Retirement Income Blog

It’s a little crazy but investors with IRA savings want to know “what do I do now that my IRA account has dropped by 40%?” Would the best time to have asked that question have been before you invested the money?  To ask what to do now is like asking how to catch the train after it left the station.  So rather than succumb to the illogic of how to deal with a contingency when you had no contingency plan, let’s look at the rational way to handle your retirement savings from here on.

1. You can get all of your IRA savings out of the market and into a 2% money market fund.  This will insure that it takes a very long time to recover what you lost because at 2%, it takes 25 years to recover your loss.  Of course, the money market fund also insures that you won’t lose any more.  So you must ask yourself this question: does the market have a higher probability of going to zero or to 15,000?  Does Citicorp at $5 per share have a greater chance of going to zero or to $20?  If you think that there is a greater opportunity to the upside, then the money market alternative would be foolish.

2. You can sit tight and do nothing.  This means you have the same type of risk as when you started–the risk of loss or gain.  If you were willing to accept that risk before with your IRA savings, then why not now?  Additionally, consider that you have taken the risk and experienced the negative aspect of risk–don’t you need to stay in the market to experience the positive aspect of risk?

3. You can do something very irrational like invest all the money in gold because you heard some guy on CNBC says that gold is going to $2000 an ounce.  In other words, you lost money, are unhappy that you took so much risk and now want to take more risk with your retirement savings to gain it back.  Reminds me of the guy who lost everything in a card game and only had one asset left–his house.  In an effort to gain everything back he had lost, he wagered his house.  Does that seem like a crazy idea to you? If so, then you don’t try to gain your money back with an “all or nothing” bet.

4. What’s gone is gone.  You cannot think about “getting even.”  You have what you have and the best way to think of the right action is to ask yourself this, “I have $xxxx of retirement savings.  Based on what I know about myself and my emotional stability, my view of the future and my future needs, what is the best course of action NOW (with no reference to the past)?”

Hopefully, with these distinctions laid out here you can consider them calmly and the appropriate course of action will be obvious with your retirement savings.  And by the way–remember that your retirement savings are no different than the rest of your money (other than they grow tax deferred).  So if your non-IRA savings have been sitting in a money market during the market fall, look at everything you have and maybe you’re only down 10% overall and shouldn’t feel so bad.

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Many of you are somewhat familiar with the traditional Individual Retirement Account (IRA). It’s a type of retirement account that you can open yourself; it’s not run by your employer. For many people , it’s the bedrock of their retirement plan. Whatever you contribute to it grows tax deferred until you withdraw money. Your IRA savings are taxed as ordinary income in the year you withdraw it.

For 2008, you can deduct your yearly contribution of up to $5000 if you’re not covered by a retirement plan at work. If you are covered, then you can deduct this full amount if you file single (or head of household) with a modified adjusted income of $53,000 or less or file married filing jointly with income of $85,000 or less. For every $1,000 you’re over these income limits, your maximum deductible IRA savings contribution is reduced by $500 for single and $250 for married taxpayers . Nondeductible contributions to your IRA savings aren’t taxed when you take them out - only their earnings.

Tax-deferred compounding of your IRA svaings is the key aspect of an IRA. Deductible contributions help you to get more money in. If you’re taxed at the same or lower rate when you retire then that’s another plus. That’s pretty much the basics. But what else might be important to know for decisions you make as you approach or begin your retirement?

What can we do to increase our IRA savings? For those of you 50 or over, be sure to contribute the extra ’the catch up’ amounts of $1,000 -beyond the standard $5,000. And you can do this for your spouse too. A spousal IRA is an IRA to which a couple contributes on behalf of a nonworking spouse, even when that person earns little or no income. If your spouse is 50 or over too, she can contribute the full $6000.

You can contribute IRA savings to a traditional IRA until year before you turn 70½. This gives you a lot of time to take advantage of catch-up contributions to increase your retirement savings. When you reach 59½, you’re no longer subject to a 10% penalty on withdrawals. But remember, you must begin withdrawing your IRA savings at least the minimum required distribution the year after you turn 70½.

What about bankruptcy? The new bankruptcy law says that retirement accounts are protected from creditors in a bankruptcy. It’s best to consult a lawyer about your IRA savings if you do file bankruptcy and get professional retirement help.   In many states, IRA savings are protected from creditors without a bankruptcy filing.

What else can you use you IRA savings to invest in beyond the usual investments? Although not well-known, you can buy unencumbered real estate (i.e. condos, apartment buildings, single family homes, etc) directly with your IRA. Of course, you can also use your IRA to buy real estate indirectly through a corporation or a real estate investment trust (REIT). But, you can’t use your IRA savings to buy your home or vacation property that you live in, or property that you use in your business. 

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Under the Pension Protection Act of 2006, there are some new items beneficial to IRA owners that the average IRA owner will miss:

First, if you leave your employer and you had a tax sheltered annuity (typically the type of plan at school districts and governments), you can roll both the pre-tax and after-tax amounts to an IRA. That way, the whole account can continue to grow tax deferred.

Next, the silly requirement to first roll your company account into a regular IRA and then into a Roth IRA has been dropped. Under the new rule, when you retiree, you can roll your company account directly into a Roth IRA (of course, you pay the income tax due and then the Roth will grow tax free). This is effective January 1, 2008.

The nonsensical prior rule that a non-spouse beneficiary of a company plan could not roll over the money had been dropped. Here’s an example. Dad worked for Chevron. He listed his son as beneficiary on his 401k. If Dad dies, the son can now do a trustee-to trustee transfer of Dad?s account into an inherited IRA. Previously, only a spouse could move money from a deceased’s 401k into an inherited IRA or their own IRA. The non-spouse beneficiary still cannot take possession of the money or else it will be taxed–there is no 60 day rollover provision.

There’s more good news about the above. Let’s say Dad died in 2003 and the son was subject to the 5 year rule which required that the IRA be emptied by 2008. Now, the son can just do the rollover in 2007 (the rule is effective January 1, 2007) and take advantage of the new rule even though Dad dies a while back.

Last, good for seniors, starting in 2010, the $100,000 MAGI limitation on Roth conversion is repealed. Therefore, retirees, for whom Roth conversions are most appealing, will be able to do a Roth conversion without limitation and also spread the tax so that half is paid in 2011 and half in 2012.

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