MONEY retirement income

The New Way to Get IRA Income

Thanks to a government rule on annuities, retirees can be rewarded for their patience.

For years, financial planners have touted the benefits of longevity annuities for retirees. Now a new IRS rule has made these income generators an even better deal.

With a longevity annuity—also called a deferred income annuity or longevity insurance—you pay a lump sum in return for monthly income for life, starting at some future date. Because the issuer assumes that—let’s just say it—some buyers will die before they start receiving money, or soon after they do, your monthly check will be far more than you would receive from an immediate annuity costing the same (see the chart below). A longevity annuity’s larger, delayed payout helps hedge against the risk of outliving your money. It also frees you up to invest more aggressively in the rest of your portfolio, because you know you’ll have this income later on.

Under a rule passed last year, if you use IRA funds to buy a longevity annuity meeting certain IRS guidelines, its cost—up to $125,000 or 25% of your account, whichever is less—won’t be used in calculating the required minimum distributions you have to take from your retirement account starting at age 70½. Such a qualified longevity annuity contract, or QLAC, as it’s known, lets you leave more money to continue growing tax-free in your portfolio. To decide whether a longevity annuity is right for you, follow these steps:

Assess your cash situation. As useful as the annuity can be, you have to balance that future income stream with your need for money that you can tap for emergencies, either now or later. So commit only a small portion of your portfolio— no more than 20%—to a deferred annuity, suggests Michael Finke, financial planning professor at Texas Tech. “The sweet spot for buying a deferred annuity is $500,000 to $1 million or more in retirement assets,” he says. Less than that, and you won’t be able to purchase much income; more than that, and you can likely fund your future needs without annuitizing.


Make sure you can wait. Some buyers of longevity insurance are workers who plan to defer their annuity only until they retire, often within 10 years. But to maximize your benefit, defer 15 years or longer and wait until you’re in your seventies or eighties. Otherwise, you won’t get a big income bump from the issuer’s expectation that a certain number of buyers like you won’t collect. “If you can’t afford to wait more than a few years, there’s not much advantage over an immediate annuity,” says York University finance professor Moshe Milevsky.

Get ready to research. Several insurance companies have started selling QLACs, including Principal Financial and American General. You can get quotes for them at or through Vanguard and Fidelity.

So your money will be there when you need it, stick with insurers rated A+ or better by A.M. Best or Standard & Poor’s, says Coral Gables, Fla., financial planner Harold Evensky. After all, the whole point is to have fewer financial worries in retirement.

Read more about annuities:
What is an immediate annuity?
How do I know if buying an annuity is right for me?
What payout options do I have?


What Happens If I Overcontribute to My Retirement Account?

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Act fast to fix the mistake or you'll pay a hefty tax penalty.

Using a 401(k) or an IRA can be a powerful, tax-advantaged way to save for retirement, because your investment grows tax-deferred, and the contributions you make now can help reduce your taxable income.

But the tax advantages are limited through caps on how much you can contribute to these accounts.

For 2015, the contribution limits are $18,000 for a 401(k) (plus an extra $6,000 in catch-up contributions if you’re 50 or older) and $5,500 for IRAs (plus another $1,000 for those 50 and older).

Congress may set the limits, but generally, investors are responsible for sticking to them. So if you contribute more than the allowed amount in a given tax year, you potentially face IRS penalties and double taxation on your contributions.

Why So Many People Ask This Question: This is a more common issue for people who have IRAs because many employers have systems in place to prevent you from going over the 401(k) limit.

However, it is possible to overcontribute to a 401(k) if you change jobs and fail to inform your new employer of how much you contributed to your old 401(k) plan.

For IRAs, the onus is definitely greater on the individual to keep track of their contributions—and it can be easy for people to forget that they made a big contribution early in the year and then make a similarly large one later.

People who automate their IRA contributions might also miscalculate how much they are funneling into their account, only to find they’ve exceeded the limit at the end of the year.

What I Tell Them: If you contribute too much to a 401(k), the only way to correct the mistake is to have the plan administrator refund your extra contributions—known as excess deferrals—as well as any earnings on that money by the tax-filing deadline.

For excess deferrals made in 2015, the deadline is April 18, 2016, because of a federal holiday being observed on April 15.

Your excess deferral will then be reported as income in the year the contribution was made, while the earnings—or losses—will count toward your income in the year youreceived the refund.

So say you overcontributed $2,000 in 2015 and got your $2,100 refund in March 2016. The $2,000 would count toward your 2015 income, but the $100 in earnings would count toward your 2016 income.

What happens if you fail to meet the excess deferrals tax-filing deadline?

You will have to not only report your excess deferral as income for the year you made the contribution, but also pay taxes on it in the year you finally withdraw it. In other words, you’ll get taxed twice on the same contribution.

For overcontributions to IRAs, you must also withdraw the excess contribution, plus earnings, by the same tax-filing deadline as for 401(k)s.

But if you discover the mistake only after you’ve already filed your tax return, you have two options.

Within the next six months, you can file an amended return—with the excess contribution, plus earnings, removed—by the filing-extension deadline of October 17, 2016.

Or you can leave the excess contributions in your IRA in order to carry them over toward next year’s contribution limit—making sure, of course, to lower your ongoing IRA contributions to make room for the excess. However, you’ll have to pay a 6% penalty (via Form 5329) per year on that excess until it’s been absorbed or rectified.

The Bottom Line: While it doesn’t seem like it should be difficult to correct an honest error, the reality is that overcontributing to your retirement accounts can wreak tax havoc if you don’t act fast.

So once your realize your mistake, arrange to withdraw the excess contributions, and make sure you understand the tax implications on those withdrawals—ideally with the help of a tax professional.”

LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc., that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment, legal or tax planning advice. Please consult a financial adviser, attorney or tax specialist for advice specific to your financial situation. Unless specifically identified as such, the individuals interviewed or quoted in this piece are neither clients, employees nor affiliates of LearnVest Planning Services, and the views expressed are their own. LearnVest Planning Services and any third parties listed, linked to or otherwise appearing in this message are separate and unaffiliated and are not responsible for each other’s products, services or policies.

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MONEY College tip of the day

1 Really Bad Way to Pay for College

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Why you should keep your paws off your IRA.

You may have read that you can take cash from your IRA to pay for college tuition, without incurring the usual 10% penalty on withdrawals made before age 59 1/2. The IRS calls it the “education exception to additional tax on early IRA distributions.”

But just because you can doesn’t mean you should. In fact it’s a pretty dreadful idea.

Among the reasons:

1. You’ll have less money saved for retirement. And not just the amount you withdraw but whatever it might earn, tax-deferred, between now and the time you retire.

2. You’ll still have to pay taxes on the withdrawal. As a result, you’ll net considerably less than you withdraw. Julian Block, an attorney and tax expert in Larchmont, N.Y., gives this simplified example: Let’s say you want to take $10,000 from your IRA. Even if you’re in the relatively low 15% federal income tax bracket, you’ll owe $1,500 in taxes, netting you just $8,500. If your state has an income tax, that will reduce your net further. What’s more, the amount you withdraw will increase your adjusted gross income for the year, which could affect your eligibility for certain tax deductions and even push some of your income into a higher tax bracket.

Note that this applies to early withdrawals from Roth IRAs as well as the traditional kind, although you can withdraw your contributions to a Roth, but not their earnings, at any time without taxes or penalties. The IRS has more details on its website.

Block suggests that if you own a home, taking out a home equity loan might be a better idea. Not only will you sidestep the problems associated with IRA withdrawals, but some or all of the interest you pay should be tax deductible.

“I would look on an IRA withdrawal as an option of last resort,” Block says.

“Before you go ahead with one,” he adds, “first see what rate is available from Tony Soprano.”

For more advice on paying for college, and to create a customizable list of colleges based on criteria such as size, selectivity, and affordability, visit the new MONEY College Planner.

MONEY Retirement

Why Keeping Your Retirement Funds In One Place Pays Off

Ask the Expert Retirement illustration
Robert A. Di Ieso, Jr.

Q: I am retired with the majority of my assets in IRAs. For a sense of security I have kept my money in several accounts, with Fidelity and Vanguard. They’re far from a Bernie Madoff risk, but I figure why not spread it around just in case? I also worry about a cyber-attack on the holder of all my assets. Am I being too paranoid or could I safely consolidate all my eggs into one basket? — Bob Drahushuk

A: There are plenty of good reasons to consolidate your investments at one firm rather then spreading them over multiple accounts, says Mark Hebner, founder and president of Index Fund Advisors in Irvine, Calif. You’ll find it easy to ensure that you have the right asset allocation, you can save on administrative fees, and some firms reduce transaction costs for larger balances. It means less paperwork, and you have just one firm to deal with when you want to make a transaction. It’s also simpler for your spouse and heirs when you pass away.

But if splitting your investments between two brokerages will give you peace of mind, do it, says Hebner. There’s no harm. You can use an account aggregator such as or Quicken to keep tabs on your overall portfolio, he adds.

As for the risk of losing your money in a Madoff-like Ponzi scheme, keeping your money at large, well-respected brokerages, as you are doing, will mitigate that. You aren’t alone, though, in your concerns about cyber attacks on financial institutions. The Securities and Exchange Commission has beefed up its examination of brokerage cyber security policies. But most large firms, including Fidelity, Vanguard, and Schwab, have policies that guarantee reimbursement against unauthorized activity in your account.

Beyond Ponzi schemes and hackers, Hebner says that since the 2008 market crash, clients worry more about the risk of brokerage firm failing. You have protection there too.

The Securities Investor Protection Corp. (SIPC) steps in if a brokerage goes out of business and will reimburse your account up to $500,000 per account holder and per account (coverage of cash is $250,000). In the Madoff case, customers got money back that they deposited with him but not any of the fictitious profits Madoff claimed, says Steve Harbeck, SIPC president and CEO of SIPC, which is a non-government organization funded by member securities firms. “We protect cash deposited with an institution and any securities bought with that money for member brokerages.”

Brokerage bankruptcies are rare, though—just 328 cases since SIPC was created in 1970 and 625,000 customer claims. The SIPC has reimbursed $2.34 billion in claims and administrative costs, but that number is skewed by Madoff, which accounts for $1.8 billion of the $2.34 billion. Not including the continuing Madoff case, fewer than 400 people haven’t received the full amount of their assets left with a collapsed SIPC-member firm because it was above the limit, according to SIPC. But most major brokerage firms also carry private insurance beyond SIPC limits known as “excess SIP insurance.”

That should give you peace of mind whether or not you consolidate your accounts, says Hebner. But do whatever helps you sleep at night.

“There’s enough to worry about when it comes to the ups and downs of the financial markets. You should feel as comfortable as you can about any possible risks to your account,” says Hebner.

MONEY Retirement

The Right Way to Lower Your Tax Bill on an Inherited IRA

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Q: My dad has a traditional IRA with non-deductible, after-tax contributions. He has to figure out the taxable and non-taxable portion of the distribution every time he withdraws money. I will inherit the IRA when he passes away. As the beneficiary, do I need to do the same thing when I take distributions? – Max Liu, West Hills, Calif.

A: Yes, you will have to do the same thing your father does or you’ll end up paying more taxes than necessary when you take the money out, says Jeffrey Levine, a CPA and IRA technical consultant at

Here’s why: You can’t deduct your IRA contributions on your taxes if you already participate in an employer-sponsored retirement plan such as a 401(k) and earn more than $71,000 as an individual or $118,000 as a married couple. But you can still contribute up to $5,500 a year in 2015 ($6,500 if you’re 50 or older) to a non-deductible IRA.

When you fund a non-deductible IRA, as your dad has done, you have already paid income taxes on that money. Unfortunately, the onus is on you, the account holder, to show the IRS that the taxes have been paid. You do that by filing IRS form 8606 each year you make after-tax IRA contributions. (The institution where you keep your account won’t keep track.)

If you don’t, the IRS has no record that you ever paid taxes on money in your IRA. But even if you do the paperwork properly upfront, you must file form 8606 again when you take withdrawals to prove that you already ponied up to Uncle Sam.

Though many rules are different when you inherit an IRA (more on that later) vs. funding one yourself, in this case the process is very similar for IRA beneficiaries, says Levine.

When you inherit an IRA that holds after-tax contributions, you must also file Form 8606 to claim the non-taxable part of the distribution, even if your dad already did. If you don’t, you’ll essentially be paying taxes on money that’s already been taxed. It’s even more complicated if you also have your own IRA with after-tax funds. You have to file two 8606 forms, one for your own IRA and one for your inherited IRA, says Levine. But it’s worth the effort.

“Taxes are bad enough to start,” says Levine. “There’s no reason anyone should pay more than they should just because of poor record keeping.”

You might wonder why anyone would make contributions to an IRA when you can’t get a tax break and all that paperwork is involved. After all, even when people qualify for tax breaks, not a lot of money is flowing into IRAs on a regular basis. But making non-deductible contributions still has benefits. Your investment grows without the drag of taxes, and you don’t pay tax on earnings until you withdraw them.

Keep in mind that when you inherit an IRA, a lot is different from when you own an IRA that you opened yourself. You can’t contribute new money to an inherited IRA and you can’t roll it into another IRA. Unlike regular IRA holders, who don’t have to start taking distributions until after age 70½, you generally have to begin taking money from the account the year after you inherit it.

It’s not wise to withdraw the money all at once though, says Levine. “Many people take the money and run. But that money is immediately taxable, and the income could phase you out of other tax breaks.”

You can reduce the tax hit by taking money out over time. The IRS requires you to withdraw a minimum amount based on your age and the year you inherit the money. You can use a calculator like this one to figure out the annual minimum. If you don’t take at least that much, you’ll be hit with a penalty. Plus, the longer you keep money inside the IRA, the more you benefit from the tax-deferred growth, adds Levine.

This can be complicated stuff, so you may want to consult with a tax expert or financial adviser who has experience in this area.

It’s terrific that your father has been diligent about his record keeping and taxes. To make the most of his legacy, you’ll have to be too.

MONEY Savings

Vanguard Founder Jack Bogle’s Surprising Retirement Advice

The one thing you absolutely, without question, unavoidably, simply must not do while saving for retirement.

Don’t you dare open that monthly statement you get about your retirement account, says Jack Bogle, founder of the mutual fund giant Vanguard, which now has about $3 trillion of assets under management. “You’re gonna get a statement every month,” says Bogle. “Don’t open it. Never open it. Don’t peek.” Wait until you actually get to your retirement, then you can open your statement (although, Bogle jokes, you may want to have a cardiologist on hand). Not knowing how much you have growing in a retirement account makes you less likely to want to raid it when your kids go to college or when you want to buy that shiny new car. It also makes you less likely to trade in and out of the market, which can be a fool’s errand.

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Here’s the Best Way to Invest a Roth IRA in Your 20s

Ask the Expert Retirement illustration
Robert A. Di Ieso, Jr.

Q: I just rolled over a Roth 401(k) from my previous employer into a Roth IRA. How diversified should my Roth IRA investments be? How do I select the right balance being a 28-year-old? – KC, New York, NY

A: First, good for you for reinvesting your retirement savings. Pulling money out of your 401(k) can do serious damage to your retirement prospects—and that’s a common mistake that many people make, especially young investors, when they leave their employers. According to Vanguard, 29% of 401(k) investors overall and 35% of 20-somethings cashed out their 401(k)s when switching jobs.

Cashing out triggers income taxes and a 10% penalty if you’re under 59 ½. And you lose years of growth when you drain a chunk of savings. Cash-outs can cut your retirement income by 27%, according to Aon Hewitt.

So you’re off to a good start by rolling that money into an IRA, says Brad Sullivan, a certified financial planner and senior vice president at Beverly Hills Wealth Management in California.

At your age, you have thirty or more years until retirement. With such a long-time horizon, you need to be focused on long-term growth, and the best way to achieve that goal is to invest heavily in stocks, says Sullivan. Over time, stocks outperform more conservative investments, as well as inflation. Since the 1920s, large cap stocks have posted an average annual return of about 10% vs. 5% to 6% for bonds, while inflation clocked in at 3%.

Granted, stocks can deliver sharp losses along the way, but you have plenty of time to wait for the market to recover. A good starting point for setting your stock allocation, says Sullivan, is an old rule of thumb: subtract your age from 110 and invest that percentage of your assets in stocks and the rest in bonds. For you, that would mean a 80%/20% mix of stocks and bonds.

But whether you should opt for that mix also depends on your tolerance for risk. If you get nervous during volatile times in the stock market, keeping a higher allocation in conservative investments such as bonds—perhaps 30%—may help you stay the course during bear markets. “You have to be comfortable with your asset allocation,” says Sullivan. “You don’t want to get so nervous that you pull your money out of the market when it is down.” For those who don’t sweat market downturns, 80% or 90% in stocks is fine, says Sullivan.

Diversification is also important. For the stock portion of your portfolio, Sullivan recommends about 70% in U.S. stocks and 30% in international stocks, with a mix of large, mid-sized and small cap equities. (For more portfolio help, try this asset allocation tool.)

All this might seem complicated, but it doesn’t have to be. You could put together a well-diversified portfolio with a few low-cost index options: A total stock market index fund for U.S. equities, a total international stock index fund and a total U.S. bond market fund. (Check out our Money 50 list of recommended funds and ETFs for candidates.)

Another option is to invest your IRA in a target-date fund. You simply choose a fund that’s labeled with the year you plan to retire, and it will automatically adjust the mix of stocks, bonds and cash to maximize your return and minimize your risk as you get older.

That’s a strategy that more young people are embracing as target-date funds become more available in 401(k) plans. Among people in their 20s, one-third have retirement savings invested in target-date funds, according to the Employee Benefit Research Institute.

Keeping your investments in a Roth is also smart. The money you put into a Roth is withdrawn tax-free. What’s more, you’re likely to have a higher tax rate at retirement, which makes Roth IRAs especially beneficial for younger retirement savers.

Still, you can’t beat a 401(k) for pumping up retirement savings. You can put away up to $18,000 a year in a 401(k) vs. just $5,500 in an IRA—plus, most plans offer an employer match. So don’t hesitate to enroll, if you have another opportunity, especially if the plan offers a good menu of low-cost investments.

If that’s the case, look into the possibility of a doing a “reverse rollover”: transferring your Roth IRA into your new employer’s 401(k), says Sullivan. About 70% of 401(k)s allow reverse rollovers, according to the Plan Sponsor Council of America, and a growing number offer a Roth 401(k), which could accept your Roth IRA. It will be easier to stay on top of your asset allocation if you’ve got all your retirement savings in one place.

Read next: This Is the Biggest Mistake People Make With Their IRAs

MONEY financial advice

Vanguard’s Founder Explains What Your Investment Adviser Should Do

Jack Bogle, founder of the mutual fund giant, shares what makes an investment adviser worth paying for.

The life of a financial adviser can be very tricky. Many of them believe that leaving a client’s investments alone is the best option, but when, year after year, clients come in asking what the best course of action is for their money, what do you tell them? Jack Bogle, who 40 years ago founded the mutual fund giant Vanguard (it now has about $3 trillion of assets under management), explains exactly what a financial adviser should do and what a financial adviser should say.

Read next: Jack Bogle Explains How the Index Fund Won With Investors

MONEY Savings

Here’s How Much Cash You Need in Retirement

Q: I am in my eighth year of retirement. A few years in, I found myself spending a considerable amount on repairs and upkeep on my old house. I also had to replace my car. Luckily, I was able to build up a reserve fund to cover costs so I didn’t have to dip into my investments for these “life happens” events. What is your advice on how much cash a retiree should have on hand to feel secure? – Karen Hendershot

A: Of course, everyone should have a cash cushion to handle unexpected expenses, but retirees need a larger cash reserve than people who are still working, says Richard Paul, president of Richard W. Paul and Associates in Novi, Mich. “The stakes are higher for retirees,” Paul says. “When you’re no longer earning an income, the money you have saved isn’t easily replaced.”

If you need to tap your investments for emergencies, you risk spending down your portfolio too quickly. And if you have to sell securities in a down market, you’ll need to take a bigger chunk to get the amount you need.

Relying on your investments for unexpected expenses could also trigger some nasty tax consequences. If you liquidate money from a taxable account, the income could bump you into a higher tax bracket and cost you even more.

So, how much do you need? While the standard recommendation is to have six to 12 months of money set aside to cover emergencies, retirees should have at least 12 to 18 months of cash, says Paul. That should be enough to cover daily expenses as well as any emergencies that might crop up. “This creates a safety valve, so you’re not at the whims of the market,” he says. Use an interactive worksheet like this one from Vanguard to tally up your monthly expenses.

Exactly how much you will need depends on your individual circumstances. If you have guaranteed cash flow, say from a pension and Social Security, that covers your daily expenses, you won’t need to have as much set aside as someone who is already withdrawing money from a portfolio to cover living costs. You can’t foresee emergencies but you can plan for them. If you have an older home, for example, you can anticipate needed repairs or upgrades like a new roof. If you have any medical issues, you’ll want to keep a larger stash for medical costs. “Medicare doesn’t cover everything,” Paul notes.

Since people tend to enter retirement with most of their money tied up in investments, such as 401(k)s and IRAs, Paul recommends that you start building up an emergency fund before you retire. While you’re still earning, start funneling money into a savings account and move a portion of an IRA into a short-term bond fund.

On the flip side, you don’t want to keep too much of your savings in cash. You won’t earn much interest in a money market fund or basic savings account, so balance that cash cushion with investments that can keep up with inflation. “You still need your money to grow,” Paul says.

MONEY Savings

When Good Investments Are Bad for Your Retirement Savings

Q: I have an investment portfolio outside of my retirement plans. That portfolio kicks out dividend and interest income. If I roll all that passive income back into my portfolio, can I count that toward my retirement savings rate? — Scott King, Kansas City, Mo.

A: No. The interest income and dividends that your portfolio generates are part of your portfolio’s total return, says Drew Taylor, a managing director at investment advisory firm Halbert Hargrove in Long Beach, Calif. “Counting income from your portfolio as savings would be double counting.”

There are two parts to total return: capital appreciation and income. Capital appreciation is simply when your investments increase in value. For example, if a stock you invest in rises in price, then the capital you invested appreciates. The other half of the equation is income, which can come from interest paid by fixed-income investments such as bonds, or through stock dividends.

If your portfolio generates a lot income from dividends and bonds, that’s a good thing. Reinvesting it while you’re in saving mode rather than taking it as income to spend will boost your total return.

But dividends can get cut and interest rates can fluctuate, so counting those as part of your savings rate is risky. “The only reliable way to meet your savings goal is to save the money you earn,” says John C. Abusaid, president of Halbert Hargrove.

It’s understandable why you’d want to count income in your savings rate. The amount you need to save for retirement can be daunting. Financial advisers recommend saving 10% to 15% of your income annually starting in your 20s. The goal is to end up with about 10 times your final annual earnings by the time you quit working.

How much you need to put away now depends on how much you have already saved and the lifestyle you want when you are older. To get a more precise read on whether you are on track to your goals, use a retirement calculator like this one from T. Rowe Price.

It’s great that you are saving outside of your retirement plans. While 401(k)s and IRAs are the best way to save for retirement and provide a generous tax break, you are still limited in how much you can put away: $18,000 this year in a 401(k) and $5,500 for an IRA. If you’re over 50, you can put away another $6,000 in your 401(k) and $1,000 in an IRA.

That’s a lot of money. “But if you’re playing catch-up or want to live a more lavish lifestyle when you retire, you may have to do more than max out your 401(k) and IRAs,” Taylor says.

Read next: How to Prepare for the Next Market Meltdown

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