Ask Liz Weston

Get smart with your money

IRA

Q&A: Which to tap first: IRA or Social Security?

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Dear Liz: I retired in 2015 but have not started Social Security. My wife and I are living on a pension and savings. I read an article saying that taking early IRA withdrawals and holding off on Social Security can help minimize the so-called tax torpedo, which is a sharp rise and fall in marginal tax rates due to the way Social Security benefits are taxed.

I made a spreadsheet to compare the cumulative income we could expect by starting IRA withdrawals now and delaying Social Security until age 70, versus starting Social Security now and delaying the IRA withdrawals. The spreadsheets indicate that by taking early IRA distributions and delaying Social Security, we would get a significant increase in total cumulative income as the years go by.

We feel we need a professional to verify our results and perhaps advise us as to which might be our best route, as well as getting an assessment of our income tax implications for the next five years or so. My wife thinks we should ask a Certified Public Accountant and is concerned about the price of a fee-only advisor.

Answer: Your findings are similar to what researchers reported in the July 2018 issue of the Journal of Financial Planning. The tax torpedo increases marginal tax rates for many middle-income households. One solution is to delay Social Security until age 70 and tap IRAs instead. That maximizes the Social Security benefit while reducing future required minimum distributions.

It’s always a good idea to get an objective second opinion on retirement distributions, however. Mistakes can be costly and irreversible. A fee-only certified financial planner should have access to powerful software that can model various scenarios to help confirm your results and guide your next steps.

Tuesday’s need-to-know money news

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Today’s top story: Home Down payment – more attainable than you may think. Also in the news: The best balance transfer credit cards for business, the SmartMoney podcast tackles converting an IRA to a Roth, and how to avoid higher airline baggage fees.

Home Down Payment: More Attainable Than You May Think
Big down payments don’t have to be an obstacle.

Best Balance Transfer Credit Cards for Business
Three great options.

SmartMoney Podcast: ‘Should I Convert My IRA to a Roth?’
How to decide if and when to convert.

To Avoid Higher Airline Baggage Fees, Plan Ahead
Pay online to pay less.

Thursday’s need-to-know money news

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Today’s top story: How to get traction paying off your credit cards in 2020. Also in the news: 8 moves to consider for IRAs and 401(k)s under the new Secure Act, using points and miles for wedding travel, and the 5 best states for retirees in 2020.

How to Get Traction on Paying Off Your Credit Cards in 2020
Finding the right strategy for your situation.

8 Moves to Consider for IRAs, 401(k)s Under New Secure Act
Looking at the major changes to retirement savings plans.

Ask a Points Nerd: Should I Use Points and Miles to Book Wedding Travel?
To pay or not to pay?

Here are the 5 best states for retirees in 2020
Which one sounds good to you?

Tuesday’s need-to-know money news

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Today’s top story: New Year, Fresh Finances: How to rebound after banking troubles. Also in the news: Gift card expiration dates, 5 great reasons to carry a hotel credit card, and why lawmakers may kill this popular retirement tax break for the wealthy.

New Year, Fresh Finances: How to Rebound After Banking Troubles
Giving yourself a fresh start.

When Do Your Gift Cards Expire?
Checking the fine print.

5 Great Reasons to Carry a Hotel Credit Card
Extra perks that make it worthwhile.

Lawmakers may kill this popular retirement tax break for the wealthy
Say goodbye to the “stretch IRA”?

Q&A: This forgotten account shouldn’t turn into a spending spree

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Dear Liz: I just got a message about thousands of dollars I have in a 401(k) account from a job I had over 10 years ago. They are asking me what I want to do with the money, roll it over into an IRA or cash it out. What should I do?

Answer: Don’t cash it out.

Unexpected money can feel like a windfall, and it’s natural to dream about potential splurges you could afford. But this cash didn’t fall out of the sky. This is money you earned and that could grow substantially if you make the right moves now. If you cashed it out, you’d lose a substantial chunk to taxes and penalties, plus you’d lose all the future tax-deferred growth that money could earn.

Your best option probably would be to transfer the money directly into your current employer’s retirement plan, if you have one and it allows such transfers. Employer plans may offer lower-cost access to investments than you’d get with an IRA, plus consolidating the old plan into the new means one less account to monitor. Also, employer plans may offer more protection from creditors, depending on where you live.

Rolling the money directly into an IRA is another good option. You’ll need to open an account, preferably at a discount brokerage that keeps costs low. An IRA would give you access to more investment options, but beginning investors might just want to opt for a target date retirement fund or a robo-advisory service that invests using computer algorithms. With either option, the mix of investments and the risk over time would be professionally managed.

Whichever you choose, make sure the old plan sends the money directly to your chosen option, rather than sending you a check. If a check is sent to you, 20% of the money would be withheld for taxes and you’d have to come up with that amount out of your own pocket within 60 days or that portion would be considered a withdrawal that’s taxed and penalized.

Q&A: Here’s a big tax mistake you can easily avoid

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Dear Liz: I’m self-employed and my wife wasn’t working last year. In December, we returned to California and found a small home to purchase using $107,000 I took out of my IRA. Since we weren’t quite certain of what our income would be, we received our health insurance in Oregon through an Affordable Care Act exchange.

When we filed our taxes we got hit with a $20,000 bill for the insurance, because we earned too much to qualify for subsidies, and a $10,000 bill for the IRA withdrawal. Our goal was to own our home outright, which we do, but now we have a $30,000 tax bill hanging over us.

Can we work with the IRS somehow on this? We didn’t “earn” the $107,000; we invested it in a home. It wasn’t income, so why should we be punished for using our savings to purchase a home?

Answer: If you mean, “Can I talk the IRS out of following the law?” then the answer is pretty clearly no. The IRA withdrawal was income. It doesn’t matter what you did with it.

Consider that you probably got a tax deduction when you contributed to the IRA, which means you didn’t pay income taxes on that money. The gains have been growing tax deferred, which means you didn’t pay tax on those, either.

Uncle Sam gave you those breaks to encourage you to save for retirement, but he wants to get paid eventually. That’s why IRAs and most other retirement accounts are subject to required minimum distributions and don’t get the step-up in tax basis that other investments typically get when the account owner dies.

(If you did not get a tax deduction on your contributions, by the way, then part of your withdrawal should have been tax-free. If you’d contributed to a Roth IRA, your contributions would not have been deductible but withdrawals in retirement would be tax-free.)

The IRS does offer long-term payment plans that may help. People who owe less than $50,000 can get up to six years to pay their balances off. You would file Form 9465 to request a payment plan. The IRS’ site has details.

Here’s a good rule to follow in the future: If you’re considering taking any money from a retirement account, talk to a tax professional first. People often dramatically underestimate the cost of tapping their 401(k)s and IRAs; a tax pro can set you straight.