MONEY retirement planning

Why You Should Think Twice Before Choosing a Roth IRA or Roth 401(k)

two gold eggs
GP Kidd—Getty Images

Sure, Roth plans let your savings grow tax free. But if you're nearing retirement, a traditional pre-tax account may be the best choice.

Even assuming a Republican Congress doesn’t go along with the tax hikes President Obama has proposed, the mere fact that talk of higher taxes is in the air could very well make Roth IRAs and Roth 401(k)s even more popular than they already are. But is that necessarily a good thing?

For years, the conventional wisdom held that you were better off saving for retirement in a Roth IRA or Roth 401(k) rather than the traditional versions, provided you expect to face a higher tax rate in retirement than when you make the contribution. This makes sense because you would be paying tax at a lower rate upfront and avoiding a higher tax bill down the road when you withdraw your contribution and earnings tax-free.

Lately, however, it seems more people are challenging this view, and suggesting that you may still be better off in a Roth even if you end up in a lower tax rate when you withdraw the money in retirement. For example, T. Rowe Price released research last year showing not only that a Roth IRA or Roth 401(k) could generate more income in retirement than a traditional account for people who drop to a lower tax rate; it also showed that even older savers—people in their 50s and early 60s—who fall into a lower marginal tax rate in retirement could come out ahead with a Roth.

But while this can be true—and there may also be other good reasons to fund a Roth—it’s hardly a given. So if you think you may end up dropping into a lower marginal tax rate in retirement, you should be aware of a few important caveats before doing a Roth, especially if you’re nearing retirement age.

The Drag of Taxes

For example, according to T. Rowe Price’s analysis a 55-year-old in the 33% tax bracket today who retires at age 65 would receive 9% more retirement income by making a contribution to a Roth 401(k) or Roth IRA instead of a traditional account, even if he slipped into the 28% tax bracket upon retiring.

How is that possible? Let’s assume this 55-year-old has the choice of contributing $24,000 (the 2015 maximum for someone 50 or older) to a Roth 401(k) or a traditional 401(k). If he does the Roth and the $24,000 grows in a diversified mix of stocks and bonds at 7% a year, he would have $47,212 tax-free after 10 years.

If, on the other hand, he puts the $24,000 into a traditional 401(k) that returns 7% annually, he also would have $47,212 after 10 years. But assuming he drops to a 28% tax rate at retirement, he would owe $13,219 in taxes at withdrawal, leaving him with $33,993 after tax.

But the $24,000 he puts into the traditional 401(k) also gets him a tax deduction, which at a 33% pre-retirement tax rate effectively frees up $7,920 he can invest in a separate taxable account. If that account also earns 7% a year, after 10 years the 55-year-old would end up with $2,361 more in the traditional 401(k) plus the taxable account than he would with the Roth.

But wait. He must also pay taxes on gains in the taxable side account. Assuming he pays tax each year at a 33% rate before retiring, that would effectively reduce his after-tax return in the taxable account from 7% to roughly 4.7%, giving him a total after-tax balance in the traditional 401(k) plus side account of $694 less than the Roth.

In short, it’s the drag of taxes on the money invested in the taxable side account that allows the Roth to come out ahead. Or, to put it another way, the Roth wins out in this scenario because it effectively shelters more of your money from taxes than a traditional 401(k) plus the separate taxable account.

Check Your Time Horizon

But anyone, young or old, hoping to capitalize on this advantage by choosing a Roth 401(k) or Roth IRA over a traditional account needs to be aware of two things.

First, as this example shows, the advantage the Roth gets from this tax-drag effect is relatively small. It can take many years for the Roth to build a meaningful edge in cases where someone slips into a lower marginal tax rate in retirement. In the example above, the Roth account is ahead by only 1.5% after 10 years. And if that 55-year-old were to drop from a 33% tax rate to a 25% rate in retirement, the Roth account would actually still be behind by about 1.5% after 10 years.

So for the 55-year-old to get that extra 9% of retirement income, the T. Rowe Price analysis assumes that the contribution made at age 55 not only stays invested until retirement at 65, but is withdrawn gradually over the course of 30 years (and earns a 6% annual return during that time). Which means at least some of the funds must remain invested in the Roth as long as 40 years.

The second caveat is that to take full advantage of the Roth’s tax-shelter benefits, you must contribute the maximum allowed or something close to it—specifically, enough so that you would be unable to match the aftertax Roth contribution by putting the pretax equivalent into a traditional account.

For example, had the 55-year-old in the scenario above been investing, say, $10,000 in the Roth instead of the maximum $24,000, he could have simply invested the entire pretax equivalent of his Roth contribution ($14,925 in the 33% tax bracket) in the traditional account instead of splitting his money between the traditional account and the separate taxable account. Doing so would eliminate the tax drag of the taxable account as well as the Roth’s 9% income advantage. Indeed the Roth account would provide 7% less after-tax income over 30 years than the traditional 401(k).

The upshot: Unless you’re willing to make the maximum contribution to a Roth IRA or 401(k) or an amount approaching that limit, dropping into a lower tax bracket in retirement could do away with much, if not all, of the expected advantage of going with a Roth. (The Roth might still come out ahead over a very long time since you can avoid required minimum distributions).

Diversify, Tax-wise

There are plenty of compelling reasons to choose a Roth IRA or Roth 401(k), even if you’re unsure what tax rate you’ll face in retirement. For example, I’ve long been an advocate of “tax diversification.” By having money in both Roth and traditional accounts you can diversify your tax exposure, so not every cent of your retirement savings is taxed at whatever tax rate some future Congress sets on ordinary income.

And since (under current law, at least) there are no required distributions from a Roth IRA starting after age 70 ½, money in a Roth IRA can compound tax-free the rest of your life, after which you can pass it on as a tax-free legacy to your heirs. Roth IRA distributions also won’t trigger taxes on your Social Security benefits, as can sometimes happen with withdrawals from a regular IRA or 401(k).

Bottom line: Before doing a Roth IRA or Roth 401(k), take the time run a few scenarios on a calculator like those in RDR’s Retirement Toolbox using different pre- and post-retirement tax rates. Such an exercise is even more important if you think you might face a lower marginal tax rate in retirement, and absolutely crucial if you’re nearing retirement age.

But above all, don’t assume that just because Roth withdrawals can be tax-free that Roths are automatically the better deal.

[Note: This version has been revised to make it clear that the scenario with the hypothetical 55-year-old compares a Roth 401(k) vs. a traditional 401(k), not a traditional IRA.]

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

More from RealDealRetirement.com

Can You Afford To Retire Early?

The 4 Biggest Retirement Blunders

How To Double The Size of Your Nest Egg in 10 Years

Read next: The Right Way to Tap Income in Retirement

Listen to the most important stories of the day.

MONEY retirement planning

Why Women Are Less Prepared Than Men for Retirement

Women outpace men when it comes to saving, but they need to be more aggressive in their investing.

Part of me hates investment advice specifically geared towards women. I’ve looked at enough studies on sex differences—and the studies of the studies on sex differences—to know that making generalizations about human behavior based on sex chromosomes is bad science and that much of what we attribute to hardwired differences is probably culturally determined by the reinforcement of stereotype.

So I’m going to stick to the numbers to try and figure out if, as is usually portrayed, women are actually less prepared for retirement—and why. One helpful metric is the data collected from IRA plan administrators across the country by the Employment Benefit Research Institute (EBRI.) The study found that although men and women contribute almost the same to their IRAs on average—$3,995 for women and $4,023 for men in 2012—men wind up with much larger nest eggs over time. The average IRA balance for men in 2012, the latest year for which data is available, was $136,718 for men and only $75,140 for women.

And when it comes to 401(k)s, women are even more diligent savers than men, despite earning lower incomes on average. Data from Vanguard’s 2014 How America Saves study, a report on the 401(k) plans it administers, shows that women are more likely to enroll when sign up is voluntary, and at all salary levels they tend to contribute a higher percentage of their income to their plans. But among women earning higher salaries, their account balances lag those of their male counterparts.

It seems women are often falling short when it comes to the way they invest. At a recent conference on women and wealth, Sue Thompson, a managing director at Black Rock, cited results from their 2013 Global Investor Pulse survey that showed that only 26% of female respondents felt comfortable investing in the stock market compared to 44% of male respondents. Women are less likely to take on risk to increase returns, Thompson suggested. Considering women’s increased longevity, this caution can leave them unprepared for retirement.

Women historically have tended to outlive men by several years, and life expectancies are increasing. A man reaching age 65 today can expect to live, on average, until age 84.3 while a woman can expect to live until 86.6, according to the Social Security Administration. Better-educated people typically live longer than the averages. For upper-middle-class couples age 65 today, there’s a 43% chance that one or both will survive to at least age 95, according to the Society of Actuaries. And that surviving spouse is usually the woman.

To build the portfolio necessary to last through two or three decades of retirement, women should be putting more into stocks, not less, since equities offer the best shot at delivering inflation-beating growth. The goal is to learn to balance the risks and rewards of equities—and that’s something female professional money managers seem to excel at. Some surveys have shown that hedge fund managers who are women outperform their male counterparts because they don’t take on excessive risk. They also tend to trade less often; frequent trading has been shown to drag down performance, in part because of higher costs.

Given that the biggest risk facing women retirees is outliving their savings, they need to grow their investments as much as possible in the first few decades of savings. If it makes women uncomfortable to allocate the vast majority, if not all, of their portfolio to equities in those critical early years, they should remind themselves that even more so than men they have the benefit of a longer time horizon in which to ride out market ups and downs. And we should take inspiration from the female professional money managers in how to take calculated risks in order to reap the full benefits of higher returns.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

Read next: How to Boost Returns When Interest Rates Totally Stink

MONEY retirement planning

Why Obama’s Proposals Just Might Help Middle Class Retirement Security

150122_RET_ObamaHelpRet
U.S. President Barack Obama delivering the State of the Union address to a joint session of Congress at the Capitol in Washington, D.C., U.S., on Tuesday, Jan. 20, 2015. Andrew Harrer—Bloomberg via Getty Images

Congress probably won't pass an auto IRA, and Social Security is being ignored. But the retirement crisis is finally getting attention.

Remember Mitt Romney’s huge IRA? During the 2012 campaign, we learned that the governor managed to amass $20 million to $100 million in an individual retirement account, much more than anyone could accumulate under the contribution limit rules without some unusual investments and appreciation.

Romney’s IRA found its way, indirectly, into a broader set of retirement policy reforms unveiled in President Obama’s State of the Union proposals on Tuesday.

The president proposed scaling back the tax deductibility of mega-IRAs to help pay for other changes designed to bolster middle class retirement security. I found plenty to like in the proposals, with one big exception: the failure to endorse a bold plan to expand Social Security.

Yes, that is just another idea with no chance in this Congress, but Democrats should give it a strong embrace, especially in the wake of the House’s adoption of rules this month that could set the stage for cuts in disability benefits.

The administration signaled its general opposition to the House plan, but has not spelled out its own.

Instead, Obama listed proposals, starting with “auto-IRAs,” whereby employers with more than 10 employees who have no retirement plans of their own would be required to automatically enroll their workers in an IRA. Workers could opt out, but automatic features in 401(k) plans already have shown this kind of behavioral nudge will be a winner. The president also proposed tax credits to offset the start-up costs for businesses.

The auto-IRA would be a more full version of the “myRA” accounts already launched by the administration. Both are structured like Roth IRAs, accepting post-tax contributions that accumulate toward tax-free withdrawals in retirement. Both accounts take aim at a critical problem—the lack of retirement savings among low-income households.

The president wants to offset the costs of auto-IRAs by capping contributions to 401(k)s and IRAs. The cap would be determined using a formula tied to current interest rates; currently, it would kick in when balances hit $3.4 million. If rates rose, the cap would be somewhat lower—for example, $2.7 million if rates rose to historical norms.

The argument here is that IRAs were never meant for such large accumulations; the Government Accountability Office (GAO) looked into mega-IRAs after the 2012 election, and reported back to Congress that a small number of account holders had indeed amassed very large balances, “likely by investing in assets unavailable to most investors—initially valued very low and offering disproportionately high potential investment returns if successful.”

The report estimated that 37,000 Americans have IRAs with balances ranging from $3 million to $5 million; fewer than 10,000 had balances over $5 million.

Finally, the White House proposed opening employer retirement plans to more part-time workers. Currently, plan sponsors can exclude employees working fewer than 1,000 hours per year, no matter how long they have been with the company. The proposal would require sponsors to open their plans to workers who have been with them for at least 500 hours per year for three years.

These ideas might seem dead on arrival in the Republican-controlled Congress. But the White House proposals add momentum to a growing populist movement around the country to focus on middle class retirement security.

As noted here last week, Illinois just became the first state to implement an innovative automatic retirement savings plan similar to the auto-IRA, and more than half the states are considering similar ideas.

These savings programs are sensible ideas, but their impact will not be huge. That is because the households they target lack the resources to sock away enough money to generate accumulations that can make a real difference at retirement.

Expanding Social Security offers a more sure, and efficient, path to bolstering retirement security of lower-income households. If Obama wants to go down in the history books as a strong supporter of the middle class, he has got to start making the case for Social Security expansion—and time is getting short.

Read next: Why Illinois May Become a National Model for Retirement Saving

TIME Innovation

Five Best Ideas of the Day: January 13

The Aspen Institute is an educational and policy studies organization based in Washington, D.C.

1. The U.S. could improve its counterinsurgency strategy by gathering better public opinion data from people in conflict zones.

By Andrew Shaver and Yang-Yang Zhou in the Washington Post

2. The drought-stricken western U.S. can learn from Israel’s water management software which pores over tons of data to detect or prevent leaks.

By Amanda Little in Bloomberg Businessweek

3. Beyond “Teach for Mexico:” To upgrade Latin America’s outdated public education systems, leaders must fight institutional inequality.

By Whitney Eulich and Ruxandra Guidi in the Christian Science Monitor

4. Investment recommendations for retirees are often based on savings levels achieved by only a small fraction of families. Here’s better advice.

By Luke Delorme in the Daily Economy

5. Lessons from the Swiss: We should start making people pay for the trash they throw away.

By Sabine Oishi in the Baltimore Sun

The Aspen Institute is an educational and policy studies organization based in Washington, D.C.

TIME Ideas hosts the world's leading voices, providing commentary and expertise on the most compelling events in news, society, and culture. We welcome outside contributions. To submit a piece, email ideas@time.com.

MONEY IRAs

The Extreme IRA Mistake You May Be Making

A new study reveals that many savers have crazy retirement portfolios. This four-step plan will keep you from going to extremes with your IRA.

When did you last pay attention to how your IRA is invested? It’s time to take a close look. Nearly two out of three IRA owners have extreme stock and bond allocations, a new study by the Employee Benefit Research Institute (EBRI) found. In 2010 and 2012, 33% of IRA savers had no money in stocks, while 23% were 100% in equities.

Many young savers and pre-retirees have portfolios that are either too cautious or too risky: 41% of 25- to 44-year-olds have 0% of their IRAs in stocks, while 21% of 55- to 65-year-olds are 100% in stocks.

An all-bond or all-stock IRA may be just what you want, of course. Perhaps you can’t tolerate the ups and downs of the stock market or you think you can handle 100% equities (more on that later). Or maybe your IRA is part of a larger portfolio.

But chances are, you ended up with an out-of-whack allocation because you left your IRA alone. “It seems likely many investors aren’t investing the right way for their goals, whether out of inertia or procrastination,” says EBRI senior research associate Craig Copeland. An earlier study by the Investment Company Institute found that less than 11% of traditional IRA investors moved money in their accounts in any of the five years ending in 2012.

To keep a closer tab on how your retirement funds are invested, take these four steps.

See where you stand. Looking at everything you have stashed in your IRA, 401(k), and taxable accounts (don’t forget your spouse’s plans), tally up your holdings by asset class—large-company stocks, short-term bonds, and the like. You’ll probably find that the bull market of the past five years has shifted your allocation dramatically. If you held 60% stocks and 40% bonds in 2009 and let your money ride, your current mix may be closer to 75% stocks and 25% bonds.

Get a grip on your risks. An extreme allocation—or a more extreme one than you planned—can put your retirement at risk. Hunkering down in fixed income means missing out on years of growth. Putting 100% in stocks could backfire if equities plunge just as you retire—what happened to many older 401(k) investors during the 2008–09 market crash.

Reset your target. If you also have a 401(k), your plan likely has an asset-allocation tool that can help you settle on a new mix, and you may find that you need to make big changes. That’s especially true for pre-retirees, who should be gradually reducing stocks, says George Papadopoulos, a financial planner in Novi, Mich.  A typical allocation for that age group is 60% stocks and 40% bonds. As you actually move into retirement, it could be 50/50.

Make the shift now. If moving a large amount of money in or out of stocks or bonds leaves you nervous, you may be tempted to do it gradually. But especially in tax-sheltered accounts, it’s best to fix your mistake quickly. (In taxable accounts you may want to add new money instead to avoid incurring taxable gains.) “If you’re someone who’s a procrastinator, you may never get around to rebalancing,” says Boca Raton, Fla., financial planner Mari Adam. And you don’t want a market downturn to do your rebalancing for you.

Get more IRA answers in the Ultimate Retirement Guide:
What’s the Difference Between a Traditional and a Roth IRA?
How Should I Invest My IRA Money?
How Will My IRA Withdrawals Be Taxed in Retirement?

MONEY Savings

Why Illinois May Become a National Model for Retirement Saving

150107_RET_StateRetirement
Chris Mellor—Getty Images/Lonely Planet Image

Illinois will automatically enroll workers who lack an employer retirement plan into a state-run savings program

In what may emerge as a standard for all states, Illinois is introducing a tax-advantaged retirement savings plan for most residents who do not have such a plan at work. The program echoes one that President Obama has endorsed at the federal level, and it boosts momentum that has been building for several years at the state level.

Beginning in 2017, Illinois businesses with 25 or more employees that do not offer a retirement savings plan, such as a 401(k) or pension, must automatically enroll workers in the state’s Secure Choice Savings Program, which will enable them to invest in a Roth IRA. Workers can opt out. But reams of research suggest that inertia will keep most employees in the plan.

Once enrolled, workers can choose their pre-tax contribution rate and select from a small menu of investment options. Those who do nothing will have 3% of their paycheck automatically deducted and placed in a low-fee target-date investment fund managed by the Illinois Treasurer.

The plan may sound novel, but at least 17 states, including bellwethers like California, Connecticut, Massachusetts and Wisconsin, have been considering their own savings plans for private-sector employees. Many are taking steps to establish one. In Connecticut, lawmakers recently set aside $400,000 to set up an oversight board and begin feasibility studies. Wisconsin and others are moving the same direction. Oregon may approve a plan this year.

But Illinois appears to be the first set to go live with a plan, and for that reason the program will be closely watched. If more workers open and use the savings accounts, more states are almost certain to push ahead. The estimate in Illinois is that two million additional workers will end up with savings accounts.

The Illinois plan may serve as a model because there is little cost to the state—that’s crucial at a time when many states face budget problems. (The budget shortfalls in Illinois, in particular, led to a pension crisis.) All contributions come from workers, and employers must administer the modest payroll deduction. Savers will be charged 0.75% of their balance each year to pay the costs of managing the funds and administering the program.

About half of private-sector employees in the U.S. have no access to retirement savings plans at work, which is one key reason for the nation’s retirement savings crisis. Those least likely to have access are workers at small businesses. The Illinois program addresses this issue by mandating participation from all but the very smallest companies.

These state savings initiatives have been spurred by the lack of progress in Washington to improve retirement security. President Obama promoted a federally administered IRA for workers without an employer plan in his State of the Union address last year, but bipartisan bills to establish an automatic IRA have long been stalled in Congress. Still, the U.S. Treasury unveiled a program called myRA for such workers to invest in guaranteed fixed-income securities on a tax-advantaged basis. Clearly, there is broad support for these kinds of programs. Now Illinois just has to show they work.

Read next: 5 Simple Questions that Pave the Way to Financial Security

MONEY Estate Planning

The Perils of Leaving an IRA to Your Kid

141224_FF_INHERITIRA
Cindy Prins—Getty Images/Flickr RM

People with the best of intentions can make life difficult for their heirs.

Naming a child as the beneficiary to important assets like your IRA may seem like a no-brainer. Unfortunately, doing that can create several problems.

I once worked with a client who left his IRA to his daughter. When he put her on his beneficiary form, he was fairly young and healthy, so he had little concern about his decision.

When he passed away, however, his daughter was only five years old — a minor unable to inherit the account. The father had the intention of leaving his daughter roughly $40,000 to help fund an important expense or investment. Instead, a judge had to step in and appoint a custodian to manage the asset until the child reached legal age. Even though the child will eventually receive these funds, without any specific guidelines set, the young daughter could potentially make a poor investment decision much different from what her father had envisioned.

I see this problem often with single parents who, because they don’t have a spouse who might receive their assets, make their children their direct heirs. While these clients have the best intentions, I have come to realize that they often don’t understand the consequences of their actions: The courts may delay, interfere or misinterpret their true intentions if a beneficiary is a minor.

The first option I offer to those looking to leave assets to a minor is through a Uniform Transfers to Minors Act account. An UTMA account gives the owner — often the parent, though it could be a grandparent or someone else — control over selecting the custodian should the owner pass away before the child reaches the age of majority. Had my client done this, he could have avoided the involvement of the court-appointed custodian. This option, though, may not always be the best solution, since it fails to give the parent control of how the funds will be distributed.

The second option I offer to parents is to name a trust as a beneficiary. This option provides the most control of how the funds are managed and distributed – an option many parents find appealing because it could prevent the child from making a poor investment, incurring a major tax liability, or quickly running through the money.

A trust can also allow or even require distributions to be stretched over the beneficiary’s lifetime, maximizing the tax-deferred or tax-free growth for the greatest duration and overall lifetime payout for the heirs.

Using separate trusts for each child can allow each heir to use his or her own age for calculating required minimum distributions. That can make a significant difference if there is a large age variance between them. For example, let’s say a grandmother passes away and leaves her IRA to two children, ages 53 and 48, and two grandchildren, ages 12 and 2. If she has created a trust for each heir, then they can each use their own age from the IRS’s life expectancy table to calculate their required minimum distributions. If she has failed to do this, they will all be forced to calculate RMDs based on the oldest heir, age 53 – greatly shortening the stretch period of the tax benefits for the young children.

For parents with more than one child who do not want to incur the legal costs of setting up a trust but want to maximize the stretch benefits of their retirement accounts have another option: splitting the IRA into multiple IRA accounts, creating one to be left to each heir. This will not provide the control over the custodian or distribution, but will allow each heir to use his or her own age in calculating the RMDs of an inherited account.

As advisers, it’s our job not only to help our clients prepare for retirement, but also to make sure their money is taken care of after they die. By helping them properly plan for their beneficiaries, advisers can do just that.

———-

Herb White, CFP, is the founder and president of Life Certain Wealth Strategies, an independent financial and retirement planning firm in Greenwood Village, Colo., dedicated to helping individuals achieve their financial goals for retirement. A certified financial planner with more than 15 years of experience in the financial services industry, White is also life and health insurance licensed. He is a member of the Financial Planning Association and the National Association of Insurance and Financial Advisors.

MONEY IRAs

The Best Way to Tap Your IRA In Retirement

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

Q: I am 72 years old and subject to mandatory IRA withdrawals. I don’t need all the money for my expenses. What should I do with the leftover money? Jay Kahn, Vienna, VA.

A: You’re in a fortunate position. While there is a real retirement savings crisis for many Americans, there are also people with individual retirement accounts (IRAs) like you who don’t need to tap their nest egg—at least not yet.

Nearly four out of every 10 U.S. households own an IRA, holding more than $5.7 trillion in these accounts, according to a study by the Investment Company Institute. At Vanguard, 20% of investors with an IRA who take a distribution after age 70 ½ put it into another taxable investment account with the company.

The government forces you to start withdrawing your IRA money when you turn 70½ because the IRS wants to collect the income taxes you’ve deferred on the contributions. You must take your first required minimum distribution (RMD) by April of the year after you turn 70½ and by December 31 for subsequent withdrawals.

But there’s no requirement to spend it, and many people like you want to continue to keep growing your money for the future. In that case you have several options, says Tom Mingone, founder and managing partner of Capital Management Group of New York.

First, look at your overall asset allocation and risk tolerance. Add the money to investments where you are underweight, Mingone advises. “You’ll get the most bang for your buck doing that with mutual funds or an exchange traded fund.“

For wealthier investors who are charitably inclined, Mingone recommends doing a direct rollover to a charity. The tax provision would allow you to avoid paying taxes on your RMD by moving it directly from your IRA to a charity. The tax provision expired last year but Congress has extended the rule through 2014 and President Obama is expected to sign it.

You can also gift the money. Putting it into a 529 plan for your grandchildren’s education allows it to grow tax free for many years. Another option is to establish an irrevocable life insurance trust and use the money to pay the premiums. With such a trust, the insurance proceeds won’t be considered part of your estate so your heirs don’t pay taxes on it. “It’s a tax-free, efficient way to leave more to your family,” Mingone says.

Stay away from immediate annuities though. “It’s not that I don’t believe in them, but when you’re already into your 70s, the risk you’ll outlive your capital is diminished,” says Mingone. You’ll be locking in a chunk of money at today’s low interest rates and there’s a shorter period of time to collect. “It’s not a good tradeoff for guaranteed income,” says Mingone.

Beyond investing the extra cash, consider just spending it. Some retirees are reluctant to spend the money they’ve saved for retirement out of fear of running out later on. With retirements that can last 30 years or more, it’s a legitimate worry. “Believe it or not, some people have a hard time spending it down,” says Mingone. But failure to enjoy your hard-earned savings, especially while you are still young enough and in good health to use it, can be a sad outcome too.

If you’ve met all your other financial goals, have some fun. “There’s something to be said for knocking things off the bucket list and enjoying spending your money,” says Mingone.

Update: This story was changed to reflect the Senate passing a bill to extend the IRS rule allowing the direct rollover of an IRA’s required minimum distribution to a charity through 2014.

Do you have a personal finance question for our experts? Write to AskTheExpert@moneymail.com

Read next: How Your Earnings Record Affects Your Social Security

MONEY IRAs

Closing the Loophole Behind $10 Million Tax-Free Retirement Accounts

Fewer than 1,100 of 43 million IRA owners have what may be called outsized balances, and the IRS wants to rein them in.

The former presidential hopeful Mitt Romney lit a fuse three years ago when he disclosed his IRA was valued at as much as $102 million. Now the federal government wants to keep the issue from exploding, and is weighing actions that would prevent rich people from accumulating so much in a tax-advantaged account.

Last week, the General Accounting Office recommended that the IRS either restrict the types of investments held in IRAs or set a ceiling for IRA account balances. The idea is to give all taxpayers equal ability to save while making certain the amounts put away tax-advantaged do not go beyond what is generally regarded as sufficient savings to secure a comfortable retirement.

Romney’s campaign disclosure caught almost everyone by surprise. How could one person build such a large IRA balance when yearly allowable contributions — up to $5,500 a year in 2014 and $6,500 if you’re age 50 or older — have always been comparatively low? The answer lies in the types of investments he and privileged others were able to put in their IRA: extremely low-priced and often non-public securities that later soared in value.

One such security might be the shares of a privately owned business. These can reasonably be expected to take flight if the business does well and later goes public. That produces a wealth of tax-advantaged savings to company founders, investment bankers and venture capitalists. But these gains are not generally available to any other investor. Once an asset is inside an IRA there is no limit to how valuable it may become and still remain in the tax-advantaged account.

Restricting eligible IRA holdings to publicly available securities is one way to level the field and rein in the accumulation of tax-advantaged wealth. Another way is to cap IRA balances at, say, $5 million and require IRA holders to take an immediate taxable distribution anytime their combined IRA holdings exceed that threshold.

The GAO found that the federal government stands to forego $17 billion of 2014 tax revenue through the IRA contributions of individuals. That’s not a high price to pay for added retirement security for the masses. The problem is that under current rules only a select few will ever be able to put together multi-million-dollar IRAs. There are 43 million IRA owners in the U.S. with total assets of $5.2 trillion. Fewer than 10,000 have more than $5 million, and the GAO seems to have little quarrel with even this group. They tend to be above-average earners past age 65 who had been contributing to their IRA for many years—pretty much exactly as designed.

But just over 1,100 have account values greater than $10 million and only 300 have account values greater than $25 million, the GAO found. “The accumulation of these large IRA balances by a small number of investors stands in contrast to Congress’s aim to prevent the tax-favored accumulation of balances exceeding what is needed for retirement,” the report states.

Officials are now gathering data on the types of assets held in IRAs, including the so-called “carried interest” stake that private equity managers have in the investment funds they run. These stakes, which give them a percentage of a fund’s gain, are another way that a select few manage to sock away multiple millions of dollars in IRAs. No one doubts the data will illustrate that only a privileged few have access to outsized IRA savings. The Romney campaign showed us that three years ago.

Read next: 3 Ways to Have a Happier, Healthier Retirement

MONEY retirement income

Retirees Risk Blowing IRA Deadline and Paying Huge Penalties

Egg timer
Esben Emborg—Getty Images

With just seven weeks left in the year, most IRA owners required to pull money out have not yet done so.

Two-thirds of IRA owners required to take money out of their account by Dec. 31 have yet to fulfill the obligation, new research by Fidelity shows. Now, with the year-end in sight, and thoughts pivoting to holiday shopping and get-togethers, legions of senior savers risk getting distracted–and socked with a punishing tax penalty.

IRA owners often wait until late in the year to pull out their required minimum distributions. Especially at a time when interest rates are low and the stock market has been rising, leaving your money in an IRA as long as possible makes sense. Some retirees may also be reluctant to take distributions for fear of spending the money and running short over time.

But blowing the annual deadline can be costly. The IRS sets a schedule of required minimum distributions, or RMDs, to keep savers from deferring taxes indefinitely. After reaching age 70 1/2, IRA owners must begin to take money out of their account each year and pay income tax on the amount. Failure to pull money out triggers a hefty penalty equal to 50% of the amount you were supposed to take out of the account.

Among 750,000 IRA accounts where distributions are required, 68% have yet to take the full amount and 56% have yet to take anything at all, Fidelity found. These IRA owners should begin the process now to avoid end-of-year distractions and potential mistakes like using the wrong form or providing the wrong mailing address, which can take weeks to find and correct.

A report by the Treasury Inspector General estimated that as many as 250,000 IRA owners each year miss the deadline, failing to take required minimum distributions totaling about $350 million. That generates potential tax penalties totaling $175 million. The vast majority of those who fail to take their minimum distributions are thought to do so as part of an honest mistake, and previously the IRS hasn’t always been eager to sock seniors with a penalty. But the IRS began a crackdown on missed distributions a few years ago. Don’t look for leniency if you miss the deadline without a good reason, like protracted illness or a natural disaster.

Early each year, your financial institution should notify you of any required distributions you must take by year-end. If this is the first year you are taking a required distribution, you have until April 1 to do so, but then only until Dec. 31 every subsequent year. Once notified, you still need to initiate a distribution. A lot of people simply do not read their mail and fail to initiate action in time.

Among other reasons IRA owners miss the deadline:

  • Switching their account Institutions that open an account during the year are not required to notify new account holders of required minimum distributions until the following year.
  • Death Often there is confusion about inherited IRAs. The beneficiary must complete the deceased IRA owner’s distributions in the year of death. Non-spousal beneficiaries of any age must begin taking distributions in the year following the year that the IRA owner died—and no notice of this is required.

With the penalties so stiff and the IRS cracking down on missed mandatory distributions, this is a subject that seniors and their adult children should talk about. In general, financial talk between the generations makes seniors feel less anxious and more prepared anyway. Required distributions can be especially confusing, and the penalties may have the effect of taking away money that heirs stand to receive. So it’s in everyone’s interest to get it right. Consider putting mandatory distributions on autopilot with a firm that will make the calculation and send you the money on a schedule you choose.

Related:

How will my IRAs be taxed in retirement?

Are there any exceptions to the traditional IRA withdrawal rules?

When can I take money out of my IRA without penalty?

Your browser, Internet Explorer 8 or below, is out of date. It has known security flaws and may not display all features of this and other websites.

Learn how to update your browser