Saving for Retirement; Tapping IRAs Early

QUESTION: I’m 62, have paid off my mortgage and have $390,000 saved for retirement. A little more than half of that is in mutual funds (including target-date retirement funds), and
the rest is in CDs. Will I ever be able to retire?

—Jean West, Vernon, N.J.

ANSWER: You’ll probably need to step up your savings over the next several years, but it’s your current asset allocation that’s the real problem. How much anyone needs to retire, of course, is highly subjective; many financial planners recommend withdrawing no more than 4 percent to 5 percent of your portfolio annually (adjusted for inflation). 

Your current asset allocation isn’t helping you as much as it could. Having multiple target retirement funds (each with a weighting of stocks and bonds that becomes more conservative as retirement nears) means you have significant fixed-income holdings in addition to your CDs. That’s no doubt a comfort in times like these, but it limits your long-term growth, says financial planner Mark Balasa of Itasca, Ill. It’s not just a temporary down market that you need to watch out for—prolonged inflation can also ravage a portfolio. Speak with a good financial planner to help determine the best investment mix for you.

QUESTION: I’m 55 years old with a traditional IRA. I’m planning to take early distributions. How does that work?

—Ed Davis, McKinney, Texas

ANSWER: So-called 72t distributions are a way to tap your IRA before the magic age of 59½ while avoiding the 10 percent early-withdrawal penalty. Here you agree to make “substantially equal periodic payments,” which means you agree to take ongoing regular withdrawals for five years or until you reach age 59½—whichever is later. Folks can choose from three different Internal Revenue Service–approved methods for calculating the withdrawal amount. Talk to a tax pro for help with the calculations. And keep in mind that while the withdrawal amount can change from year to year based on the methodology you’ve chosen, you can’t take out more than the allotted amount, says IRA expert Ed Slott, of Rockville Centre, N.Y. Given the hassle, if you can afford to, you’re likely better off waiting.

QUESTION: Is it true that for some folks dividends and capital gains are tax free in 2008?

—Carl Jones, Hot Springs Village, Ark.

ANSWER: Yes, for those in the 10 percent and 15 percent tax brackets, the tax rate is indeed zero, starting this year. It’s a great deal—if you qualify. The 15 percent bracket taps out for singles with taxable income of $32,550 in 2008; for married couples that figure is $65,100. (Those in higher tax brackets pay 15 percent on capital gains and dividends.) That’s taxable income, though—which means folks with considerably higher gross income can reduce it through 401(k) contributions, a health savings account, sizable itemized deductions and so on, thereby getting their income low enough to qualify for the zero capital gains rate.

But even if you don’t qualify, someone you help out financially might. Giving appreciated stock to, say, your recent college grad or an elderly parent in the 15 percent bracket allows the recipient to take advantage of the zero percent rate, provided you’ve held the stock for at least a year. (Warning: If you gift the shares to a child claimed as a dependent, he or she will likely get snared by the kiddie tax, which means they’ll be taxed at the parents’ rate, rendering this strategy moot.) To take advantage of the zero percent rate, the recipient of your shares should sell relatively quickly. The current capital gains rules are set to expire at the end of 2010. And with a new occupant in the Oval Office, changes could happen sooner than that. e