Retirement Savings

An Investor’s Guide to Transitioning Your Money — and Your Mindset — to Retirement

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The transition to retirement after years in the workplace, as welcome as it may be, can also be jolting and even downright daunting, for all the changes it brings to a person’s day-to-day lifestyle, to their state-of-mind and to the handling of their finances.

 

A key part of the shift into retirement mode, explains Michael Palazzolo, a Certified Financial Planner™ who heads Birmingham, MI-based Fintentional, is adjusting from a growth-focused approach to asset-management and investing, to an approach which recognizes that protecting assets from downside risk and volatility is as important as growing them. Successfully transitioning to retirement entails not only a shift in investing mindset, but also an actual shift in how assets are invested.

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And that may raise some potentially unsettling questions: Will the assets I’ve worked so hard to build last as long as I need them to, and are they adequately protected from potentially damaging swings in the financial markets? Will the sources I’m relying on for income provide enough to live the lifestyle I desire?

 

Questions like these can make the move into retirement “quite intimidating,” Palazzolo acknowledges. “It brings up a lot of emotions and for some people, a lot of fear.”

 

One way to find answers to these questions and defuse some of the anxiety that often accompanies retirement is by planning in advance for how to execute the shift from accumulation mode, where growing assets usually is top priority, to distribution or decumulation mode, where the focus is balancing growth with protection to ensure those assets are distributed efficiently to supply an adequate amount of income throughout retirement.

 

Here’s a look at some of the key steps involved in the accumulation-to-distribution transition and planning process:

 

Figure out the “when.” Financial professionals such as Palazzolo suggest starting the transition process five years before your projected retirement date. So an important first step for a person considering retirement is to pick a target retirement date.

 

Adjust how assets are allocated to reflect changing risk tolerance. A person for whom retirement is looming close has less time to recover from a sharp downturn in the value of their assets. For them, a sharp dip in asset value just prior to retirement can be particularly devastating, since they’ll be drawing from these assets for income during retirement. The less valuable their assets, the less the income-producing capability of these assets. So, to address this risk — sequence of returns risk, it’s known as in financial circles — it often makes sense for people whose assets are heavily weighted toward stocks to shift a portion of their money out of the stock market, into bonds and other more conservative fixed investments.

 

It also may make sense to shift the composition of the portfolio, including both stocks and bonds, to lower-risk investments, such as with more value-driven stocks and/or shorter-term bonds, adds Certified Financial Planner™ Leon C. LaBrecque, who heads LJPR Financial Advisors in Troy, MI.

 

Take steps to manage tax exposure. Because taxes can have a particularly negative impact on retirees living on a fixed income, financial experts recommend taking steps before and during retirement to manage and mitigate potential tax exposure. That can mean phasing in the aforementioned reallocation of assets over a period of years to spread out potential capital gains tax liabilities, says Palazzolo.

 

It also can mean taking steps to diversify assets in terms of their tax treatment. Distributions from pre-tax accounts such as a 401(k) or traditional IRA are taxed as ordinary income when they come out, unlike distributions from a Roth 401(k) and Roth IRA, which aren’t taxed when they come out. Converting a traditional IRA to a Roth IRA prior to retirement gives people access to a tax-free source of income. While they likely will incur taxes on the conversion, gaining access to that tax-free income source later can make the move worthwhile, explains Palazzolo.

Build a cash reserve. Having access to a pool of readily available cash, stowed someplace like in a money market account or CD, is vital for retirees, says Palazzolo. Say a person is planning to sell investments from their stock portfolio to provide income during the early years of retirement, only to see the stock market — and the value of their portfolio — drop precipitously. Instead of being forced to sell stocks when their value is down in order to generate income, people with a substantial cash reserve can start drawing from that reserve for income while holding onto their stock investments, hopefully until they regain their value. They also can use money from that reserve to purchase stock-based investments when their price is relatively low. All this leads back to the fundamental “buy low, sell high” investing credo.

 

How much cash to keep in reserve? Some financial professionals recommend stashing enough to cover one or two years’ worth of retirement income. Others suggest more, in case the stock market downturn lasts longer.

Keep assets in the stock market. Equity investments such as stocks and stock-based funds can serve as the main growth engine of a portfolio, even in retirement. Indeed, with people living longer these days, they need their assets to keep growing so they last as long as they’re needed. Equities also are proven to help investors keep up with inflation, should that become more of a factor. So while it may make sense for a person heading toward retirement to move some of their assets out of the stock market, keeping a substantial chunk of their assets in equities can be a good idea for many.

 

Review retirement accounts, including 401(k), 403(b) and IRAs, with an eye toward potentially consolidating them to make eventual distributions (withdrawals) from these accounts easier to manage, and, perhaps, to reduce investment fees and costs, which can free up additional money to use constructively. “By keeping [investment] costs down, you’re basically giving yourself more money to reinvest,” Palazzolo explains.

 

Take stock of income sources. It’s important to gain a clear picture of your retirement income well before retirement hits. That means looking at both the supply and demand sides of the equation: on the supply side, the sources you expect to provide income during retirement, how much they will supply, when they’ll supply it, for how long and in what form (lump sum or in a series of payments); and on the demand side, projecting how much income you expect to need to cover your expenses and support your retirement lifestyle. This way, if there’s an apparent income shortfall, you can start addressing it now, before it becomes a pressing problem.

 

In the context of income planning, it’s also important to consider when to start taking Social Security benefits. People have options as to when they can begin drawing benefits — early, at age 62, at retirement age (65 to 67), or later, up until age 70. Waiting can make a substantial difference in the monthly benefit a person receives.

 

Revisit your asset mix and recalibrate if necessary, to maintain an optimal allocation. As financial markets move, the percentages of stocks and bonds in your portfolio likely will fluctuate, sometimes substantially enough to warrant a process called rebalancing, which entails moving money out of one class of assets inside the portfolio, to another class. Financial professionals recommend revisiting asset allocation at least annually — and as circumstances dictate.

 

Turn to a financial professional for guidance. The transition from the working world to retirement, and from accumulation mode to distribution mode, involves a variety of moving parts and a series of critical decisions. One misstep can prove costly. So consider enlisting the services of a financial planner for help making the transition as smooth as possible. To find one in your area, check out the Financial Planning Association’s searchable national database of personal finance experts at www.PlannerSearch.org.

This column is provided by the Financial Planning Association® (FPA®) of Northeastern New York, the principal professional organization for Certified Financial PlannerTM (CFP®) professionals. FPA is the community that fosters the value of financial planning and advances the financial planning profession and its members demonstrate and support a professional commitment to education and a client-centered financial planning process. Please credit FPA of Northeastern New York if you use this column in whole or in part.

The Financial Planning Association is the owner of trademark, service mark and collective membership mark rights in: FPA, FPA/Logo and FINANCIAL PLANNING ASSOCIATION. The marks may not be used without written permission from the Financial Planning Association.

 

Building a Retirement Nest Egg: Smart Approaches to Growing and Protecting Your Assets

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From Baby Boomers over age 50 who have been part of the workforce for several decades to Millennials in their twenties who are relatively new to the working world, Americans of all generations share a dream: to live comfortably later in life, with the lifestyle they desire, free from worries about running out of money.

 

Indeed, one reason people spend so much of their lives working is to earn money not only to meet their needs and wants today, but also to build a nest egg of savings they eventually can use during retirement.

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Growing and protecting that nest egg is important, whether you plan to retire soon, decades from now or perhaps not at all. Here financial planning experts from the Financial Planning Association offer suggestions for how to go about it:

 

  1. Enlist a retirement planning expert to develop a plan: Having dreams and goals you want to fulfill later in life means little without a plan to fulfill them. For an investment of just a few hours of your time and perhaps as little as a few hundred dollars, a Certified Financial Planner™ can help you develop a well-articulated strategy to get where you want to go in life, both in the near term and over the long haul, using a holistic, multi-disciplinary approach that encompasses investing strategy, retirement and insurance planning, debt management, tax planning and more. To find a CFP® in your area, check out the Financial Planning Association’s national database at www.PlannerSearch.org.

 

With a plan in place, you’re less likely to worry about financial security during retirement. Indeed, workers with a retirement plan are more than twice as likely to be “very confident” about having enough retirement savings as workers who lack a plan, according to recent findings by the Employee Benefits Research Institute.

 

  1. Commit to saving: Setting aside even a small amount of your earnings each month in some kind of tax-favored retirement plan, such as a 401(k) or individual retirement account (IRA), can result in a sizable nest egg for retirement. Set up an automatic deposit to help you stick to the savings commitment. Start early or start late, but be sure to save something. While it’s optimal to start saving earlier to give assets more time to grow in value, it’s not too late for people in their forties and fifties to begin saving.

  1. Maximize retirement plan contributions: One rule of thumb says to set aside 10-15% of your salary each year in a retirement account, according to Scott Ranby, a Certified Financial Planner™ with Kuhn Advisors in Denver, CO. Another is to save eight times your ending salary. “So, if you earn $80,000 [a year when you retire], your goal should be to end up with $640,000 when you retire,” he says.

 

To reach those goals, consider contributing as much you can afford, and as much as the law allows, to your retirement plan. The tax code sets limits on the amounts individuals and couples can contribute to various types of retirement accounts in a given year. Ask a tax specialist what those limits are for you, and plan accordingly.

 

While it’s not formally classified as a retirement savings vehicle, a Health Savings Account is another tool to maximize retirement savings, says Certified Financial Planner™ Andrew Weckbach, founder of Scaling Independence in St. Louis, MO. Not only can a person deposit money into an HSA tax-free (up to a specified amount each year) and remove it tax-free to cover qualified medical expenses, they can leave money in the account and utilize investment options tied to the account to grow that money over time. “They can keep saving money into the account until retirement, then use it like an IRA, withdrawing money from it to use for medical or non-medical expenses, and paying taxes on the withdrawals like they would on withdrawals from an IRA.”

  1. Prioritize tax diversification: It’s unwise to put your retirement nest egg in one basket, Weckbach cautions. For maximum flexibility and efficiency when the time comes to start spending down your nest egg, seek diversity in the tax categorization of your assets. Rather than put all your assets in qualified (pre-tax) retirement plans such as a 401(k) or traditional IRA, where contributions go in tax-free and are taxed on the way out, also be sure some of your assets reside in Roth accounts, where money is taxed on the way in, not the way out). It also makes sense in many situations to have some retirement assets in a taxable account, such as a brokerage account in which stocks and other assets are held outside a traditional retirement plan.

  1. Seek asset diversification: The same all-eggs-in-one-basket adage applies to the type of assets you own. History tells us that one of the best ways to grow your money and increase your net worth is by building a diversified asset portfolio of stocks, bonds, mutual funds, exchange-traded funds (ETFs), real estate, etc.

 

If you’re lucky enough to have a employee pension plan from which to draw a guaranteed income throughout retirement, that, too, may dictate the approach to asset diversification. “Having a pension in your back pocket allows you to be more aggressive with some of your investments,” explains Weckbach.

 

A financial professional with investment expertise can provide valuable guidance in developing a diversified portfolio with an age- and objective-appropriate allocation strategy.

  1. Revisit your asset allocation strategy periodically, reallocating and rebalancing assets as circumstances and life stage dictate. “Ignore the short-term noise of the [stock] market and its inevitable stretches of volatility,” Ranby urges. “Focus on your long-term plan.”

 

 

November 2015 — This column is provided by the Financial Planning Association® (FPA®) of Northeastern New York, the principle professional organization for Certified Financial PlannerTM (CFP®) professionals. FPA is the community that fosters the value of financial planning and advances the financial planning profession and its members demonstrate and support a professional commitment to education and a client-centered financial planning process. Please credit FPA of Northeastern New York if you use this column in whole or in part.

The Financial Planning Association is the owner of trademark, service mark and collective membership mark rights in: FPA, FPA/Logo and FINANCIAL PLANNING ASSOCIATION. The marks may not be used without written permission from the Financial Planning Association.

 

More Perks at Work: A Guide to Maximizing Voluntary Benefits

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For many people in the working world, the onset of fall means it’s benefits election season: time for employees to review and choose from among the workplace benefits offered by their employer.

 

Known as the “open enrollment period,” this annual window for employees to evaluate and select benefits offers an excellent — yet often overlooked — opportunity for workers to maximize their on-the-job compensation by taking advantage of the voluntary benefits available to them, whether it’s certain forms of insurance or less traditional benefits such as wellness incentives, identity theft protection, or even pet insurance.

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Voluntary benefits are offered by employers as add-ons to a core benefits package. Employees usually pay for them out of their own pockets, in most cases via an automatic payroll deduction.

 

Don’t be deterred by the extra cost, and don’t infer from the “voluntary” label that they’re superfluous, however. From an employee’s perspective, voluntary benefits are a powerful way to enrich your compensation package, asserts Darin Shebesta, a certified financial planner with Jackson/Rosskelley Wealth Advisors in Scottsdale, Ariz. “Virtually every aspect of a person’s financial life is touched by their [workplace] benefits. But few people take the time to really look at them. They’re leaving benefits on the table that are rightfully theirs.”

 

Don’t let another open enrollment season pass without at least investigating the voluntary benefits offered by your employer. Here are some that can deliver valuable perks at an affordable price:

 

An employer-sponsored retirement plan typically comes with a limit on annual tax-favored contributions, depending on the type of plan. Shebesta suggests contributing as much as you can afford, not only into so-called “qualified” retirement accounts such as a 401(k), where money is taxed on the way out, not the way in (pre-tax), but also to a Roth account, where money is taxed on the way in, not the way out (after-tax).

 

If your employer has some form of program to match your retirement plan contributions, take full advantage of it, he says. These matching contributions essentially amount to extra income for you — income that, when invested, has a chance to grow over time.

 

Health insurance: If your employer offers a high-deductible health plan (HDHP) that comes with a health savings account (HSA) option, consider it. “Everybody should have access to an HSA for the flexibility they provide,” Shebesta says. That flexibility includes the ability to deposit a certain amount annually into the account tax-free, then take it out (also tax-free) to pay for qualifying medical expenses. For people over 50, it’s worth considering using HSA money to pay for a long-term care insurance (LTCI) policy, according to Shebesta, because LTCI can protect a person from potential financial devastation if they should require expensive care for an extended period.

 

It’s also worth taking advantage of health and wellness benefits and incentives, if your employer offers them, says Shebesta. Some employers may offer a health club membership or discounts on membership fees as a benefit to employees. Others may offer financial incentives to employees who undergo preventive medical tests, for example.

 

HSAs also function as useful retirement savings vehicles, providing an IRA (individual retirement account)-like home for pre-tax dollars, whereby funds deposited in the account can be withdrawn for non-medical purposes starting at age 65. As with funds inside a qualified IRA, the account owner will in most cases be required to pay income tax on that money on the way out. “The HSA works almost like an alternate retirement plan,” Shebesta explains. “It’s basically another pre-tax investment vehicle.”

 

Life insurance is a worthwhile investment, particularly when you have someone else dependent on you and your income, such as a spouse, life partner and/or children, he says. Oftentimes, a life insurance policy is more affordable when purchased through an employer, where a person may gain access to special group rates and/or avoid medical underwriting.

 

If your employer doesn’t offer disability insurance as a core benefit, it’s worth investing in is an optional benefit, according to Shebesta. Long-term disability insurance in particular is a valuable tool to protect your earning power — the biggest asset you have — by replacing income that’s lost if you’re no longer able to work due to an injury or disability. He suggests getting as much optional long-term and short-term disability insurance as possible.

 

Additional voluntary benefits worth considering:

  • Long-term care insurance, particularly for people 50 and over. LTCI coverage can be less expensive when purchased through a group. “Before age 50, I recommend focusing on disability coverage. After that, start looking at long-term care coverage,” Shebesta suggests.
  • Legal plans: Legal plans provide ready access to legal counsel from a network of attorneys, making them handy for services such as drawing up a will or a contract, filing or responding to a legal complaint, etc. “You pay a couple of bucks a month for what amounts to a couple thousand dollars worth of legal help,” says Shebesta.
  • Identity theft protection: Identity theft topped the Federal Trade Commission’s national ranking of consumer complaints for the 15th consecutive year in 2014.
  • Reimbursement for education expenses, such as graduate school.

 

…and the list goes on. The selection of voluntary benefits that an employer can offer employees is broad and expanding. What’s more, offering voluntary benefits costs employers virtually nothing, as employees are the ones paying for them. So if you hear about a voluntary benefit you think your employer should offer, Shebesta says, “don’t be shy about approaching the HR department about it.”

 

November 2015 — This column is provided by the Financial Planning Association® (FPA®) of Northeastern New York, the principle professional organization for Certified Financial PlannerTM (CFP®) professionals. FPA is the community that fosters the value of financial planning and advances the financial planning profession and its members demonstrate and support a professional commitment to education and a client-centered financial planning process. Please credit FPA of Northeastern New York if you use this column in whole or in part.

The Financial Planning Association is the owner of trademark, service mark and collective membership mark rights in: FPA, FPA/Logo and FINANCIAL PLANNING ASSOCIATION. The marks may not be used without written permission from the Financial Planning Association.

RMD Time: A Guide to Handling Retirement Account Distributions

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Anyone who owns a tax-advantaged retirement account such as a 401(k) or individual retirement account (IRA) — that’s 63% of (or 77.5 million) American households as of 2014, according to the Investment Company Institute — would be well-served to familiarize themselves with required minimum distributions, or RMDs, and the sometimes complex rules that govern them.

“RMDs aren’t that tricky,” says certified financial planner Andrew Weckbach, founder of Scaling Independence in St. Louis, MO., “but there are wrinkles you need to be aware of.”

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An RMD is the minimum amount the owner of an IRA or retirement plan must withdraw from their account each year once they reach age 70½, as specified by the Internal Revenue Service. RMDs apply to people who own traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k) plans 403(b) plans, 457(b) plans, profit sharing plans, and other defined contribution plans.

RMDs from an IRA must be taken by April 1 of the year following the calendar year in which the account owner reaches age 70½. RMDs from 401(k), profit-sharing, 403(b) and other defined contribution plans generally must be taken by April 1 following the LATER OF the calendar year in which the account owner reaches age 70½ OR retires. RMDs then must be made by December 31 of each subsequent year. Withdrawals typically are considered taxable income except for any part that was taxed before (the basis). Delaying the first distribution into the second year doubles up the required distribution for that year and increases taxes for that year, which may not be a desirable result.

People who own multiple IRAs may choose to take their RMD for a given year from only one account, or they may take distributions from multiple accounts to meet the requirement. The former can make sense, Weckbach notes, when one of their multiple accounts includes an illiquid investment (such as a stock position in a small company) that’s not easily sold in order to raise funds for an RMD.

The RMD amount is calculated by dividing the amount in the account as of the end of the immediately preceding calendar year by a life-expectancy-based distribution period specified in the IRS’s “Uniform Lifetime Table.”

The IRS offers an overview of RMD rules on its website at www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Required-Minimum-Distributions.

Failing to follow those rules can be costly. Account owners who do not take any required distributions, or take distributions below the required amount, may have to pay a 50% excise tax on the amount not distributed as required. On the other hand, account holders may withdraw more than the RMD amount without penalty.

The above rules generally do not apply to Roth IRAs. The amount you invest in a Roth IRA (the basis) can be withdrawn anytime penalty- and tax-free after five years, and there are no RMDs on Roth IRAs held by the original owner. For more about IRS rules for Roth IRAs, visit http://www.irs.gov/Retirement-Plans/Roth-IRAs.

Before RMD time rolls around, IRA owners can begin taking penalty-free withdrawals at age 59½. Taking those withdrawals makes sense in certain situations, such as when the goal is to minimize RMD amounts — and the associated income tax burden — when the account holder hits age 70½. The goal, says Weckbach, is to manage income and retirement account withdrawals in order to avoid income spikes (and thus, income tax spikes) that may result from a large RMD in a given tax year. Thus, starting withdrawals before age 70½ can be an effective way to reduce income tax exposure.

Distributions taken from traditional IRAs prior to age 59½ are subject to a 10% penalty and are taxed as ordinary income, with several notable exceptions. IRS rules allow penalty-free (though not income-tax-free) early withdrawals from an IRA before age 59½ to cover such things as higher education and medical expenses, a first-time home purchase and health insurance if you’re unemployed. Making early withdrawals for any reason “isn’t ideal,” says Weckbach, and should be viewed more as a last resort due to the damage they can inflict upon a retirement nest egg.

Some of the RMD wrinkles to which Weckbach refers pertain to inherited IRAs — retirement accounts that pass into the hands of a beneficiary following the death of the original account owner. Generally, a person who inherits an IRA from a person age 70½ or older who had been required to take RMDs must take the RMD the deceased account owner would have received. Then, in the year following the owner’s death, the RMD is calculated using the beneficiary’s age and life expectancy.

However, a person who inherits an IRA from a spouse (and is the sole beneficiary on the account) has several choices:

  • They can avoid the beneficiary RMD by electing to treat the IRA as their own;
  • They can base RMDs on their own current age;
  • They can base RMDs on the decedent’s age at death, reducing the distribution period by one each year; or
  • They can withdraw the entire account balance by the end of the fifth year following the account owner’s death, if the account owner died before the required beginning date.

If the account owner died before the required beginning date, the surviving spouse can wait until the owner would have turned 70½ to begin receiving RMDs.

Likewise, non-spouse individual beneficiaries can withdraw the entire account balance by the end of the fifth year following the account owner’s death, if the account owner died before the required beginning date, or calculate RMDs using the distribution period from the IRS’s Single Life Table.

Given the potential financial ramifications of these choices, it makes sense to consult a financial professional for advice and guidance on RMDs. Visit the Financial Planning Association’s national database at www.PlannerSearch.org to find a Certified Financial Planner™ (CFP®) professional in your area.

April 2015 — This column is provided by the Financial Planning Association® (FPA®) of NENY, the principle professional organization for Certified Financial PlannerTM (CFP®) professionals. FPA is the community that fosters the value of financial planning and advances the financial planning profession and its members demonstrate and support a professional commitment to education and a client-centered financial planning process. Please credit FPA of NENY if you use this column in whole or in part.

The Financial Planning Association is the owner of trademark, service mark and collective membership mark rights in: FPA, FPA/Logo and FINANCIAL PLANNING ASSOCIATION. The marks may not be used without written permission from the Financial Planning Association.

Traditional IRA or Roth IRA? Choosing the Right Retirement Savings Vehicle

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Recognizing that saving for retirement is a must for anyone who wants to control their own financial destiny and avoid running out of money later in life, Uncle Sam offers a variety of tax incentives to encourage people to set money aside in a range of investment vehicles, individual retirement accounts (IRAs) being among the most popular.

The challenge for investors is deciding to which type of IRA to contribute. Are they better off putting money in a traditional IRA, a Roth IRA, or both? The answer to that question is, “It depends.”

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“There are some general rules of thumb to help guide you, but it really is a very situation-specific decision,” explains Scott Arnold, a certified financial planner with G&S Capital in Englewood, Colo. For that reason, he suggests potential IRA investors discuss their options with a financial professional before investing in an IRA. To find a Certified Financial Planner™ (CFP®) professional in your area, check out the Financial Planning Association’s national database at www.PlannerSearch.org. The following FAQ can help frame that discussion:

  1. What are some of the key distinctions and similarities between Roth and traditional IRAs?

Here are five to keep in mind:

  1. Traditional IRAs are tax-deferred vehicles, meaning distributions are taxed as earned income when they’re withdrawn. Roth IRAs work the opposite way: contributions are considered after-tax (that is, they are taxed on the front end as earned income, prior to landing in the account) and money comes out tax-free.
  2. Contributions to traditional IRAs may be tax-deductible. The amount of the deduction (full, partial or none) depends on whether the person (or their spouse) also has made contributions to a work-based retirement plan like a 401(k).
  3. In the case of Roth IRAs, contribution limits are lower for people whose income exceeds certain thresholds. No income restrictions apply to contributions to traditional IRAs. However, the tax deductibility of traditional IRA contributions may be limited for individuals (and couples) who also contribute to an employer plan.
  4. With a traditional IRA, withdrawals before age 59½ may be subject to a 10% early withdrawal penalty unless an exception applies, such as to cover the cost of college tuition. Those withdrawals also are taxable as ordinary income. With a Roth IRA, the amount invested (the basis) can be withdrawn anytime penalty- and tax-free.
  5. With traditional IRAs, the account owner must start taking required minimum distributions (RMDs) beginning at age 70.5 or face stiff penalties. No RMDs apply to a Roth IRA held by its original owner.
  1. How do current age and income factor into the decision?

The tax-deductibility of contributions to a traditional IRA means contributions lower a person’s taxable income, potentially putting them in a lower tax bracket, a key consideration come tax time.

Personal finance experts such as Arnold often steer younger clients toward Roth IRA contributions when their income (and thus their tax bracket as well) tends to be lower, so those contributions have longer to grow. Lower-income individuals and couples may also qualify for a retirement savings contributions tax credit for up to 50% of their contribution.

  1. How do a person’s current tax bracket and their expectations for future tax status figure into the decision?

Roth IRA contributions make sense for people who expect to pay taxes at a higher rate during the withdrawal stage (retirement) than they’re paying currently. Of course, this relies on a degree of speculation, as tax rules change frequently. On the other hand, if you think you will be in a lower tax bracket when you are ready to retire and take distributions, it may make sense to contribute to a traditional IRA.

When clients move from a low (15%) tax bracket to a higher (25% or more) tax bracket, it also can be wise to start contributions to a traditional IRA rather than a Roth to lower their taxable income and diversify the tax status of their retirement savings, explains Ben D. Gurwitz, a certified financial planner with Jim Oliver & Associates in San Antonio, Texas.

After age 59.5, it may also make sense for certain people to start taking penalty-free distributions from a traditional IRA in order to minimize RMD amounts — and associated income taxes — later, when they hit age 70.5. The goal is to manage retirement account withdrawals in order to avoid income spikes (and thus, income tax spikes), taking into account income from IRA RMDs and other sources like Social Security, pension, etc.

  1. Which type of IRA is best for people looking to pass wealth to beneficiaries?

For people to whom tax-efficient wealth transfer is a priority, a Roth IRA may be the best option, says Arnold, because a lack of RMDs allows the account holder to keep money inside the account so it has more time to grow before it transfers to beneficiaries.

  1. How important a consideration is tax diversification?

“It’s very important,” says Arnold, who recommends people maintain retirement assets in three categories: (1) tax-deferred accounts, such as a traditional IRA; (2) tax-free accounts, such as a Roth IRA); and (3) taxable accounts, such as brokerage accounts with stocks, bonds, etc.

Such an approach allows for maximum flexibility when it comes time to draw down from those accounts during retirement, says Andrew Weckbach, CFP, founder of Scaling Independence in St. Louis, MO.

  1. How much flexibility do you need with your IRA?

A Roth IRA account holder can withdraw account contributions (the basis amount) anytime, at any age, with no penalty, and can begin taking out earnings (above the basis) tax-free from a Roth after five years.

That’s one of the reasons Troy, Michigan-based certified financial planner Leon C. LaBrecque calls Roth IRAs “the Swiss Army knife of retirement tools.”

May 2015 — This column is provided by the Financial Planning Association® (FPA®) of Northeastern NY, the principle professional organization for CERTIFIED FINANCIAL PLANNERTM (CFP®) professionals. FPA is the community that fosters the value of financial planning and advances the financial planning profession and its members demonstrate and support a professional commitment to education and a client-centered financial planning process. Please credit FPA of Northeastern NY if you use this column in whole or in part.

The Financial Planning Association is the owner of trademark, service mark and collective membership mark rights in: FPA, FPA/Logo and FINANCIAL PLANNING ASSOCIATION. The marks may not be used without written permission from the Financial Planning Association.