Sunday, June 26, 2011

Only tap an IRA, 401(k) as last resort

You've built a financial fortress with several walls of protection. Now, facing a job loss, you need to decide which bastions to hunker down behind.

There are advantages to tapping certain accounts and assets before others.

"Jobless benefits and personal savings would be the first line of defense," said Gary Daniels of Personal Financial Mavens in Payson. After that, he said, it's often a matter of individual circumstances.

Ideally, like a stout castle, you will have several rings of defense, perhaps with a moat and drawbridge for good measure. Occupying the innermost sanctum of your castle should be your retirement accounts.

Financial advisers routinely suggest restraint before withdrawing retirement money, even when times get tough.

If you pull cash from 401(k)-style plans or traditional Individual Retirement Accounts, you would trigger federal and state taxes, typically on the full amount. You also face a 10 percent early-withdrawal penalty if under age 59 1/2, though that drops to age 55 if you pull money from 401(k) accounts and you're laid off or leave the job for other reasons.

"The taxes are almost always much higher than expected, often more than 40 percent of the amount withdrawn if there is a 10 percent early-withdrawal penalty," Daniels said.

Taxes and penalties even could apply on early withdrawals from Roth IRAs.

But taxes aren't the only reasons to leave retirement accounts alone.

With withdrawals, you'd also be depleting your retirement savings and raising the likelihood of having to rely solely on Social Security in old age. As it is, millions of Americans already are way behind in retirement planning.

"An issue even bigger than taxes or penalties is what your account could be worth in 10 or 20 years," said Stephen Barnes, a certified financial planner and chartered financial analyst at Barnes Investment Advisory in Phoenix.

Plus, you'd be removing money from accounts that enjoy legal protections.

"Both federal and Arizona laws protect $1 million or more of retirement funds from creditors in a bankruptcy," said Daniels, who is also a certified public accountant.

If you withdrew money from retirement accounts, those amounts would be subject to regular taxes and possibly penalties that probably wouldn't be discharged in a bankruptcy proceeding, he said.

But while many jobless and underemployed Americans seem to recognize these dangers, they still might not be able to avoid retirement-account withdrawals if their employment problems persist.

Respondents in a new survey by the Transamerica Center for Retirement Studies said they relied mainly on jobless benefits and personal savings during the first year out of work or being underemployed. But after a year, more survey respondents started using credit cards heavily and draining their retirement accounts.

Many of these people didn't have much of a nest egg anyway, with 36 percent reporting less than $10,000 in household retirement savings and 49 percent with less than $50,000.

During that first year of a job loss or an underemployment situation, many respondents said they relied mainly on jobless benefits, non-retirement savings and spousal income.

Cost cutting also should be a priority.

"Immediately scrub the budget and get rid of any expenses that aren't absolutely necessary," Barnes said.

Such non-essential costs might include cable TV, movies and the "daily latte," he said.

If you must rely on credit cards or other debt to make it through a rough patch, try to access your least costly form of borrowing, said Mike Sullivan, director of education at Phoenix debt-counseling firm Take Charge America.

For example, if you participate in a 401(k) plan, you typically can take out a loan against your account balance at a low interest rate. This could be an option for underemployed individuals. But if you get laid off, such borrowings must be repaid.

Credit cards would be a more costly form of debt, and options such as auto-title loans more expensive still, he said.

"Taking on more debt only makes sense if you're pretty confident you'll have more income soon," Sullivan said.

Even if you focus on other lines of defense, you still might come to a stage where retirement accounts are next up. Here are a few considerations for dealing with that.

- If you have a Roth IRA, this could be a good retirement account to withdraw from first. You can pull amounts equal to your original contributions (not earnings) from a Roth without triggering taxes or the early-withdrawal penalty, Daniels said.

- If you must pull money from a retirement account, you might be able to minimize the tax bite by doing so in a year when you have little taxable income - which could be the case anyway if you're jobless.

- If you're in your late 50s, it might pay to rely on credit cards or loans from other sources such as relatives, Daniels said. Upon reaching 59 1/2, you could then withdraw from retirement accounts and pay off the debts without incurring the 10 percent penalty.

But Barnes suggests caution here. "The last place I'd want to go is adding more debt," he said.

by Russ Wiles The Arizona Republic Jun. 26, 2011 12:00 AM

Only tap an IRA, 401(k) as last resort

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