While some baby boomers have already settled into retirement mode, others aren’t that far behind. Hard to believe when you consider it seems like only yesterday we were wearing bellbottoms and humming Beatles tunes.
It’s time to get real. We’re living longer, better, and more active lives than previous generations. We’re traveling, perhaps looking toward living in warmer climates, helping with the grandkids. All that takes money. Fortunately, there are options for boomers to make the most of the dollars they’ve made and/or saved throughout their lifetimes.
One of those options is an Individual Retirement Account (IRA), which allows you to save money for retirement in a tax-advantaged way. Another is a 401(k) account—a plan established by employers to which eligible employees may make salary-deferral contributions on a post-tax and/or pretax basis.
So what should you do if an unexpected expense arises? Take out the cash from your 401(k)? Withdraw from the IRA? Or how can the two work together to your best advantage?
According to Erika Eckman, financial adviser with Rodgers & Associates in Lancaster, cashing out a 401(k) is the least favorable option.
“When cashing out a 401(k), the employer is required to withhold 20 percent for federal taxes,” she says. “If not rolled into a qualified retirement plan within 60 days, the entire amount will be taxed as ordinary income for the current tax year. An additional 10 percent penalty will be withheld if the individual is under 59.5.”
In many cases, individuals take a distribution from their IRA with the intent of rolling the funds back into an IRA and using it as a means for a short-term loan. If a distribution is taken from an IRA, says Eckman, the Internal Revenue Service allows tax consequences to be avoided if the money is rolled back into an IRA within 60 days. The tax code permits one 60-day IRA rollover in a 12-month period.
New regulations prevent those with several IRAs from taking a distribution from each IRA with no tax consequences, even if it’s rolled back into an IRA within 60 days. As of Jan. 1, 2015, you are allowed one IRA rollover per year pertaining to all of your IRAs collectively. In other words, those several IRAs are all aggregated and not viewed on an individual basis.
“When utilizing a 60-day rollover, it is important to understand the new ruling because tax consequences can be severe,” Eckman says. “The new ruling does not apply to direct trustee-to-trustee transfers, rollovers to or from a qualified plan, or Roth conversions.”
There are factors to consider with a 401(k) vs. IRA. Investment options within a 401(k) are limited and loaded with fees. IRAs offer more diversified options. Distributions cannot be taken from an IRA before age 59.5 without a 10 percent early withdrawal penalty applied.
However, in a 401(k) plan, if you are separated from employment during or after the year you reach age 55, distributions may be taken with no penalty. An IRA allows for a more strategic tax-planning approach.
Distributions from 401(k) plans are required to have 20 percent withheld for federal taxes, whereas an IRA does not have a required amount. An individual is still required to pay tax on IRA distributions; however, depending upon the individual’s tax situation, it could be substantially less than the required 20 percent on a 401(k) distribution.
“An IRA also creates an opportunity to consolidate investable assets in one place, making it easier to manage, allocate, and create a diversified portfolio,” Eckman adds.
Another financial “outlet” for boomers is Social Security, a “complex system with many moving parts,” says Nathan Imboden, financial advisor with Conte Wealth Advisors in Camp Hill. According to Imboden, recent rule changes taking effect later this year have greatly reduced the number of claiming strategies available to married couples pertaining to Social Security.
Tips for a married couple to think about when it comes to Social Security include whether they will work and have income while receiving benefits, which might reduce those benefits; spousal benefits where a spouse is entitled to a maximum of 50 percent of their spouse’s full retirement age (FRA) benefit amount; and longevity.
As part of longevity, survivor benefits are defined as the higher of the two spouses—surviving or deceased. In this case, the smaller amount of the two will stop.
“This can be a factor in deciding to delay and increase the benefit amount,” Imboden says.
The age of when someone is eligible for the full retirement benefit differs according to when an individual was born. That holds true for baby boomers, born between 1946 to 1964. If born between 1943 to 1954, the FRA is 66. If born between 1955 to 1959, the FRA is somewhere between 66 to 67. Anyone born after 1960 has an FRA of 67.
“Unfortunately, the specific year you are born and the specific age year/month you collect determines the percent reduction should you collect prior to FRA,” Imboden says. “The earliest age one can collect retirement benefits is age 62. Average reduction at age 62 is between 20 to 30 percent.”
But no matter what your FRA is, Imboden says, for every year an individual delays taking benefits beyond their FRA, they are entitled to a guaranteed 8 percent per year increase in their benefit for each year they delay until age 70.
“This is called a Delayed Retirement Credit,” he says. “So if one’s FRA is age 66, their benefit amount at age 70 would be 132 percent of their FRA amount. Those with an FRA of age 67 would receive 124 percent of their FRA at age 70. In addition, if there is a Cost of Living Adjustment (COLA), that would be added in addition to the 8 percent guaranteed increase.”
Remember: Each individual has different circumstances or needs, and whether you’re considering a 401(k) plan, an IRA, or Social Security, it is imperative for boomers to discuss their unique financial situations with a financial adviser before making any decisions that could affect their financial future. )))