Your Retirement Account Survival Guide

An IRA is a simple little thing. It's a common, garden-variety retirement vehicle, basically nothing more than a savings account with initials — right? Wrong.

The rules regulating IRAs are varied and vexing; IRS Publication 590 [PDF], the definitive source for Uncle Sam's shalls and shan'ts regarding IRAs, weighs in at a hefty 108 pages. And then there are all the guidelines about employer-sponsored plans — e.g., 401(k)s and 403(b)s. Whew! Seems like all this would be enough to fill a two-day conference focusing on nothing but retirement accounts.

Actually, it is. I know, because I attended one — Ed Slott's two-day IRA workshop (fun!). Slott, a CPA and the operator of, is recognized as one of America's foremost authorities on individual retirement arrangements (yep, that's what the “A” in “IRA” actually stands for). At the conference, he and his team led 100 financial-services pros (and one Fool) through a 430-page manual that described the care and feeding of retirement accounts, as well as several real-life examples of people who made mistakes that cost them thousands of dollars.

Some examples:

    • A teacher withdrew $67,553 from her 403(b) to pay her daughter's college expenses. She paid the income taxes, but thought she'd be exempt from the 10% penalty since the money was used for higher-education expenses. Sadly, that exemption applies only to IRAs, not 403(b)s or 401(k)s. Oops.


    • A widow inherited a $2,646,798 retirement account from her deceased husband. She transferred it to her own IRA, then withdrew $977,888. She wasn't yet 59-1/2 but figured she'd be spared the 10% early withdrawal penalty since she inherited the account. Indeed, distributions from inherited accounts are exempt from the 10% penalty. However, since she transferred the account to her own IRA, she owed Uncle Sam $97,789. Bigger oops.


It would be the ultimate in stinkiness if you spent years — nay, decades — saving in a retirement account, only to lose thousands due to one simple mistake. Here are just some of the guidelines you must follow to prevent just such a mistake from happening to you.

Stuffing It
The maximum you can contribute to an IRA in 2011 is $5,000 — or $6,000 if you're 50 or older. Granted, the biggest source of your IRA's funds is likely a transfer from a 401(k) or other employer plan, but contributing $5,000 annually is nothing to sneeze at. For one thing, sneezing at something is rude — but more importantly, contributing $5,000 a year to an account that earns 8% annually would result in $78,227 after 10 years and $247,115 after 20 years. Not shabby at all.

While contributing to an IRA can pay off over the long term, most people first contribute to their employer's retirement plan, especially if the boss matches contributions. After that, you may want to contribute additional savings to an IRA; if you have money in a retirement plan with a former employer, moving that to an IRA also makes sense.

Here are the advantages of an IRA over a 401(k) or other plan:

    • More investment options. The typical 401(k) offers a menu of five to 15 mutual funds, whereas an IRA with a discount brokerage allows the owner to choose from among thousands of stocks, exchange-traded funds (ETFs), mutual funds, individual bonds, CDs, and, if approved, alternative strategies such as options.


  • Lower costs. This depends on the plan and the IRA provider, but the cost-conscious investor will have more ways to limit fees in an IRA, such as investing in index funds, ETFs, or stocks that you hold for many years (avoiding the annual expenses of funds).

There are two reasons not to transfer an employer plan to an IRA:

    • If you retire between the ages of 55 and 59-1/2, you can take money out of the plan from your last employer penalty-free, whereas withdrawals from an IRA before age 59-1/2 might result in a 10% penalty.


  • If you own stock in your employer, you're likely better off transferring it to a taxable account to take advantage of net unrealized appreciation (NUA).


Getting It There From Here
The easiest and best way to move money from one retirement account to another is with a “trustee-to-trustee transfer.” Contact the company to which you wish to move the money, complete the paperwork they send you, and they'll handle the rest.

You want to avoid being sent a check payable to you alone. If that happens, you'll generally have 60 days to get the money into the new account. Wait any longer and it may be considered a distribution from your previous plan, subject to taxes and possible penalties. In addition, 20% of the distribution may be withheld; you'll have to cover that gap with personal funds when you move the money to a new account, but you'll get a refund when you file your taxes. If you don't make up that 20%, it, too, will be considered a distribution subject to taxes and penalties. This is all very bad.

If your current account provider insists on sending you a check, request that it be made payable to the new financial institution — for example, “XYZ Bank as trustee of IRA of John Doe” or “ABC Firm FBO Jane Smith” (FBO means “for benefit of”).

Spending It
As mentioned earlier, you generally have to wait until age 59-1/2 before tapping retirement accounts, whether IRAs or 401(k)s — if you don't, you'll be charged a 10% early-distribution penalty. However, there are several exceptions. Some apply to both IRA and employer-sponsored plans, others to just one. (Any exceptions apply just to the 10% penalty; regular taxation will still apply.)

The chart below lists the possible exceptions. If you find yourself in any of these situations, take the time to know all the details before you make a withdrawal. Most exceptions are restricted to certain groups, but Substantially Equal Periodic Payments are available to everyone; they're explained in IRS Code 72(t), but they're complicated and can trigger the penalty if not done properly. For all the details, visit

Note: The very first exception listed is also available to everyone, but it's a large price to pay to avoid an IRS penalty.


Exceptions to 10% Early- Distribution Penalty Plans and IRAs IRAs Only (Including SEP and SIMPLE IRAs) Plans Only
Death ?    
Total and permanent disability ?    
Substantially Equal Periodic Payments, a.k.a. 72(t) ?    
Medical expenses that exceed 7.5% of adjusted gross income ?    
IRS levy ?    
Active reservists ?    
Distributions from inherited accounts ?    
Higher education, for self or qualified relatives   ?  
“First-time” home buyer, up to $10,000 per account owner (can be used for qualified relatives, or for yourself if you didn't own a home in the previous two years)   ?  
Health insurance if unemployed   ?  
Age 55     ?
Age 50 for public safety employees     ?
457 plans     ?
Dividends from employee stock ownership plans     ?
Qualified Domestic Relations Order     ?
Totally insane prices on flat-screen TVs at an after-Christmas sale      


Contributions to a Roth IRA can be withdrawn tax- and penalty-free at any time, while earnings will be subject to the age 59-1/2 rule (as well as the five-year rule, which is a whole other complicated ball of wax). A Roth 401(k) is a different matter; all withdrawals are a proportional mix of contributions and earnings, with any taxes and penalties being assessed against the earnings only.

When You Gotta Take It
Owners of traditional IRAs as well as traditional and Roth employer plans must begin taking annual required minimum distributions (RMDs) the year they turn 70-1/2. Alternately, they can wait until the following year but take two distributions in that year. Otherwise, they'll pay a 50% penalty. Yes, even a Roth 401(k) has RMDs, but they can be avoided by transferring the money to a Roth IRA — the only account not subject to forced liquidation.

Surprisingly, beneficiaries of inherited retirement accounts must also take RMDs beginning in the year following the death of the original owner. This is true regardless of age — even if the account is a Roth IRA. The only exception: a surviving spouse who elects to make the inherited account her own (i.e., has it re-titled in her name) or rolls over the inherited account to her own existing account.

While non-spouse beneficiaries can roll an inherited 401(k) to an inherited IRA, they can't avoid the RMDs. The account must remain titled something along the lines of “Joe Smith, deceased, IRA for the benefit of Joe Smith Jr. as beneficiary.”



Bequeathing It
If you're interested in passing on wealth to your family, you probably want as little to go to taxes and lawyers as possible. Start by naming living, breathing human beings on your account beneficiary forms. Doing this means the account bypasses your will and probate (which can cost time and money), and the beneficiary or beneficiaries can “stretch” the account over their lifetimes. If the form is blank, or the listed beneficiaries are themselves deceased, the money will go to the estate. In that case, the account may have to be liquidated within five years, and it will lose all the tax advantages of an IRA or 401(k).

Keep in mind that the beneficiary form often trumps other legal documents, such as wills and prenuptial agreements. If your beneficiary form says your IRA should be split between your son and daughter, but your will says it should just go to your daughter (because your son has turned out to be an irresponsible spendthrift — or a banker), the account may end up being split. And to minimize the risk of lost or messed-up beneficiary forms (it does happen!), keep copies in your own records.

It's important to name primary beneficiaries as well as contingent beneficiaries (the people who will inherit your accounts if the primaries are deceased, or if they'd rather the contingent beneficiaries get the money). If you've inherited an IRA, make sure you name new beneficiaries.

Protecting It
Finally, here are three other considerations for protecting your retirement accounts, during this life and beyond:

    • Creditors and bankruptcy. The money in your employer-sponsored retirement account most likely can't be lost to bankruptcies, creditors, or lawsuits. IRAs receive bankruptcy protection up to $1 million. However, the amount of protection from other creditors varies by state.


    • IRA fees paid with non-IRA money. Many IRA providers charge an annual account fee, which is automatically taken from your account assets. However, you can instead send a check to the custodian and leave more money in the IRA to grow. This also applies to annual “wrap” fees, though not to commissions and mutual fund expenses.


  • Estate taxes. Retirement accounts, including Roths, are included in a gross estate for tax purposes. Recent laws increased the federal estate tax exemption to $5 million per person and $10 million per couple, but the limits drop in 2013. Twenty states also impose estate taxes, with exemptions as low as $338,333. If your estate is or will be worth a few million dollars or more, see a local, qualified estate-planning attorney.

Remember: Get help if you need it. If you're going to make a significant change to your retirement accounts, you might want a little professional help to make sure you're doing everything right. features a listing of advisors in your area who have taken extra training about IRAs and 401(k)s. Also, the fee-only financial advisors at the Garrett Planning Network charge by the hour (among other methods), which makes it easier to get your questions answered without having to turn over your entire financial life.

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