Try to avoid tapping retirement funds early

But if you must, consider periodic-payment plan

Dollars & Sense

May 26, 2002|By Liz Pulliam Weston | Liz Pulliam Weston,SPECIAL TO THE SUN

I was laid off 18 months ago and last year rolled over my 401(k) account and my cash-balance retirement account into new, separate IRA accounts. My cash-balance retirement account was a pension plan funded solely by the company. If I need to access my funds, would my cash-balance retirement fund be subject to the same 10 percent early-withdrawal penalty as my 401(k), or would I just pay normal taxes on it?

The source of the money in your IRAs doesn't really matter. It's subject to all the rules, taxes and penalties that apply to IRAs. If you needed to tap that money, you would pay income taxes on your entire withdrawal, and you might owe federal and state penalties for early withdrawal as well. The federal penalty is 10 percent, and the state penalty varies.

As you can see, it would be easy to lose at least half of your withdrawals to taxes and penalties. Once you've taken the money out, there's no way to put it back. You will have lost those retirement funds, and all their potential future earnings.

Your best bet is to avoid tapping retirement funds prematurely. If you have no other options, however, you might consider taking what's called "substantially equal periodic payments," which will help you avoid the early-withdrawal penalties.

Under this system, you make regular withdrawals based on your life expectancy. The withdrawals must continue for at least five years.

If you haven't reached age 59 1/2 by the time the five years are up, you have to continue taking the payments until you do. If you want more details about how this works, check with the IRS or pick up the book IRAs, 401(k)s and Other Retirement Plans: Taking Your Money Out by Twila Slesnick and John C. Suttle (Nolo Press, 2002).

In a recent column, you suggested that people see an estate-planning attorney when their estates are big enough to incur estate taxes. Just how big an estate would that be these days?

If your net worth is approaching $1 million, it's time to make an appointment with an estate-planning attorney. You can get referrals to qualified estate planning specialists from your local bar association. That $1 million figure isn't drawn out of thin air. It's the current estate-tax exemption limit - the amount of money that can pass tax-free to heirs in 2002.

The limit is scheduled to rise over the next several years until 2010, when the estate tax is scheduled to be repealed.

But no one knows whether Congress will tinker with those limits. The estate-tax repeal was popular, but it will be increasingly expensive, both for the federal government and for states that shared in the take.

As it stands now, the repeal is scheduled to be in effect for only one year - 2010 - before the tax returns in 2011. The exemption limit in 2011 is scheduled to revert to $1 million.

You also might want to see an estate-planning attorney if your net worth is smaller but you expect problems, such as contentious family members or nasty creditors. Careful estate planning also is a must if you have a special-needs child or someone else who may need care or supervision for the rest of their lives.

And remember that estate taxes are only part of the estate-planning equation. Depending on the state in which you live, you may want to take steps to avoid probate, the court process that follows a death.

Some states - California for example - may have a long and expensive probate process, which can eat up as much as 4 percent of your gross estate and which typically kicks in once your assets are worth $100,000 or more. Other states, including Washington and Minnesota, have much shorter and less expensive systems, so probate avoidance is lower priority.

Even if you decide not to see an estate-planning attorney, you should make sure you draw up the essential documents: a will and durable powers of attorney for health and finances. The powers of attorney are documents that allow someone else to make decisions for you if you are incapacitated, while the will specifies how you want your money and property distributed after you die.

A will is particularly important if you have minor children. Don't subject them or the rest of your family to a court fight: Name a guardian now. Legal publisher Nolo Press offers kits, including Nolo's Simple Will Book (Nolo Press, 2001), and has teamed with personal finance software maker Intuit to produce "Quicken Lawyer 2002," software that can help you create wills, trusts and powers of attorney.

Liz Pulliam Weston is a columnist for the Los Angeles Times, a Tribune Publishing newspaper.

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