When to cash in your IRA

Save all you can for retirement, but don't wait too long to spend it, says Money Magazine's Walter Updegrave.

By Walter Updegrave, Money Magazine senior editor

NEW YORK (Money) -- Question: I'm 65 and my husband is 70. We're both retired and receiving Social Security and pensions. We have about $150,000 in traditional IRAs, but we don't want to take money from these accounts for another 10 years, unless we're forced to. We're also wondering how our IRA funds should be invested. We're thinking 80 percent in stocks and 20 percent in bonds. Does that make sense to you? - Dana Chaoxia, San Francisco, California

Answer: I'll start by addressing the issue of withdrawals from your IRA accounts. That done, we can move on to the question of the asset allocation you're contemplating, which at 80 percent stocks and 20 percent bonds, in my opinion needs some serious re-thinking, given your age.

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Indeed, considering what's been happening in the market the past week or so, maybe you're already having second thoughts about taking such an aggressive stance. But let's begin with your IRA withdrawals. I don't want to say that you'll be forced to withdraw money from your IRA accounts within the next 10 years. But let me put it this way: If you don't, you'll be very sorry.

Here's the deal. By April 1 of the year after you become 70 1/2 years old, the government mandates that you begin taking RMDs, or Required Minimum Draws, from your IRA accounts, Roth IRAs excluded. If you don't take at least the minimum, you'll be subject to a 50 percent penalty on the amount you were short.

So, for example, if the RMD rules required that you take a distribution of at least $10,000 and you took only $5,000, you would owe a penalty of $2,500, or 50 percent of the $5,000 you should have withdrawn but didn't.

There is a whole set of rules and regulations surrounding RMDs - how you calculate them, how you can handle withdrawals if you have several IRAs in your name, etc. You can get the skinny on all the details by reading IRS Publication 590: Individual Retirement Arrangements.

Or, if you just want to cut to the chase, you can go to an RMD calculator like this one. By the way, you and your husband would each calculate your RMDs separately based on the IRA accounts in your own names, which makes sense since the "I" in IRA does stand for "Individual."

Just because you must take the distributions, however, doesn't mean you've got to spend them. You can always re-invest them, although you can't put them back into a traditional IRA after you've reached age 70 1/2.

You could, however, reinvest them into a Roth IRA, since you can contribute to a Roth IRA at any age, although, surprise, surprise, there are some eligibility criteria you must meet to do this too.

First, you can't exceed the income limits for contributing to a Roth. Nor can you exceed the maximum annual Roth contribution limit of $4,000 this year ($5,000 in 2008), plus a $1,000 catch-up contribution for people 50 and older. And you must have actual compensation income from either spouse or both combined at least equal to your Roth contributions. So if your only income is interest, dividends or withdrawals from your IRA, you can't fund the Roth.

On the other hand, you could reduce or even completely eliminate your mandatory withdrawals by converting all or some of your respective IRA stashes to Roth IRAs. Again, you must meet the income criteria, this time for conversions, although legislation passed last year allows anyone to do a Roth conversion starting in 2010.

There are some other things to think about as well. If you convert after reaching age 70 1/2, you'll still have to take a required minimum withdrawal for that year (although that draw, while taxable, doesn't count as income in determining whether you're eligible to do the conversion).

You'll also pay tax on the amount you convert. Depending on how large a sum that is, it could push you into a much higher tax bracket. If that's the case, you can always consider a partial conversion and do some more later.

Although a conversion can have a number of benefits aside from freeing you from RMDs, it's not always a given that it's the best way to go. For a look at some of the benefits and what you should do to increase the odds that a Roth conversion will work in your favor, click here. And for a closer look at some possible disadvantages, click here. You can also assess whether converting makes sense for you by going to a Roth conversion calculator. Or you could have an adviser run some numbers for you and help you decide.

And, of course, if for whatever reason you can't do a regular Roth or converting doesn't make sense in your case, you can always just reinvest any money you're required to withdraw from your traditional IRA into a regular old taxable account. In that case, you may want to consider tax-efficient options like tax-managed funds, index funds or exchange-traded funds. (For more on these options, click here and here.)

Now, about your investing strategy. An 80-percent stock, 20-percent bond mix strikes me as more than a tad aggressive for a couple your age. That's an allocation I'd expect to see for someone in their 30s or 40s. I suppose it could make sense if you're were really sure that one way or another you would keep that money invested for at least 10 years and that you have plenty of other resources you can tap if you need extra cash for emergencies and the like.

Truthfully, though, I still have trouble buying that racy an asset allocation. If I were you, I'd probably go with something more like 60 percent stocks, 40 percent bonds at the most, if only because I know that emotionally I might have a hard time dealing with a big loss when I'm your age. And given the way the market has been behaving lately, you may very well have to weather some big setbacks. But that's your call.

If you wouldn't be freaked out seeing your IRA balances lose 30 percent or more in a major market meltdown after which it could take three years or longer for you to get back to even, fine.

But if that sort of scenario would rattle you - or even have you unloading your stock funds as quickly as you could speed dial the fund company - then you should probably consider a more moderate approach that can still give you plenty of growth, and a somewhat softer landing if things go terribly wrong.  Top of page