How NOT to Run Out of Money in Retirement

When it comes to paying your taxes it is not optional and is a must. However, as individuals my tax situation is most likely different that yours.

 

For example I may have more deductions, exemptions, credits, etc… than you making my tax bill low or even non-existent. Another difference might be the sources of income. You may be collecting a pension that already is withholding tax or maybe your making estimated payments on a quarterly basis. Whatever your situation is, it will affect your withholding and may be sufficient to cover your tax bill. But you can also withhold too much and in doing so lend the government a tax-free loan until you file your tax return and receive a refund.

 

When you have IRAs, you can avoid this from happening. You can choose to opt out of withholding any tax when taking a distribution. The end result being more money for you to enjoy!

 

Now with 401ks, you do not have the option to choose your withholding. When taking distribution you are subject to a mandatory 20% tax bill. Thus increasing your tax bill!

 

The general rule when withdrawing money from IRAs before age 59 1/2 is this: You pay income tax on the amount drawn (assuming it was all pre-tax) plus a 10% penalty.

 

However, there is a number of exceptions to this rule. One such exception is to higher education expenses. Let’s say you or your children have decided to pursue a college degree. You can take a distribution from your IRA to help make for things such as books, tuition and school supplies such as a computer. The one stipulation in doing this is that you must be under the age of 59 1/2.

 

When trying to apply this same exception to your 401k, you will be met with paying a larger tax bill than you planned for. We have seen this point argued in court and to date have not seen it overturned. Don’t make the same mistake and be sure you know the differences!

 

Even though the IRAs and 401ks are retirement accounts with the intention to save for non working years, life can throw us a curve ball where you need money unexpectedly. This is where the IRA can be superior to your 401k.

 

The IRA will allow you to access your money at any time. Hence you have flexibility in controlling your situation. Remember however, once you access your money and make the distribution under the age of 59 1/2, you will be assessed income tax as well as a 10% penalty. But if you have no other place to turn and your are in a jam, you have a choice.

 

If you do not have an IRA and choose to take the same distribution from your 401k you will be at the mercy of the plan rules along with the tax code regarding employer sponsored plans. In many cases regarding 401ks and accessing your money you will be limited to such especially under the age of 59 1/2. While you may be able to utilize loan or a hardship distribution, you will be greatly limited by the rules that govern them. Nothing is guaranteed!

 

Today, it is more common that not for people to have worked for several companies. In doing so you find yourself having several 401ks and IRAs. And with these retirement funds when you turn age 72, you will be required to take a distribution whether you want to or not. With multiple accounts it can become confusing on how to avoid mistakes which can be costly.

 

When dealing with 401ks, you must calculate each RMD separately and you must take each RMD separately from those 401ks. For example, if you have 5 401ks, you must calculate each and send 5 separate RMDs to yourself.

 

In contrast, IRAs are different. You must calculate each RMD separately for each IRA but if you want to you can combine all the RMDs and take them from one IRA or a combination of IRAs. However you choose!

 

Now if you try to do the same with your 401ks, you will be subject to a 50% penalty for each 401k that you did not take the RMD from. Ouch!

 

If you choose to give money to a cause you believe in you have a great planning opportunity to eliminate a tax bill to yourself.

 

IRA owners and beneficiaries can send up to $100,000 to a charitable organization without any tax ramifications to their income. The only string attached is you must be 70 1/2 years of age to do so.

 

Now understand, you will not get a deduction come tax time, however you never added to your income in the first place. This will often result in a lower tax bill versus taking a normal distribution, making the charitable gift and then taking the regular charitable deduction. Keep in mind the flexibility you have when it comes to your RMD at age 72. You can use all or part of it for use in a charitable distribution.

 

With these 5 key differences between an IRA and a 401k you an lower your tax bill, provide more flexibility to your planning and make a difference all the while helping yourself in the end.