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A top way to tap an IRA
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August 29, 2000: 11:19 a.m. ET
Guest on chat series advises people to be careful how they take distributions
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NEW YORK (CNNfn) - The best way to start dipping into your IRA is by choosing a withdrawal method known as "term certain," a national expert on IRAs and taxes told a CNNfn.com chat audience recently.
Ed Slott, a CPA and editor of the newsletter Ed Slott's IRA Advisor, answered questions Friday as part of a week-long chat series on CNNfn.com's special report, The Road to Riches. He is also a CNNfn.com columnist.
Here is an edited transcript of Slott's session. (Note: CNN staffers asked some questions).
Chat moderator: Thank you for joining us today, Ed Slott.
Ed Slott: It's a pleasure to be with you today.
Chat moderator: Can you tell us a little about your background?
Slott: I am a CPA and a specialist in IRA distribution planning, which is really estate planning for your retirement benefits. The purpose of this planning is to make sure that your IRA or retirement account outlives you and continues to grow, tax deferred, for as many years as possible.
Question: Is a 401(k) considered a qualified retirement plan under the strict meaning? Can you co-mingle 401(k) funds and profit-sharing money in a rollover IRA?
Slott: Yes. They are both qualified plans and can both be rolled over into an IRA, but that depends on your plan. For example, if you are still working, your plan may not let you roll over to an IRA.
Question: How often do people get poor advice on IRA rollovers?
Slott: Most of the time, which is why it's a real problem and often costs families hundreds of thousands of dollars in needless taxes.
I'm located in Rockville Centre, New York, but I speak throughout the U.S. educating financial advisers, financial professionals and the general public on these complicated rules. There is a tremendous demand for this information and especially for accurate information on this subject. Too many people plan only to accumulate retirement funds, but have no plan on how to protect these funds from taxes when they are distributed, or upon death.
Question: What distribution method do you recommend when one spouse is 18 years younger than the other?
Slott: Generally, the best distribution method is the "Term Certain" method.
Question: Why?
Slott: That method guarantees a tax-deferral term, regardless of who dies or in what order. It also guarantees that the beneficiaries will be able to extend distributions for as long as possible - generally, over their lifetimes. The fact that the spouse is so much younger will allow distributions in smaller amounts because of the age difference.
Question: Could the 401(k) and the profit-sharing plan funds be rolled into the same IRA without adverse consequences?
Slott: Yes.
Question: Do you have to start distribution when you're 59-1/2? And can you change the amount of the distribution at a later time?
Slott: Distributions are not required until after you reach 70-1/2 years old. Any distributions taken after 59-1/2 and before 70-1/2 years old are totally voluntary; meaning you can take as much as you want, penalty free, but you will still owe tax on any distributions.
Chat moderator: Why is it so important to pick a beneficiary for my IRA?
Slott: Without a beneficiary, you cannot extend the life of the IRA for as long as would otherwise be possible if you did name a beneficiary.
Question: Can you take out more than your required distribution?
Slott: You can always withdraw more than your required amount. The required amount is a minimum, not a maximum.
Question: And the distributions are taxed as ordinary income?
Slott: Yes.
Chat moderator: What does it mean to pick a "life expectancy" for my IRA?
Slott: Generally, naming a beneficiary who is a person will automatically entitle you to use a joint life expectancy. You only have two choices: (1) single life expectancy, and (2) joint life expectancy. Single life expectancy should really never be elected, because it will cause the IRA to be paid out the fastest. You need to name a beneficiary. That will generally allow you to use a joint life expectancy, which means that you can extend required distributions over both your life and the life of your designated beneficiary.
Question: Who sets the required amount of the withdrawal?
Slott: The tax law determines the required amount, but the calculation is based on who your beneficiary is and the distribution method you have elected.
Question: One of the CNN links talks about "Hybrid" methods.
Slott: The "Hybrid" method is when you use two different distribution methods. For example, for yourself, you elect "Recalculation;" and for your beneficiary, you elect "Term Certain." The "Hybrid" method, as the name implies, contains some of the best features of each of the other two methods. The problem with the "Hybrid" method is the complicated calculations, and the fact that you are betting that you will outlive the life expectancy tables. If you don't outlive the life expectancy tables, you would have been better off with a "Joint Term Certain" election, which is why I generally recommend a "Joint Term Certain" election as opposed to a "Hybrid" method.
Chat moderator: What do you think of maximizing the IRA distribution and using life insurance to cover the beneficiary?
Slott: That is probably the best overall and most cost effective strategy to maintain the IRA for beneficiaries, while providing other non-IRA money to cover the cost of estate taxes. Life insurance is the most cost effective way to leverage your funds and protect your IRAs for your beneficiaries. I often recommend this strategy for clients with large IRAs who would be subject to estate taxes.
Chat moderator: What do you think about the estate tax bill?
Slott: I don't know. What do you think about it? I guess we will find out today or whenever the president decides to veto the bill or sign it.
If it was up to me, I would just immediately raise the exemption to a flat $2.5 million per person, which means five million per couple, with no phase-ins and no other related gimmicks. That should protect 99.99 percent of all estates from ever having to pay an estate tax. In addition, it would be effective immediately rather than the proposed bill, which really doesn't repeal the estate tax until 2010.
My plan may be too simple, though. What do you think?
Chat moderator: What is the difference between a Roth IRA and a standard IRA?
Slott: A Roth IRA is a non-deductible IRA, as opposed to what we are now calling a traditional IRA, for which you can get a tax deduction. For the long-term, the Roth IRA is, by far, a better deal because all the back end build-up in the Roth IRA will be completely tax-free for you and for your beneficiaries. That's income tax-free, not estate tax-free.
Chat moderator: When is it beneficial to cash out an IRA, take the tax hit, and then put the net into a Roth IRA?
Slott: As early as possible, because the longer you wait, the more money will build up in your regular IRA, and you'll pay more taxes later. You're better off biting the bullet now and have the account grow tax-free forever.
Chat moderator: What are some good high-yield but safe investment vehicles for use in an IRA?
Slott: That's an investment question. I'm a tax adviser, not an investment adviser. This decision also depends on your risk tolerance. For example, everybody would like to earn 30 percent, but any investment that you could earn 30 percent on, you could also lose 30 percent on.
Question: Is there an income limit on who can participate in Roth IRA's? Is there a limit on how much you can put in a Roth IRA per year?
Slott: The Roth IRA comes in two flavors. First is the annual contributory Roth IRA. That is limited to a contribution of $2,000 per year -- $4,000 if married -- similar to a traditional IRA. If you are single, you can contribute the full $2,000, as long as your income does not exceed $95,000. For a married couple filing jointly, the income limit is $150,000.
The second type of Roth IRA is the Roth Conversion. This is where the big money is because there is no limit on how much you can convert to a Roth IRA. The only qualification is that your income cannot exceed $100,000 in the year you convert; and you cannot convert if you file married separate. Money that you convert from a traditional IRA to a Roth IRA will be taxed as ordinary income; but as long as you can afford to pay the tax, you can convert as much as you like.
Question: If you continue to work after age 70-1/2, can you contribute to a Roth? Can a younger spouse?
Slott: Yes, as long as you have earnings. For a traditional IRA, you cannot contribute after age 70-1/2, even if you do have earnings.
Chat moderator: Do you have any final thoughts to leave with our audience?
Slott: I have a Web site that answers similar questions and more complicated ones: www.irahelp.com. It also has links to numerous other sites that have related tax and IRA information.
The bottom line to all this for consumers is to get educated and not rely on others who may not know these complicated rules, because mistakes are costly in this area, and there are few second chances.
Chat moderator: Thank you, Ed Slott, for joining us today!
Slott: You're welcome. Great questions, and I hope you find the answers you need in this complicated area. 
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