By Dr. Gary L. Deel
Faculty Director, Wallace E. Boston School of Business
and Dr. Karin Ford-Torres
Faculty Member, Wallace E. Boston School of Business
This is the fifth and final retirement article in an ongoing series on sound tips for financial security and prosperity. These articles are intended to share a general overview of conventional, commonly practiced financial methods from business school faculty members and are in no way intended to influence or impart financial/legal advice or actions to or on behalf of readers. Readers should always consult with an attorney or licensed financial advisor before making any financial decisions.
In the last few parts of the Smart Finance 101 series, we discussed different types of retirement investment strategies and how you can best leverage them. In this part, we’ll look at the important questions about when retirement accounts pay out, when you must take disbursements, when you can defer them, and what this means for your financial well-being.
Investment Accounts and Paying Taxes
Understanding when the returns of your hard-earned retirement investments will be realized is important. And as with most points in this discussion so far, the answers depend on what types of accounts are involved and how they are structured.
Let’s start with traditional (pre-tax) accounts. First, most people wait until age 59½ or older to begin taking payments. Withdrawing funds before this age comes with a 10% penalty from the IRS. It’s important to note that there are certain exceptions when the IRS penalty may be waived, but most of these involve incidents of financial hardship, medical emergencies or disability, and other extenuating circumstances. It’s best to speak with a licensed financial advisor if you think one of these exceptions might apply to you.
Again, you can begin taking traditional account withdrawals after age 59½, though you will still have to pay taxes on the disbursements. At age 72, the IRS requires you to begin taking required minimum distributions (RMDs). If you can afford to leave your money alone until the RMDs kick in, it can sometimes be better to do that since it will continue to accrue interest and returns for as long as it’s invested. Also, if your income bracket drops considerably between 59½ and 72, you might see benefits from lower taxation on the disbursements.
Roth Individual Retirement Accounts
Roth individual retirement accounts (IRAs) are quite a bit different by comparison. The first key difference is that with Roth accounts you can take withdrawals on your contributions at any time without penalty. This makes sense if you think about it. Tax was already paid on the contributions, so you can access those contributions at any time you want, just like a bank account. However, it’s important to note that you cannot touch the earnings on those contributions before the recognized retirement age of 59½.
So if you invest $100,000 in your Roth IRA, you can pull from that $100,000 contribution anytime you want. However, suppose your $100,000 investment earns 7% interest (or $7,000) in the first year. Your total account balance would then be $107,000, but you’d only be allowed to take the original $100,000 out without penalty. If you tried to withdraw the additional $7,000, you’d be subject to the same 10% penalty we discussed for early traditional account withdrawals. And again, as with traditional accounts, exceptions apply here too, so it’s important to consult a financial expert for details.
The other important distinction for Roth retirement accounts is that there are no mandatory withdrawals or distributions at any point. You can withdraw the earnings without penalty after 59½, but you will never be required to take a withdrawal. You can keep the money in the Roth account for as long as you live.
On that note, it’s important to mention that both traditional and Roth retirement accounts can pass to descendants after death. So if you should die before withdrawing all of your retirement funds, those funds will likely pass to your next of kin. However, changing tax implications and rules for disbursements will apply.
Always Consult with the IRS or a Licensed Financial Advisor before Making Decisions
At the close of this five-part series on retirement accounts, it’s really important to note, one more time: the rules and stipulations for retirement accounts are far more detailed and nuanced than what is reviewed in this very basic discussion. So again, please consult with the IRS or a licensed financial advisor for specific questions you may have before making any decisions.
That said, there is still a lot you can do now to promote your financial well-being in retirement. And leveraging investment vehicles like traditional and Roth retirement accounts is one way to begin that process.
About the Authors
Dr. Gary Deel is a Faculty Director with the Wallace E. Boston School of Business at American Public University. He holds a J.D. in Law and a Ph.D. in Hospitality/Business Management. Gary teaches human resources and employment law classes for American Public University, the University of Central Florida, Colorado State University and others.
Dr. Karin Ford-Torres is an Associate Professor with the Wallace E. Boston School of Business at American Public University. She holds a Ph.D. in Business Administration with a concentration in Advanced Accounting and Financial Management. Karin teaches accounting and finance courses for American Public University, Purdue University Global and Colorado State University-Global. She has 24 years of prior banking experience with Bank of America.