expenses.

How much you pay out of pocket depends on your health, where you live and what supplemental coverage you buy. A study by Vanguard and Mercer Health and Benefits estimated that a typical 65-year-old woman in 2018 could expect to pay $5,200, but her costs could range from $3,000 to $26,200. (The researchers say a 65-year-old man’s costs are typically about 3% lower.)

Q&A: Here’s what early retirees need to know about Roth IRA and 401(k) taxes and penalties

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Dear Liz: I have been contributing to a Roth 401(k) and a Roth IRA for several years. I plan to retire early. Am I able to withdraw any of my Roth contributions without penalty before I reach age 60?

Answer: Your contributions to a Roth IRA can always be withdrawn tax free, at any time and at any age, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. Once you’ve withdrawn an amount equal to your contributions, though, the rest of your money — your earnings — may be subject to taxes and penalties. To avoid those, you generally must be at least 59½ and the account must be at least five years old.

The rules are somewhat different for Roth 401(k)s. Early withdrawals from these accounts are considered a mix of contributions and earnings, so any distributions before age 59½ typically incur taxes and penalties. Even after 59½, the withdrawals could be taxed and penalized if you haven’t been contributing to the account for at least five years.

Roth 401(k)s are also subject to rules that require minimum distributions to start at age 72. Many people who retire with Roth 401(k)s roll the money into Roth IRAs to avoid these restrictions.

Q&A: New rules for required distributions

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Dear Liz: I cannot find when the SECURE Act takes effect. My wife, who turns 69 this summer, has a traditional Roth IRA worth about $150,000, all in a single large-company growth mutual fund. Obviously we don’t want to see it depreciate during a certain-to-come down market and then have to begin withdrawals before the market recovers. Would it be wise to move from the mutual fund into certificates of deposit or bonds, within the same IRA?

Answer: There’s really no such thing as a “traditional Roth IRA.” Since you’re asking about the Setting Every Community Up for Retirement Enhancement Act, which pushed back the age at which required minimum distributions have to begin from 70½ to 72, we’ll assume she has a traditional IRA subject to those RMD rules. (Roth IRAs are not subject to required minimum distributions.)

According to the IRS, people who reached 70½ in 2019 are subject to the prior rule and must take their first RMD by April 1 of this year. Those who reach 70½ this year or later must take their first RMD by April 1 of the year they turn 72.

That means your wife has some time to find an asset allocation that protects her somewhat from market drops while still allowing some growth. A fee-only financial planner could help her customize a portfolio, or she could consider a target date retirement fund (with a target date of 2015 or 2020, to benefit from a more conservative asset allocation). Moving everything to CDs or bonds would be trying to time the market, which rarely works, but having at least a portion of her money in safer investments could be smart.

Q&A: Required distributions and charity

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Dear Liz: In a recent column, you mentioned that after age 70½, one can donate up to $100,000 to a charity directly from an IRA. Can one still take that as a charitable donation on income tax forms? If I have a required minimum distribution of $10,000, but make a $10,000 donation to a charity, does that take care of the required minimum distribution for that year?

Answer: The $10,000 charitable contribution would count as your required minimum distribution for the year and the money would not be included in your income, but you can’t also deduct the contribution. That would be double dipping.

As a refresher: Money doesn’t get to stay in retirement accounts forever. At some point, withdrawals must begin and those withdrawals are typically taxed as income. Congress recently changed the rules so that required minimum distributions now start at age 72 (they used to start at age 70½). But so-called qualified charitable distributions — donations made directly from a retirement account to charity — can still begin at 70½.

Before you make a qualified charitable distribution or any other withdrawal from a retirement account, consult with a tax pro to make sure you understand the rules that apply to your situation. Penalties for mistakes can be high, so it pays to get expert help.

Q&A: Retirement plans by the numbers

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Dear Liz: At the moment I contribute to a 403(b) retirement plan at work. I have another 403(b) with a former employer, but haven’t contributed to it since I changed jobs several years ago. Should I contribute to both rather than just one? Also, my current employer offers a deferred compensation plan, but they don’t offer a match. Should I contribute to that or stick to the 403(b)s?

Answer: Once you leave a job, you can’t contribute to its workplace retirement plan. You could leave the money where it is, or perhaps transfer it to your current employer’s plan. Rolling it over to an IRA, though, could give you access to a wider variety of investments at a lower cost. Fees for 403(b) plans tend to be higher than for their workplace cousins, 401(k)s, and the investment options are typically more limited as well.

You also may want to contribute to the deferred compensation plan. These plans allow you to make deductible contributions that can grow tax-deferred, much like a 403(b), 401(k) or other retirement plan. But unlike other retirement plans, there’s typically not a 10% federal penalty for early withdrawals (although the money will still be taxed as income). Having some money in a deferred compensation plan could give you additional flexibility in the future.

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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.