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I suppose it's not a big deal if you aren't clear on all aspects of IRA benefits, as long as you keep making your deposits. But if you are tempted to slide, remember this:
A Roth IRA is the ultimate tax shelter. And not just for you, but for your heirs as well. When a traditional IRA is part of an estate, the heirs must pay income taxes on that money in addition to inheritance tax. All of the money in a Roth IRA passes income-tax-free to your heirs. (It is still counted for inheritance tax purposes, but there is no final income tax to pay on it.)
Thinking about retiring early? It seems to be one of the IRS's best-kept secrets, but you CAN make withdrawals from an IRA before age 59 1/2 without paying the 10% penalty that applies to non-qualified distributions. I wish I could say it's simple, but, well, this is the Internal Revenue Service we're talking about. The idea is that if a withdrawal is part of a "series of substantially equal periodic payments," it is not subject to the 10% penalty.
"Substantially equal periodic payments" means that you have to set up and follow an IRS-approved annuity-type schedule of payments, and you have to stick with it for at least five years or until age 59 1/2, whichever takes longer. There are several ways to calculate these payments. I don't know enough about them to give advice on the exact method, but I did find that the simplest one, which is based on life expectancy tables and can be found in IRS Publication 590, results in a pretty low payout in the early years. It is set up to make sure that your money lasts throughout your life expectancy, but it assumes you are getting a very low return on your investments.
For example, under the life expectancy method, someone retiring at age 50 would be required to take a distribution of exactly 3.5% of his total IRA balance (all accounts) in that first year. Each year the percentage would increase slightly. On any distributions prior to age 59 1/2, he or she would pay regular federal income taxes, even for Roth distributions, but the money would not be subject to the 10% penalty normally assessed against premature withdrawals. Once you turn 59 1/2, the Roth withdrawals become tax-free.
There are two other methods that early retirees can use to calculate their distributions and they both offer more substantial withdrawals under the right circumstances. But even the IRS considers them too complicated for the average tax payer! I will try to get ahold of the publication that describes them (which isn't online for some reason although darn near everything else is!) and share at least the gist of the methods with you at some later date. In the meantime, perhaps one of my tax expert readers will help us out on this.
There are some other restrictions on withdrawals from a Roth, especially if the Roth was converted from a traditional IRA, so tread lightly, read through our Tax Area and the IRS publications, and if your situation isn't crystal clear to you after that, consult an expert.
Hmmm, sounds like one could spend more time in retirement figuring out how to manage one's IRA than playing golf. Well, they say you need to exercise your mind as well as your muscles to stay healthy as you age. I guess Uncle Sam was trying to do us a favor when he wrote all those regulations.
Here's another benefit that we touched on last Friday. Once an account reaches critical mass, it's not really necessary to keep making your annual contributions, given that you are getting substantial returns. (Don't try this if your IRA is in bank CDs or bond funds!) In Friday's example, you could have stopped your annual contributions after just 10 years, and the account would have hit the magic million-dollar mark in year 26 instead of year 25.
Of course you may prefer to retire a year early, but it's comforting to know that you can skip those payments when the kids are in college or when Fate hands you those periodic gifts that make life so interesting, like a baby when you're 45 or other, less happy surprises.
What that really brings up, though, is the value of TIME. Your early contributions have more time to grow and your non-IRA contributions function most efficiently if simply left alone to compound. That's why I've practically dedicated my life to hounding people into starting IRAs. And I mean now.
OK, a few other quick bennies. You can take the money out to buy a first house, pay for higher education, help out in certain hardship cases like substantial medical expenses, pay your medical insurance if you're unemployed. And with a Roth, you can take out the money you contributed (not the earnings, just the contributions) at any time without tax (you've already paid tax on that money) or penalty. (This doesn't apply to conversions from traditional IRA accounts, by the way, only to regular contributions. Other rules apply to conversion withdrawals.) Naturally, you wouldn't want to start taking out your contributions in the early years, but this feature could come in handy when early retirement time rolls around.
The deadline I mentioned earlier really is the deadline for last year's IRA. Up until tax day, April 17 (you get two extra days because the 15th is a Saturday), you can still contribute like it's 1999. This is a huge advantage. While it would have been better to make your IRA contribution on January 1, 1999, so that it would have had the whole year to work for you, being able to count money deposited now as part of your 1999 contribution means that you can conceivably contribute as much as $4000 to a single IRA account this year, as long as you haven't "used up" your contribution for 1999 yet. Wait until April 18, and your contribution is limited to $2000. On second thought, don't wait!
Fool on and prosper!