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IRA strategies to boost savings

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Ed Slott, a respected author and expert on IRAs, offers suggestions for savvy IRA investing to Bankrate readers.

In your latest book, “Your Complete Retirement Planning Road Map,” you start off by saying people are “daredevils” when it comes to their future. Why?

At a glance
Name: Ed Slott, CPA
Hometown: Oceanside, N.Y.
Education: B.B.A., Adelphi University
Career highlights:
  • Author of three best-selling books including “Your Complete Retirement Planning Road Map,” and “Parlay Your IRA Into a Family Fortune.”
  • Editor of Ed Slott’s IRA Advisor, a monthly newsletter used by 4,000 financial planners throughout the country.
  • Founder of Ed Slott’s Elite IRA Advisor Group, a group of financial pros who remain continually updated on the most recent tax law changes, legal cases, IRS rulings and planning strategies that can affect their clients through Slott’s Web site,
  • A recipient of Excellence in Estate Planning and Outstanding Service awards from the Foundation for Accounting Education.
  • Has lectured for more than 15 years about strategies to protect retirement plans from “needless and excessive taxation.”

People are daredevils, but not on purpose. They’re generally unaware of what precautions they need to take and what planning options are available to help them keep more of their retirement funds and pass more of that money on to their heirs. As a result, they don’t plan. Most advisers — over 99 percent — do not possess the required knowledge to help their clients through the maze of tax rules that must be navigated in order to keep their clients’ money from going right back to the government or to take advantage of the key tax provisions that will allow retirement funds to keep growing tax-deferred for decades or longer.

So people accumulate, hoping everything will be all right, but then don’t think about how they’re going to get that money later on. They give up huge chunks of their retirement savings to the government when they take the money out. Combined tax on retirement accounts can be as much as 70 percent between estate tax, income tax and your state version tax of those taxes, plus distribution mistakes. They don’t realize it until someone dies and mistakes are exposed. But the way you withdraw assets directly affects how much you keep and how much the government gets. Most people don’t take advantage of breaks that can really cut down taxes.

What are some of the biggest tax breaks people are missing when they withdraw retirement funds?

One is a net unrealized appreciation, which is a tax break for company stock in a plan. It allows you to withdraw highly appreciated company stock tax-free as part of lump-sum distribution. If your company, your adviser or your financial institution does not know about this big tax break, then you need to find an adviser that does. Again, you can find a specially trained financial adviser on our Web site at

Ten-year averaging is another break for company employees who were born before 1936 or for their beneficiaries. This is a tax break that only applies to qualifying lump-sum distributions from plans and not to distributions from IRAs. In some cases it allows you to pay a lower tax on a lump-sum distribution from a plan.

The “stretch IRA” for beneficiaries allows beneficiaries to extend distributions over their lifetime, helping them build their inheritances tax-deferred instead of paying tax on retirement funds right now. Paying tax now means you’ll have less later. Deferring tax means you’ll build more money for later.

Because they are not working with the right advisers, consumers are paying the price. They don’t focus on the distribution phase. The result is that most consumers are being underserved by their current advisers, but they don’t know it until it is too late and the damage is done and there’s unnecessary loss of retirement funds due to excessive taxation. The bigger problem is that their adviser does not know it, either. This is a recipe for retirement disaster and that is why I created Ed Slott’s Elite IRA Advisor Group. It’s a highly specialized adviser who does proactive planning. I realized this when I was lecturing planners across the country.

One recent poll by Putnam Investments showed that retirees most regret not saving in retirement accounts outside of work. With that in mind, are IRAs underutilized?

An IRA is generally where retirement funds end up. When you retire, you generally roll them into an IRA. That’s the destination for retirement savings. But yes, they are. People don’t think to save outside of work or they think they make too much money to open an IRA. Roth IRAs are especially underutilized. Everyone who can should open a Roth.

The Roth IRA is your favorite IRA. Why?

Because money in a Roth grows tax-free forever. You fund it with after-tax dollars but you never pay tax on earnings again. And you don’t ever have to take money out, so it can keep growing. Most workers can qualify for a Roth IRA. But eventually, everyone will qualify for them in 2010, thanks to last year’s Tax Increase Prevention and Reconciliation Act. It lets everyone convert an IRA to Roth if they want to in 2010. So try to put as much money in now as you can. And in 2010, you won’t pay tax on the conversion. Instead, you’ll pay half the tax in 2011 and half in 2012. It’s a great deal. The government is giving everyone a one-time interest-free loan to build tax-free savings accounts. It’s like they’re giving you a free ride. If you really want to build up retirement savings and have it come out tax-free, do this.

Tell us more about Roth 401(k) plans, which are now starting to be offered by employers. Are they a good deal, and if so, for whom?

They’re similar to a Roth IRA except you put after-tax money from your earnings through an employer’s plan. It’s a better deal than a Roth IRA only because you can put more money in — up to $15,500 or $20,500 if someone’s 50 or older. IRA limits are $4,000 and $5,000 for someone 50 or above. I’d recommend it instead of 401(k) but a company has to offer it. I think more companies will. It costs you money upfront because you won’t get the tax deduction for contributions but, in the long haul, you’ll do much better since you won’t owe taxes again.

When is a rollover not a good idea?

There are times when you may be better off to take a lump-sum distribution or leave it in the plan. For example, let’s say you’re age 55. There’s a special rule that if you separate from service at 55, you can withdraw funds penalty-free. If you had rolled money over into an IRA, you’d have to wait until you’re 59½ to avoid the (10 percent early withdrawal) penalty. This special rule only applies to employer plans like a 401(k), 403(b) or a 457. It doesn’t apply to an IRA. And you have to be separated from service. That means you can be fired, quit, retired, but it has to happen in the year you turn 55 or older.

What’s the best way to avoid rollover headaches?

With a direct trustee-to-trustee transfer, a 401(k) moves directly to an IRA, without you ever touching the money. If you get a check from your employer, you only get 80 percent; 20 percent will be mandatory withholding. You have to come up with 20 percent to make the rollover complete, and you have 60 days to do it. None of those rules apply if you do a trustee-to-trustee transfer. But then there’s the other question of, if you don’t know if an IRA rollover is the best option. This is not something to take lightly. When you’re moving life savings, it’s like an eggshell. If it cracks, it’s over. If people do not move the money correctly (as a trustee-to-trustee transfer) it could be lost to withholding and tax, and many of these mistakes cannot be fixed.

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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