Get smart with your money
By Liz Weston
Target date investments are supposed to be an easier way to invest, and they’re a popular choice in 401(k) plans. But the recent market downturn showed that some target date strategies suffered much bigger losses than others, especially for investors nearing retirement.
In my latest for the Associated Press, how to be sure the investment strategy you’re using still makes sense, especially if you’re close to retirement.
By Liz Weston
Dear Liz: I have been contributing to retirement accounts for many years, starting back in the early 1980s. Back then, there were no deductions for contributions. I made about $50,000 of after-tax contributions, meaning I’ve already paid taxes on that money. Later I switched to before-tax contributions. Now that I am retired and approaching 65, in my feeble mind, I believe I should be able to withdraw that $50,000 without having to pay any taxes on it. However, things that I’ve read indicate that it may not be that easy. Can you help with this question, or at least point me in the right direction?
Answer: You will escape taxes on a portion of any withdrawal you make from a retirement plan that has after-tax money in it, said Mark Luscombe, principal analyst at Wolters Kluwer Tax & Accounting. However, only Roth IRAs allow you to make totally tax-free withdrawals of your contributions at any time.
With a Roth IRA, any withdrawals are considered first to be a return of contributions. For example, if you contributed $50,000 to an account that’s now worth $200,000, the first $50,000 you withdraw would be tax- and penalty-free, regardless of your age, Luscombe said. If you were under 59½, additional withdrawals could be subject to taxes and penalties.
With regular IRAs and 401(k)s, the tax treatment is different. Withdrawals are considered to be a proportionate return of your after-tax money, Luscombe said. If you contributed $50,000 after tax and then withdrew the same amount from an account now worth $200,000, only one quarter of the money would escape tax.
By Liz Weston
Dear Liz: You recently mentioned that a person can withdraw money from their 401(k) and spread the taxes over three years. If 401(k) is paid back, they can amend their tax returns to get those taxes refunded. Because of some major home repairs, I asked our accountant about this before we proceeded. He said that he hasn’t read anything official about the above. Would you please provide where you obtained your information, so we can decide if that’s an avenue we can use?
Answer: It’s possible you had this conversation before March 27, when the Coronavirus Aid, Relief, and Economic Security (CARES) Act became law.
Otherwise, it’s kind of hard to imagine an accountant anywhere in the U.S. who hasn’t heard of the emergency relief package that created the stimulus checks being sent to most Americans, as well as the Paycheck Protection Program’s forgivable loans for businesses and the new coronavirus hardship withdrawal rules for 401(k)s and IRAs.
Those rules allow people who have been affected financially or physically by COVID-19, the disease caused by the novel coronavirus, to get emergency access to their retirement funds if their employers allow it.
Even if you do have access to such a withdrawal, you should consider other avenues first.
The income taxes on retirement plan withdrawals can be substantial, even when spread over three years. Perhaps more importantly, you probably would lose out on future tax-deferred returns that money could have earned because few people who make such withdrawals will be able to pay the money back.
A home equity loan or line of credit is typically a much better option for home repairs, if you can arrange it.
By Liz Weston
In an ideal world, your retirement accounts would be left alone for retirement. You’ve probably noticed that we’re not living in an ideal world.
Early withdrawals can have serious repercussions, including big tax bills today and potential shortfalls in the future. In my latest for the Associated Press, alternatives to consider and what to do if you absolutely must touch your savings.
By Liz Weston
Saving and investing for retirement may actually be easier than deciding how to safely spend what you’ve accumulated.
Withdraw too much and you could run out of money. Withdraw too little and you might stint on some retirement pleasures you could actually afford. Taxes and Medicare premiums should be considered, too, since both could be inflated by the wrong withdrawal strategies.
Financial planners use powerful software to model various ways to tap retirement funds so they can recommend the best options for their clients. Recently, some companies introduced similar software that consumers can use to find the most tax-efficient, sustainable strategies.
In my latest for the Associated Press, a look at the pros and cons of these new programs.
By Liz Weston
Dear Liz: I agree with this concept of delaying Social Security to lessen overall taxes and have a further suggestion. My spouse and I are gradually converting our traditional IRA account funds to Roth IRAs. The converted funds are immediately taxable but could continue to gain in value and future distributions would not be taxable. Also, Roth accounts don’t have required minimum distributions.
Answer: Conversions make the most sense when you expect to be in the same or higher tax bracket in retirement.
That’s not the case for most people because they’re in a lower tax bracket when they stop working. Some older people, however, do face higher tax rates in retirement — typically because they’ve been good savers, and required minimum distributions from their retirement accounts will push their tax rates higher.
When that’s the case, they may be able to take advantage of their current lower tax rate to do a series of Roth conversions.
The math can be tricky, though, so it’s advisable to get help from a tax pro or financial planner. You don’t want to convert too much and push yourself into a higher tax bracket, or trigger higher Medicare premiums.
If your intention is to leave retirement money to your heirs, Roth conversions may also make sense now that Congress has eliminated the stretch IRA.
Stretch IRAs used to allow non-spouse beneficiaries — often children and grandchildren — to take money out of an inherited IRA gradually over their lifetimes. This spread out the tax bill and allowed the funds to continue growing. Now inherited IRAs typically have to be drained within 10 years if the inheritor is not a spouse.
To compensate, some people are converting IRAs to Roths — essentially paying the tax bill now, so their heirs won’t have to do so later. Heirs would still have to withdraw all the money in an inherited Roth IRA within 10 years, but taxes would not be owed.