Tips From Donna (March 2016 Wesban Monthly)
by Donna Gordon on July 21st, 2016

​Another Option for Early-Retirement Withdrawals

Older workers generally spend a longer time looking for jobs once they've lost them. The sad result is that individuals are tapping retirement accounts to stay in their homes and fund other living expenses, as well as to pay for major life changes such as relocation or further education.

IRA-withdrawal rules are particularly complicated, so this article will focus on one aspect of them in-depth: withdrawals based on the so-called 72(t) exception. Although it's almost never ideal to raid your retirement accounts prematurely, this type of withdrawal may be useful for people who need additional cash to carry them through a specific period in their lives--before they're eligible for a pension or Social Security, for example.

In a nutshell, the 72(t) exception allows individuals who are younger than age 59 1/2 to avoid the 10% early-withdrawal penalty for premature IRA distributions. (It does not help you circumvent any taxes owed on the IRA, however; just the 10% penalty.) To take advantage of 72(t), individuals must receive their IRA assets in what the IRS calls 'substantially equal period payments' for a period of at least five years. The payments must continue until the age of 59 1/2 or until five years have elapsed, whichever is longer.

The net effect of that rule is that everyone using this exception will need to take withdrawals for at least five years, and younger folks will have to take distributions over many years. A 50-year-old woman, for example, would have to spread her distributions over 9 1/2 years, until she's 59 1/2. Meanwhile, a 57-year-old man who initiates 72(t) distributions would need to take the distributions for five years until he turns 62, well after he'd already hit the 59 1/2-year mark. If you've begun taking 72(t) distributions but later determine you want to stop, you'll owe the IRS the 10% penalties for early IRA distributions, plus interest. For that reason, it's crucial to be sure that substantially equal periodic payments will work for you.

You don't have to liquidate all of your IRA assets to take advantage of 72(t); if you have separate IRA accounts, you can withdraw from some and leave others alone. It's also possible to reposition your assets in advance of a 72(t) distribution--that is, leave some money in an IRA to compound and grow while repositioning other assets in short-term securities for 72(t) distributions. Furthermore, though the majority of people using this distribution method are doing so with traditional IRA assets, it's also possible to apply this distribution method to Roth assets. (This won't often be desirable, however.) 

In general, 72(t) withdrawals will tend to make the most sense for people who need income during a certain period of time. And at the risk of stating the obvious, they'll also be best for folks who have an alternate source of retirement funding besides the amount that they're paying themselves through 72(t).

On the flip side, using this withdrawal method can be complicated and paperwork intensive. It won't make sense for those who need a lump sum to start a business or buy a vacation home because the whole point of 72(t) is that you're receiving payments during a period of at least five years. Nor will 72(t) usually make sense for Roth IRA holders, who have a lot more flexibility in taking withdrawals than do traditional IRA holders. Finally, those who leave their former employers at age 55 or after and have assets in their old 401(k)s can take penalty-free withdrawals directly from their accounts; rolling the assets into an IRA in order to facilitate 72(t) distributions wouldn't be necessary.

Questions to Ask Before Paying Off a Mortgage

The decision to pay off a mortgage or invest in the market is far from black and white. For those who are close to retirement and already have plenty of other liquid financial assets, paying off a mortgage could be a wise use of cash. Such homeowners aren't likely to be saving a lot because of their mortgage-interest deductions, which tend to be more valuable early in the life of the loan than in the later years, and their investment-asset mixes might be skewing toward low-returning cash and bonds, not stocks. Moreover, many retirees concur that reducing their in-retirement overhead by retiring debt reduces worries and frees up cash for travel and other pursuits. For others, however, a mortgage pay down might not be the right answer. Although it might seem comforting to own your home free and clear, there's invariably a trade-off involved. You're reducing your investments in more liquid assets in favor of an asset that's not liquid at all. A happy medium for many households might be to balance modest prepayments of mortgage principal with ongoing contributions to retirement-plan accounts. Here are some questions to think through as you make this important decision for your household.

Is your retirement plan on track? Before paying off a mortgage you may want to spend some time evaluating the viability of your retirement plan. Paying off a mortgage rather than investing in the market may mean having fewer liquid assets for retirement. However, with lower household expenses, you may be able to step up your future retirement-plan contributions; having a paid-off home will also mean that your in-retirement costs may be lower. Time horizon is an important aspect of decision-making here. Those with more years until retirement can better harness the compounding benefits of investment assets, whereas those nearing or in retirement and expecting to begin drawing on their investment assets might not get such a big bang from investing more.

What's your investment mix, and where are you holding it? The composition of your investment assets and where you hold them are also important considerations. The case for investing in the market rather than prepaying the mortgage gets even stronger if you hold your investments within the confines of a tax-sheltered vehicle and/or you're earning matching dollars on your contributions. On the flip side, portfolios that are heavy on cash and fixed-income securities, especially those that are fully taxable from year to year, are less likely to out earn mortgage interest rates.

How diversified are you? Some homeowners think of their houses as a retirement-savings vehicle: When it comes time to retire, they'll cash in their equity and downsize to a smaller place. However, the past several years have taught many homeowners that's easier said than done. Many haven't been able to sell when they wanted, and they also haven't been able to receive anything close to the prices they were expecting. Pairing home equity with more liquid stock and bond assets may give you a lot more flexibility to ride out downturns in the housing market.

How much is your mortgage-interest deduction saving you? Many homeowners assume that it's wise to hang on to their mortgages because of the tax deduction they can take on their interest. But that deduction shrinks as the years go by because home loans are front-loaded toward interest payments. People who have been able to pay down a mortgage for many years may be overestimating the amount of taxes they're saving by having a mortgage, and itemizing deductions may not be saving them much versus the standard deduction. 

Financial Preparations for a Natural Disaster

As residents of areas affected by Hurricane Sandy found out, a natural disaster can bring about not only emotional hardship, but financial hardship, as well. From keeping important documents safe and accessible to having enough cash on hand to get by until things return to normal, being prepared for a disaster is an important part of protecting your home and your family. It could be a natural disaster like a hurricane, tornado, flood, fire, mudslide, or earthquake. Or it could be something on a more limited scale like a power outage. Whatever the crisis, taking the steps below will help you better handle whatever might come your way.

Get Organized Before a Disaster Strikes: Chances are that's not at the top of your to-do list for the weekend, so it's very easy to procrastinate. But think of it this way: You buy insurance to protect you from catastrophes; disaster preparedness is just another kind of insurance that you prepare yourself. It doesn't have to cost a lot, but it could really save time and added frustration should something happen to you. Once you've got a plan, you only need to update it periodically.

Keep Important Papers and Documents Safe and Easily Accessible: You might need to gather your most important papers in a hurry. Do you know where they are? Can you grab them quickly and leave the house immediately if you need to? Here are some of the documents to which you may need access: IDs (driver’s license, Social Security card, passport, birth certificate), financial documents (checkbooks, investment account numbers, passwords, and phone numbers, retirement account information, estate documents, insurance policies), and medical records. Most importantly, you’ll need cash (at least enough to cover one to two weeks' emergency expenses).

You might also want to have a list of key contacts/phone numbers, which may include family cell-phone numbers and e-mail addresses, police, fire, and ambulance numbers, Red Cross and emergency response center local numbers, as well as your company's human resources department number.

Keep all these important papers in a plastic bag in your home safe, or in any safe place from where you can grab them quickly if you need to leave your home in a hurry. Also, it may be a good idea to leave copies of everything with your attorney and/or financial advisor, in case the original documents get lost or damaged.

Prepare for a Medical Emergency: What if you or a family member suffer an injury (or worse) when disaster strikes? Check your health-insurance coverage to determine out-of-pocket costs in case surgery or emergency treatment is needed, and try to set aside enough money to cover these costs. Designate a family member or close friend as your primary contact, and prepare a living will and power of attorney for health care (documents that specify your wishes in case you’re incapacitated).

Create an Emergency Fund: Most experts recommend setting aside enough money to cover about six months of living expenses. But it is equally important that this money be easily accessible. It may be a good idea to keep about half in cash, ready to use (what if it’s impossible to get to a bank in the aftermath of the disaster?), and the other half in liquid investments that you can cash out easily.

What to Do if Disaster Strikes: If your house has been damaged, you may need emergency shelter. The Red Cross or your local emergency response center should be able to help. Your property insurance agent can help you file a claim on your homeowners or other types of insurance policies. If your area has been declared a federal disaster area, you may qualify for financial relief. If you have been injured, you might need to file for disability benefits. If you are healthy but a family member needs your care, you may be able to take as many as 12 weeks of unpaid leave under the Family and Medical Leave Act without losing your job. 

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