IRAs aren’t a rip-roaringly popular retirement savings tool.
Only a third of American adults have one, and just 41% would consider contributing to one, according to a recent survey by financial services firm TIAA.
Where’s the love? At a time when most people no longer have a traditional pension plan, but will rely on a workplace 401(k) savings plan for retirement income and security, assuming they have access to one, saving additional money outside that plan is a great hedge against the inherent risks of retirement.
An IRA can be a smart place to accumulate that money.
Just about anyone with earned income can contribute to an IRA. Even those with a retirement plan at work can make a nondeductible regular IRA contribution — subject to contribution limits. In 2016, the limits are $5,500; $6,500 if you are 50 or older.
“While a nondeductible contribution will not help you reduce this year’s taxes, there is still a benefit to making the contribution because any growth on the investments will be tax-deferred,” says Jamie Hopkins, associate professor of taxation at The American College and co-director of the school’s retirement income program.
Here are some ways that having extra cash in an IRA can help you reduce risk in retirement.
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The most common money drains that shock retirees are major home repairs and upgrades (28%), major dental expenses (24%) and significant out-of-pocket medical/prescription expenses (20%), according to the Society of Actuaries.
“The unforeseen can happen,” says Cindy Wilson, a Pasadena-based financial adviser at TIAA. “Planning to cover expenses in retirement, plus having extra to tap into can protect you.”
Reduce retirement risk by using an IRA for such events. Even a relatively modest regular contribution to an IRA can turn into serious money. For instance, if you set aside only $12 a week in spare change for 20 years and earn a modest 5% interest, you’ll accumulate about $21,500. That’s not a fortune, but it’s enough to provide a cushion when you need it most.
Retirement income research shows that if you retire when investment markets are tanking, you are more likely to run short of money. Experts call it “sequence of return” risk.
One way to avoid this mostly unpredictable timing risk is to put a portion of your retirement savings — perhaps, your IRA — into investments with relatively short fixed rates that won’t be subject to market loss.
“Take some risk off the table 5 years before you retire and 5 years after,” says Josh Tschirgi, a CFP professional and financial adviser at Somerset Wealth Strategies in Portland, Oregon. “Those 2 periods are very sensitive. The later the downturn comes, the less impact it has on retirement success. By the time you go back to the market, you’ve grown your money and you are older and you can weather a downturn better.”
Any kink in the cash-flow pipeline can create a serious problem. Fortunately, you can use your IRA to give yourself an interest-free short-term loan.
The IRS will let you withdraw money from your IRA, use it for 60 days and then put it back. You’ll pay no taxes or penalties, as long as you put the money back where it was before — or you put it in a new or different IRA. It can be a good deal if you need cash and know that you have the money coming to pay yourself back within that 60-day window.
The IRS used to be more liberal about this, allowing you to take these loans from all your IRAs and do it more than once a year. But no longer. Now you are limited to once a year, even if you have multiple IRAs.
“If you decide to take a rollover where you use the money, do it only once from all of your IRAs within the 12 months,” warns CFP professional and CPA Leon LaBrecque, CEO of LJPR Financial Advisors, in Troy, Michigan.
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Money can be tight for a surviving spouse. An IRA can provide a way for that person to stretch his or her income.
To reduce risk of a shortfall, name your spouse as your IRA’s beneficiary. A spouse who is the only beneficiary to an IRA can take that IRA as his or her own. This means that spousal beneficiaries don’t have to start taking required minimum distributions, or RMDs, until they turn 70 ½. In the case of many couples where the surviving spouse is younger than the person who died, this can make a big difference — pushing back the RMD tax bill for several years.
Caution: If you don’t name a beneficiary or you name your estate as the beneficiary, your spouse may have to treat the IRA as inherited and start paying taxes on the money within 5 years.
This can be expensive, says LaBrecque. “For a younger surviving spouse, taking RMDs later can be a big advantage,” he says.
One way to guarantee that you won’t outlive your money is to buy an annuity. Just as you can invest your IRA money in stocks or bonds, you also can use it to purchase an annuity.
Some experts think that is redundant because money in an IRA is already tax advantaged, but others say the advantages outweigh the disadvantages.
“A big advantage is dollar-cost averaging — the participant pays for the annuity in little chunks. Sometimes, the cost is low and sometimes it is a little higher, but it averages out to a pretty favorable cost overall,” says Bruce Ashton, an attorney and a partner in Drinker Biddle’s employee benefits and executive compensation practice group.
Ashton particularly likes some guaranteed minimum withdrawal benefit products — the investment accounts with annuity wrappers that promise lifetime income as long as you invest in an approved fund and withdraw only a certain amount over time. Even if you run short because of poor investment returns, the insurance company will kick in and pay you the guaranteed amount.