What are some of the biggest changes in the Pension Protection Act to impact savers?
Nonspouse beneficiaries can now transfer inherited company funds to an IRA and get tax benefits over time, if a company allows it. Before they didn't allow this and a nonspouse had to cash out and pay taxes all at once. But now, if a company allows it, a nonspouse -- such as a child or grandchild -- can make a trustee-to-trustee transfer of company funds directly into an IRA, where assets can grow tax-deferred (or tax-free) over their lifetime. Before, a nonspouse couldn't transfer a plan to IRA so they cashed out and owed all the tax at once.
Another big change affects people who are 70½ or older who want to give to charity. Now they can transfer IRA funds to a charity and not pay tax on the distribution. Before, they'd have to take the money out, pay income taxes on earnings, give away the money to charity, then maybe get a tax deduction. This is a much better deal.
Military people who are on active duty and took early distribution from their 401(k), 403(b) or IRA in prior years and paid a 10 percent early withdrawal penalty can get their money back if they took the money out after Sept. 11, 2001. The thinking is they didn't have money, they were in Iraq and they raided retirement accounts to pay the bills and paid the 10 percent penalty. They can now file to get the penalty back, but they have to do it by Aug. 17, 2007. It affects active military people who took the distribution back in 2001, 2002 and 2003. Relief is still available for 2004 and later years too, because they are not closed by statute. If they did it in 2006 and 2007, the withdrawals are already penalty-free. To get the money they'd have to file an amended return with Form 1040X for their refund.
Do you always have to pay a 10 percent early withdrawal penalty if you take 401(k) or IRA money before you turn 59½, or are there exceptions?
There's a lot of exceptions. If you're a first-time home buyer or need the money for higher education, you can take money out penalty-free from your IRA. First-time home buyers have a lifetime limit of $10,000. This applies to IRAs only. If you take out for a first-time home in a company plan, you'll pay the 10 percent penalty.
There's something called 72T payments. They're a series of equal payments from your IRA or company plan that are made to you. Basically, you're agreeing to annuitize your IRA or company plan. It only applies to a company plan if you separate from service. It applies to an IRA whenever you do it. You have to stick to the schedule either for five years or until you're age 59½, the longer of the two. So it doesn't pay for a younger person to do this. But you get equal distributions every year. If you decide to take out more, you blow the payments and you'll owe retroactive penalty on what you've withdrawn.
What about borrowing from a retirement plan?
It's the worse thing you can do. It's better to take out a second mortgage because the interest will generally be tax-deductible. If you can't do that, find money anywhere else. Don't borrow from a company plan. This is a last resort. It's wiping out your retirement savings and you'll pay interest. You cannot ever borrow from an IRA.
What's the biggest misconception people have about retirement planning?
People think they have an estate plan for retirement savings because they went to an attorney and got a will. But unless you have proper beneficiary forms, you don't have an estate plan for what may be your largest single asset. Get a copy of your beneficiary form, make sure it's up to date and that your heirs can find it. That's the first chapter of my new book, "Your Complete Retirement Planning Road Map." The average person wouldn't know where their beneficiary form is. And this is where people lose most of their money because it gets taxed too quickly after death. If you don't have the form, funds come out quickly and taxes can be paid. Again, combined tax on retirement accounts can cost as much as 70 percent between federal and state estate taxes, income tax and distribution mistakes.
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