Retirement planning: Look before you leap with account withdrawals
Retirement planning can go horribly awry with an ill-advised account withdrawal. Because of that, comprehensive retirement planning should also include a separate, well-stocked emergency fund.
It becomes obvious pretty early in life that some things are dangerous, especially if you’re lucky enough to have someone with experience to help you spot them: a parent, guardian, teacher or coach. Stove tops are hot and can burn you; broken glass is sharp and may cut you; other drivers can crash into your car if you don’t watch out for them.
Then, there are things you learn somewhat later in life — things that can pose a threat to your financial well-being. In this case, retirement savings plan withdrawals gone awry. It’s a lesson that, no matter what age we are, seeking expert help and guidance can save us from harm.
Let’s take a look at retirement plans and how some ill-advised withdrawals happen.
ERISA plans, named for the Employee Retirement Income Security Act of 1974, allow employers to provide defined contribution plans for their employees, typically to defer income taxes on some of their earnings and save a nest egg for retirement. The intention is that this money will compound tax deferred over time and eventually supplement Social Security payments for the duration of retirement.
There are a variety of plans, and many modifications have been made to the laws over the years, but most employees are familiar with the plans they have at work: 401(k)s, 403(b)s and similar retirement vehicles. Even the self-employed have options available to them beyond the traditional IRA, or individual retirement account. There are many variations of accounts available now, including Roth versions that allow for post-tax contributions and additional planning opportunities. For information about your plan, examine your plan’s Summary Plan Description.
Mistakes were made
With the recent Great Recession resulting in increased unemployment and family and business financial strains, many employees and self-employed individuals have learned the hard way about the tax and penalty consequences of making ill-timed or improper qualified plan and IRA withdrawals that, with a little research and consideration, could have been avoided.
Some have seen their income pushed up a couple of tax brackets by cashing out IRAs and liquidating annuities all in the same year. Others have paid avoidable penalties on withdrawals by classifying them as hardship withdrawals or family assistance, provisions made available through the tax code.
These are instances when some good advice could have made all the difference. For example, a direct rollover to another trustee, rather than a rollover withdrawal, will prevent the withholding of 20% of a distribution from a 401(k) plan. Direct contributions to a Roth IRA can be withdrawn without penalty or tax consequences for any reason, at any age. In the case of divorce, a properly drafted and executed Qualified Domestic Relations Order, or QDRO, can make a significant difference in a family’s long-term well-being. These are just a few of the many options that might be available to you.
A stitch in time
One of the greatest obstacles to maintaining a tax-deferred or tax-free retirement account into and through retirement is, of course, not having other available liquid assets to draw upon in the event of adversity. Your plan also should include a well-thought-out emergency fund; good credit that you carefully maintain; and even a knowledge of bankruptcy provisions and when they should be used. Remember that qualified plans and certain other asset protections are based on law and are there to help you. In order to benefit from them, you must know how to find information about them, when to seek assistance and when to act.
Fortunately, the Internet makes it easy to find the resources and professional assistance necessary to make better decisions. Professional services and information have become more easy to locate and accessible. The IRS website offers a wealth of information regarding withdrawal rules, as well as tips on how to make a distribution more tax-efficient and less likely to add to your tax and penalty burden.
There is help out there for those who seek it. Before acting, consider your options, do your research and consult the appropriate legal, accounting, tax or financial professional. Making a smarter decision today can pave the way to a more enjoyable and comfortable retirement.
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