MONEY year-end moves

3 Smart Year-End Moves for Retirement Savers of All Ages

golden eggs of ascending size
Getty Images

To give your long-term financial security a boost, take one of these steps before December 31.

It’s year-end, and retirement savers of all ages need to check their to-do lists. Here are some suggestions for current retirees, near-retirees, and younger savers just getting started.

Already Retired: Take Your Distribution

Unfortunately, the “deferred” part of tax-deferred retirement accounts doesn’t last forever. Required minimum distributions (RMDs) must be taken from individual retirement accounts (IRAs) starting in the year you turn 70 1/2 and from 401(k)s at the same age, unless you’re still working for the employer that sponsors the plan.

Fidelity Investments reports that nearly 68% of the company’s IRA account holders who needed to take RMDs for tax year 2014 hadn’t done it as of late October.

It’s important to get this right: Failure to take the correct distribution results in an onerous 50% tax—plus interest—on any required withdrawals you fail to take.

RMDs must be calculated for each account you own by dividing the prior Dec. 31 balance with a life expectancy factor (found in IRS Publication 590). Your account provider may calculate RMDs for you, but the final responsibility is yours. FINRA, the financial services self-regulatory agency, offers a calculator, and the IRS has worksheets to help calculate RMDs.

Take care of RMDs ahead of the year-end rush, advises Joshua Kadish, partner in planning firm RPG Life Transition Specialists in Riverwoods, Ill. “We try to do it by Dec. 1 for all of our clients—if you push it beyond that, the financial institutions are all overwhelmed with year-end paperwork and they’re getting backed up.”

Near-Retired: Consider a Roth

Vanguard reports that 20% of its investors who take an RMD reinvest the funds in a taxable account—in other words, they didn’t need the money. If you fall into this category, consider converting some of your tax-deferred assets to a Roth IRA. No RMDs are required on Roth accounts, which can be beneficial in managing your tax liability in retirement.

You’ll owe income tax on converted funds in the year of conversion. That runs against conventional planning wisdom, which calls for deferring taxes as long as possible. But it’s a strategy that can make sense in certain situations, says Maria Bruno, senior investment analyst in Vanguard’s Investment Counseling & Research group.

“Many retirees find that their income may be lower in the early years of retirement—either because they haven’t filed yet for Social Security, or perhaps one spouse has retired and the other is still working. Doing a conversion that goes to the top of your current tax bracket is something worth considering.”

Bruno suggests a series of partial conversions over time that don’t bump you into a higher marginal bracket. Also, if you’re not retired, check to see if your workplace 401(k) plan offers a Roth option, and consider moving part of your annual contribution there.

Young Savers: Start Early, Bump It Up Annually

“Time is on my side,” sang the Rolling Stones, and it’s true for young savers. Getting an early start is the single best thing you can do for yourself, even if you can’t contribute much right now.

Let the magic of compound returns help you over the years. A study done by Vanguard a couple years ago found that an investor who starts at age 25 with a moderate investment allocation and contributes 6% of salary will finish with 34% more in her account than the same investor who starts at 35—and 64% more than an investor who starts at 45.

Try to increase the amount every year. A recent Charles Schwab survey found that 43% of plan participants haven’t increased their 401(k) contributions in the past two years. Kadish suggests a year-end tally of what you spent during the year and how much you saved. “It’s not what people like to do—but you have a full year under your belt, so it’s a good opportunity to look at where your money went. Could you get more efficient in some area, and save more?”

If you’re a mega-saver already, note that the limit on employee contributions for 401(k) accounts rises to $18,000 next year from $17,500; the catch-up contribution for people age 50 and over rises to $6,000 from $5,500. The IRA limit is unchanged at $5,500, and catch-up contributions stay at $1,000.

MONEY Ask the Expert

Here’s a Smart Way To Boost Your Tax-Free Retirement Savings

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Robert A. Di Ieso, Jr.

Q: I am maxing out my 401(k). I understand there’s a new way to make after-tax contributions to a Roth IRA. How does that work?

A: You can thank the IRS for what is essentially a huge tax break for higher-income retirement savers, especially folks like yourself who are already maxing out contributions to tax-sheltered retirement plans.

A recent ruling by the IRS allows eligible workers to easily move after-tax contributions from their 401(k) or 403(b) plan to Roth IRAs when they exit their company plan. “With this new ruling, retirement savers are getting a huge increase in their ability contribute to a Roth IRA,” says Brian Holmes, president and CEO of investment advisory firm Signature Estate and Investment Advisors.

The Roth is a valuable income stream in retirement because contributions are after-tax, which means you don’t owe Uncle Sam anything on the money you withdraw. Unlike traditional IRAs which require you to start withdrawing money once you turn 70 ½, Roths have no mandatory distribution requirements, so your investments can continue to grow tax-free. And if you need to take a chunk out for a sudden big expense, such as medical bills, the withdrawal won’t bump you up into a higher tax bracket.

For high-income earners, the IRS ruling is especially good news. Singles with an adjusted gross income of $129,000 or more can’t directly contribute to a Roth IRA; for married couples, the income cap is $191,000. If you are are eligible to contribute to a Roth IRA, you can’t contribute more than $5,500 this year or next ($6,500 for people over 50). The IRS does allow people to convert traditional IRAs to Roth IRAs but you must pay income tax on your gains.

Now, with this new IRS ruling, you can put a lot more into a Roth by diverting your 401(k) assets into one. The annual limit on pre-tax contributions to 401(k) plans is $17,500 and $23,000 for people over 50; those limits rise to $18,000 and $24,000 next year. Including your pre-tax and post-tax contributions, as well as pre-tax employer matches, the total amount a worker can save in 401(k) and 403(b) plans is $52,000 and $57,500 for those 50 and older. (That amount will rise to $53,000 and $59,000 respectively in 2015.) When you leave your employer, you can separate the after-tax money and send it directly to a Roth, which can boost your tax-free savings by tens of thousands of dollars.

To take advantage of the new rule, your employer plan must allow after-tax contributions to your 401(k). About 53% of 401(k) plans allow both pre-tax and after- tax contributions, according to Rick Meigs, president of the 401(k) Help Center. You must also first max out your pre-tax contributions. The transfer to a Roth must be done at the same time you roll your existing 401(k)’s pre-tax savings into a traditional IRA.

The ability to put away more in a Roth is also good for people who want to leave money to heirs. Inherited Roth IRAs are free of tax, and because they don’t have taxable minimum required distributions, they can give your heirs decades of tax-free growth. “It’s absolutely the best asset to die with if you want to leave money behind,” says Holmes.

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

Read next: 4 Disastrous Retirement Mistakes and How to Avoid Them

MONEY retirement income

Retirement Withdrawal Strategies That Can Pay Off Big

To figure out the right pace for your retirement withdrawals—and to avoid ending up in higher tax brackets—start planning before you stop working.

Having your own tax-deferred retirement account is a bit like having one of those self-titrating morphine buttons that hospitals use: Press it whenever you need quick relief.

But once you’re retired and able to tap your 401(k) or individual retirement account (IRA), it’s not easy to titrate your own doses of cash. Withdraw too much, and you use up your nest egg too quickly; too little, and you might unnecessarily crimp your retirement lifestyle.

Overlaying the how-much-is-enough question are several finer points of tax planning. Because you can decide how much money to pull out of a 401(k) or individual retirement account, and because those withdrawals are added to your taxable income, there are strategies that can help or hurt your bottom line.

That’s especially true for early retirees trying to decide when to start Social Security, how to pay for health care and more. Here are some money-saving withdrawal tips.

CURB TAXABLE INCOME

If you are buying your own health insurance via the Obamacare exchanges, keep your taxable income low to qualify for big subsidies, advises Neil Krishnaswamy, financial planner with Exencial Wealth Advisors in Plano, Texas.

“It’s a pretty substantial savings on premiums,” said Krishnaswamy.

Here’s an example using national averages from the calculator on the Kaiser Family Foundation web page. Two 62-year-old spouses with annual taxable income of $62,000 would receive a subsidy of $8,677 a year, against a national average premium of $14,567. If they took another $1,000 out of their tax-deferred account and raised their taxable income to $63,000, they would be disqualified from receiving a subsidy.

Not every case may be that dramatic, but it’s worth checking the income limits and available subsidies in your own state.

DELAY BENEFITS

If you retired early, consider taking out extra money to live on and delaying Social Security benefits until you are older. Withdrawing money from retirement savings hurts. You not only lose the savings, you lose future earnings on those savings. And in most cases, you have to pay income taxes on withdrawals from those tax-deferred accounts.

But Social Security benefits go up roughly 8% a year for every year you don’t claim them. And even after you claim them, they rise with the cost of living and are guaranteed for life. When you draw down your own savings to protect a bigger Social Security payment, tell yourself you are buying the cheapest and best annuity you can get.

PLAN IN ADVANCE

Plan ahead for mandatory withdrawals. In the year you turn 70 1/2, you have to begin drawing down your tax-deferred IRAs and 401(k) accounts and paying income taxes on those withdrawals. Unless you expect to be in the lowest tax bracket at the time, it makes sense to start withdrawing at least enough every year before then to “use up” the lower tax brackets.

For single people in 2014, you’re in a 10% or 15% marginal tax bracket until you make more than $36,000 a year. For married people filing jointly, that 15% bracket goes up to $73,800. It’s a lot better to pull out that money in your 60s and use up other savings to live on, than it is to save it all until you are 70 and then withdraw large chunks at higher interest rates.

GET A GOOD ACCOUNTANT

You may want to use early years of retirement to take the tax hit required to move money from a traditional IRA into a Roth IRA that will free you of future taxes on that money and its earnings.

You may pull a lot of money out of your account in one year and spend it over two or three years, to keep yourself qualified for subsidies in most years.

You may titrate your withdrawals to keep your Medicare premiums (also income linked) as low as possible.

The best way to optimize it all? Get an adviser or accountant who is comfortable with a spreadsheet and can pull all of these different considerations together.

Related:

When do I have to take money out of my 401(k)?

How will my IRA withdrawals be taxed in retirement?

Are my Social Security payouts taxed?

MONEY retirement planning

22% of Workers Would Rather Die Early Than Run Out of Money

transparent piggy bank with one silver coin inside
Dimitri Vervitsiotis—Getty Images

Yet many of the same folks are hardly saving anything for retirement, study finds.

A large slice of middle-class Americans have all but given up on the retirement they may once have aspired to, new research shows—and their despair is both heartbreaking and frustrating. Most say saving for retirement is more difficult than they had expected and yet few are making the necessary adjustments.

Some 22% of workers say they would rather die early than run out of money, according to the Wells Fargo Middle Class Retirement survey. Yet 61% say they are not sacrificing a lot to save for their later years. Nearly three quarters acknowledge they should have started saving sooner.

The survey, released during National Retirement Savings Week, looks at the retirement planning of Americans with household incomes between $25,000 and $100,000, who held investable assets of less than $100,000. One third are contributing nothing—zero—to a 401(k) plan or an IRA, and half say they have no confidence that they will have enough to retire. Middle-class Americans have a median retirement balance of just $20,000 and say they expect to need $250,000 in retirement.

Still, Americans who have an employer-sponsored retirement plan, especially a 401(k), are doing much better than those without one. Those between the ages of 25 to 29 with access to a 401(k) have put away a median of $10,000, compared with no savings at all for those without access to a plan. Those ages 30 to 39 with a 401(k) plan have saved a median of $35,000, versus less than $1,000 for those without. And for those ages 40 to 49 with 401(k)s, the median is $50,000, while those with no plan have just $10,000.

Clearly, despite its many drawbacks, the venerable 401(k) remains our de facto national savings plan, and the best shot that the middle-class has at achieving retirement security. But only half of private-sector workers have access to a 401(k) or other employer-sponsored retirement plan, according to the Employee Benefit Research Institute. Those without access would benefit from a direct-deposit Roth or traditional IRA or some other tax-favored account, but data show that most Americans fail to make new contributions to IRAs, with most of those assets coming from 401(k) rollovers. One exception: a growing number of Millennials are making Roth IRA contributions.

Most people do understand the need to save for retirement, but they don’t view it as an urgent goal requiring spending cutbacks, the survey found. Still, many clearly have room in their budget to boost their savings rates. Asked where they would cut spending if they decided to get serious about saving, 56% said they would give up indulgences like the spa and jewelry; 55% said they’d cut restaurant meals; and 51% even said they would give up a major purchase like a car or a home renovation. But only 38% said they would forgo a vacation. We all need a little R&R, for sure. But a few weeks of fun now in exchange for years of retirement security is a good trade.

Of course, the larger problem is that a sizeable percentage of middle-class Americans are struggling financially and simply don’t enough money to stash away for long-term goals like retirement. As economic data show, many workers haven’t had a real salary increase for 15 years, while the cost of essentials, such as health care and college tuition, continues to soar.

Given these economic headwinds, it’s important to do as much as you can, when you can, to build your retirement nest egg. If you have a 401(k), be sure to contribute at least enough to get the full company match. And if you lack a company retirement plan, opt for an IRA—the maximum contribution is $5,500 a year ($6,500 if you are 50 or older). Yes, freeing up money to put away for retirement is tough, but it will be a bit easier if you can get tax break on your savings.

Related:

How much of my income should I save for retirement?

Why is a 401(k) such a good deal?

Which is better, a traditional or Roth IRA?

MONEY Ask the Expert

How to Help Your Kid Get Started Investing

Investing illustration
Robert A. Di Ieso, Jr.

Q: I want to invest $5,000 for my 35-year-old daughter, as I want to get her on the path to financial security. Should the money be placed into a guaranteed interest rate annuity? Or should the money go into a Roth IRA?

A: To make the most of this financial gift, don’t just focus on the best place to invest that $5,000. Rather, look at how this money can help your daughter develop saving and investing habits above and beyond your contribution.

Your first step should be to have a conversation with your daughter to express your intent and determine where this money will have the biggest impact. Planning for retirement should be a top priority. “But you don’t want to put the cart before the horse,” says Scott Whytock, a certified financial planner with August Wealth Management in Portland, Maine.

Before you jump ahead to thinking about long-term savings vehicles for your daughter, first make sure she has her bases covered right now. Does she have an emergency fund, for example? Ideally, she should have up to six months of typical monthly expenses set aside. Without one, says Whytock, she may be forced to pull money out of retirement — a costly choice on many counts — or accrue high-interest debt.

Assuming she has an adequate rainy day fund, the next place to look is an employer-sponsored retirement plan, such as a 401(k) or 403(b). If the plan offers matching benefits, make sure your daughter is taking full advantage of that free money. If her income and expenses are such that she isn’t able to do so, your gift may give her the wiggle room she needs to bump up her contributions.

Does she have student loans or a car loan? “Maybe paying off that car loan would free up some money each month that could be redirected to her retirement contributions through work,” Whytock adds. “She would remove potentially high interest debt, increase her contributions to her 401(k), and lower her tax base all at the same time.”

If your daughter doesn’t have a plan through work or is already taking full advantage of it, then a Roth IRA makes sense. Unlike with traditional IRAs, contributions to a Roth are made after taxes, but your daughter won’t owe taxes when she withdraws the money for retirement down the road. Since she’s on the younger side – and likely to be in a higher tax bracket later – this choice may also offer a small tax advantage over other vehicles.

Why not the annuity?

As you say, the goal is to help your daughter get on the path to financial security. For that reason alone, a simple, low-cost instrument is your best bet. Annuities can play a role in retirement planning, but their complexity, high fees and, typically, high minimums make them less ideal for this situation, says Whytock.

Here’s another idea: Don’t just open the account, pick the investments and make the contribution on your daughter’s behalf. Instead, use this gift as an opportunity to get her involved, from deciding where to open the account to choosing the best investments.

Better yet, take this a step further and set up your own matching plan. You could, for example, initially fund the account with $2,000 and set aside the remainder to match what she saves, dollar for dollar. By helping your daughter jump start her own saving and investing plans, your $5,000 gift will yield returns far beyond anything it would earn if you simply socked it away on her behalf.

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

MONEY Taxes

5 Things to Know If You Still Haven’t Finished Last Year’s Taxes

Practicing golf in office
You can't put off finishing your taxes for much longer. Jan Stromme—Getty Images

Attention tax procrastinators: Time’s nearly up if you filed for an extension last spring.

Remember the relief you felt last April when—faced with a looming tax-filing deadline—you simply applied for an automatic six-month extension for your 2013 return? The dread is back. October 15, next Wednesday, is the filing deadline for everyone who took advantage of the government’s grace period. As of the end of September, more than a quarter of the nearly 13 million taxpayers who had filed for an extension had yet to file, according to the IRS. If you’re one of those procrastinators, here’s what you need to know.

1. This time the deadline is real. No more extensions (one exception: members of the military serving in a combat zone). If you don’t file and pay your tax bill, you’ll get a failure-to-file notice. And you’ll start the clock on a failure-to-file penalty (5% of your unpaid taxes per month, up to a max of 25%), a failure-to-pay penalty (0.5% of your tax bill per month, up to a max of 25%), and interest (currently 3%).

“You could have three things adding up month by month if you do nothing by October 15,” says Mark Luscombe, principal federal tax analyst for Wolters Kluwer, CCH. Of course, if you’re expecting a refund, there’s no penalty for not filing—and also no refund until you do.

2. Do nothing, and the IRS will eventually file for you. And you may not like the results. That’s because the IRS will base your tax bill on the information it has, such as the income reported on your W-2, notes White Plains, N.Y., CPA Paul Herman. But they won’t know other things that could lower your tax bill, like all the deductions you’re entitled to or what you paid for stocks, bonds, or mutual funds you sold last year.

3. If you can’t pay your entire bill, throw out a number. File your return for sure—that at least saves you the failure-to-file penalty. When you do, request an installment agreement (Form 9465), and propose how much you can pay a month, or the IRS will divide your balance by 72 months. If the offer is reasonable, says Herman, the IRS may accept it.

4. Free help hasn’t gone away. Through October 15, you can still use the IRS’s Free File program, which makes brand-name tax-filing software available at no cost if your income is $58,000 or less. Earn more than that, and you can still use the free fillable forms at the IRS website.

5. You have one less way to cut your taxes. You’re out of luck if you had hoped to trim your tax bill by funding an individual retirement account for 2013 (depending on your income, as much as $5,500 was deductible last year, $6,500 if you’re 50 or older). Even though you got an extension to file, the deadline for opening an IRA for 2013 was last April 15. (Make a note: You have six months to open a 2014 IRA).

However, if you switched a traditional IRA into a Roth IRA last year—which meant a tax bill on your conversion—you still have until October 15 to change your mind. That’s something you might do if the value of your Roth has since dropped. You can “recharacterize” the conversion (in effect, switch back to a regular IRA) and then convert to a Roth again later, this time realizing a smaller taxable gain and owing less in taxes.

Finally, if you find yourself doing your taxes every fall, think about changing your ways. Maybe invest in a better system for organizing your records? “If you waited this long,” says Herman, “try to begin planning earlier for next year.”

MONEY Ask the Expert

The Right Way to Tap Your IRA in Retirement

Q: When I do my IRA required minimum distribution I take some extra money out and move it to a taxable account. Good idea or bad idea? Thanks – Bill Faye, Rockville, MD

A: After years of accumulating money for retirement, figuring out what to do with “extra” money withdrawn from your IRA accounts seems like a nice problem to have. But required minimum distributions, or RMDs, can be tricky.

First, a bit of background on managing RMDs. These withdrawals are a requirement under IRS rules, since Uncle Sam wants to collect the taxes you’ve deferred on contributions to your IRAs or 401(k)s. You must take your distribution by April 1st of the year you turn 70 ½; subsequent RMDs are due by December 31st each year. If you don’t take the distribution, you’ll pay a 50% tax penalty in addition to regular income tax on the amount that should have been withdrawn.

The size of your required withdrawal depends on your age and the account balance. (You can find the details on the IRS website here.) If you’re over 59 ½, you can take out higher amounts than the minimum required, but the excess withdrawals don’t count toward your future distributions. Still, by managing your IRAs the right way, you can preserve more of your portfolio and possibly reduce taxes, says Mary Pucciarelli, a financial advisor with MetLife Premier Client Group.

For those fortunate enough to hold more than one IRA, you must calculate the withdrawal amount based on all your accounts. But you can take the money out of any combination of the IRAs you hold. This flexibility means you can make strategic withdrawals. Say you have an IRA with a big exposure to stocks and the market is down. In that scenario, you might want to pull money from another account that isn’t so stock heavy, so you’re not selling investments at a low point.

You can minimize RMDs by converting one or more of your traditional IRAs to a Roth IRA. Roths don’t have minimum distribution requirements, so you can choose when and how much money you take out. More importantly, you don’t pay taxes on the withdrawals and neither will your heirs if you leave it to them. You will owe taxes on the amount you convert. To get the full benefit of the conversion, consider this move only if you can pay that bill with money outside your IRA. Many investors choose to make the move after they’ve retired and their tax bill is lower. Pucciarelli suggests doing the conversion over time so you can avoid a big tax bill in one year.

Up until this year, you could avoid paying taxes on your RMD by making a qualified charitable contribution directly from your IRA to a charity. The tax provision expired in December. It’s possible Congress will renew the tax break, though nothing is certain in Washington. Meanwhile, if you itemize on your taxes, you can deduct your charitable contribution.

As for the extra money you’ve withdrawn, it’s fine to stash it in a taxable account. If you have sufficient cash on hand for living expenses, you can opt for longer-term investments, such as bond or stock funds. But be sure your investments suit your financial goals. “You don’t want to throw your asset allocation out of whack when you move the money,” says Pucciarelli. Consider a tax-efficient option, such as an index stock fund or muni bond fund. That way, Uncle Sam won’t take another big tax bite out of your returns.

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

MONEY Kids and Money

The Best Thing You Can Do Now for Your Kid’s Financial Future

CAN'T BUY ME LOVE, from left: Patrick Dempsey, Amanda Peterson, 1987.
Your teens summer earnings can't buy love, but they can buy a bit of retirement security. Buena Vista Pictures—Courtesy Everett Collection

Open a Roth IRA for your child's summer earnings, and talk her through the decisions on how to invest that money, suggests financial planner Kevin McKinley.

In my last column, I extolled the virtues of opening—and perhaps even contributing to—a Roth IRA for a working teenager. In short, a little bit of money saved now can make a big difference over a long time, and give your child a nice cushion upon which to build a solid nest egg.

Besides underscoring the importance of saving for retirement early and regularly, opening a Roth IRA can help your child become a savvy investor (a skill many people learn the hard way).

Here’s how:

Make the Initial Contribution

Your child needs to earn money if he or you are going to contribute to an IRA on his behalf. For the 2014 tax year, the limit for a Roth IRA contribution for those under age 50 is the lesser of the worker’s earnings, or $5,500.

The deadline for making the contribution is April 15, 2015. But you can start sooner, even if your teen hasn’t yet earned the money on which you will be basing the IRA contribution. (If the kid doesn’t earn enough to justify your contributions, you can withdraw the excess with relatively little in the way of paperwork or penalties.)

For a minor child, you will have to open a “custodial” Roth IRA on her behalf, using her Social Security number. Not every brokerage or mutual fund company that will open a Roth IRA for an adult will do so for a minor, but many of the larger ones will, including Vanguard, Schwab, and TD Ameritrade.

As the custodian, you make the decisions on investment choices—as well as decisions on if, why, and when the money might be withdrawn—until she reaches “adulthood,” defined by age (usually between 18 and 21, depending on your state of residence). Once she ages out, the account will then need to be re-registered in her name.

Depending on which provider you choose, you may be able to make systematic, automated contributions to the IRA (for example, $200 per month) from a checking or savings account. To encourage your teen to participate, you might offer to match every dollar he puts in.

Have the “Risk vs. Reward” Talk

How an adult should invest an IRA depends upon the person’s goals and risk tolerance—the same is true for a teen. You can help set those parameters by pointing out to your child that, since he’s unlikely to retire until his 60s this is likely to be a decades-long investment, and enduring short-term downturns is the price for enjoying higher potential long-term gains.

You might also show him the difference between depositing $1,000 now and earning, say, 3% annually vs. 7% annually over the next 50 years—that is, a balance of $4,400 vs. a balance of $29,600. Ask your child: Which would you rather?

No doubt, your kid will choose the bigger number.

But you also want this to be a lesson in the risks involved in investing. You might talk about what a severe one-year decline of 40% or more might do to his investment and explain that bigger drops are more likely in investments that have the potential for bigger growth. Now how do you feel about that 7%?

Some teenagers will be perfectly fine accepting the risk. Others may be more skittish.

You also might explain that there are options that will not decline in value at all—such as CDs and money market accounts. But should he choose those safer options, he’ll be trading off high reward for that benefit of low risk. In fact, while his money will grow, it will likely not keep up with the rate at which prices grow (“inflation,” in adult terms). So his money will actually be worth less by the time he’s ready to retire.

Some risk, therefore, will likely be necessary in order to grow his money in a meaningful way.

Choose Investments Together

Assuming he can tolerate some fluctuation, a stock-based mutual fund is probably the most appropriate and profitable strategy—especially since a fund can theoretically offer him a ownership in hundreds of different securities even though he may only be investing a few thousand dollars. You might explain that this diversification protects against some of the risks of decline since some stocks will rise when others fall.

A particularly-suitable option might be a “target date” or “life cycle” fund. These offerings are geared toward a specific year in the future—for instance, one near the time at which your child might retire.

Target date funds are usually a portfolio comprised of several different funds. The portfolio allocation starts out fairly aggressive, with a majority of the money invested in stock-based funds, and much smaller portion in bond funds or money market accounts.

As time goes by—and your child’s prospective retirement draws nearer—the allocation of the overall fund gradually becomes more conservative.

The value of the account can still rise and fall in the years nearing retirement, but with likely less volatility than what could be experienced in the early years.

One low-cost example of this type of investment is the Vanguard Retirement 2060 Fund (VTTSX).

Of course, if you choose a brokerage account for your child’s Roth IRA, you have the option of purchasing shares in a company that might be of particular interest to your kid. Choosing a company that is familiar to your child may not only inspire her to watch the stock and learn more about it, but eventually profit from the money she is spending on “her” company’s products.

If you’re going to go this route, you should include a discussion on the increased volatility (for better or worse) of owning one or two stocks, rather than the diversification offered by the aforementioned mutual fund.

Kevin McKinley is a financial planner and owner of McKinley Money LLC, a registered investment advisor in Eau Claire, Wisconsin. He’s also the author of Make Your Kid a Millionaire. His column appears weekly.

Read more from Kevin McKinley:

 

MONEY Ask the Expert

How To Tap Your IRA When You Really Need the Money

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Robert A. Di Ieso, Jr.

Q: I am 52 and recently lost my job. I have a fairly large IRA. I was thinking of taking a “rule 72(t)” distribution for income and shifting some of those IRA assets to my Roth IRA, paying the tax now while I’m unemployed and most likely at a lower tax rate. What do you think of this strategy? – Mark, Ft. Lauderdale, FL

A: It’s a workable strategy, but it’s one that’s very complex and may cost you a big chunk of your retirement savings, says Ed Slott, a CPA and founder of IRAhelp.com.

Because your IRA is meant to provide income in retirement, the IRS strongly encourages you to save it for that by imposing a 10% withdrawal penalty (on top of income taxes) if you tap the money before you reach age 59 ½. There are several exceptions that allow you to avoid the penalty, such as incurring steep medical bills, paying for higher education or a down payment on a first home. (Unemployment is not included.)

The exception that you’re considering is known as rule 72(t), after the IRS section code that spells it out, and anyone can use this strategy to avoid the 10% penalty if you follow the requirements precisely. You must take the money out on a specific schedule in regular increments and stick with that payment schedule for five years, or until you reach age 59 ½, whichever is longer. Deviate from this program, and you’ll have to pay the penalty on all money withdrawn from the IRA, plus interest. (The formal, less catchy name of this strategy is the Substantially Equal Periodic Payment, or SEPP, rule.)

The IRS gives you three different methods to calculate your payment amount: required minimum distribution, fixed amortization and fixed annuitization. Several sites, including 72t.net, Dinkytown and CalcXML, offer tools if you want to run scenarios. Generally, the amortization method will gives you the highest income, says Slott. But it’s a good idea to consult a tax professional to see which one is best for you.

If you do use the 72(t) method, and want to shift some of your traditional IRA assets to a Roth, consider first dividing your current account into two—that way, you can convert only a portion of the money. But you must do so before you set up the 72(t) plan. If you later decide that you no longer need the distributions, you can’t contribute 72(t) income into another IRA or put it into a Roth. Your best option would be to save it in a taxable fund. “Then the money will be there if you need it down the road,” says Slott.

Does it make sense to take 72(t) distributions? Only as a last resort. It is true that you’ll pay less in income tax while you’re unemployed. But at age 52, you’ll be taking distributions for seven and a half years, which is a long time to commit to the payout plan. If you get a job during that period, the income from the 72(t) distribution could push you into a higher tax bracket. Slott suggests checking into a home equity loan—or even taking some money out of your IRA up front and paying the 10% penalty, rather than withdrawing the bulk of the account. “Your retirement money is the result of years of saving,” says Slott. “If you take out big chunks now, you might not have enough lifetime to replace it.”

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

MONEY Kids and Money

The Surprising Place Your Kid Should Save His Summer Earnings

Pitcher of lemonade and a money jar
Your teen's summer earnings may not seem like much now, but they can serve as a cornerstone for his retirement 50-odd years in the future. Somos/Veer—Getty Images

Get your teen started off now in a Roth IRA for a big payoff down the road, says financial planner Kevin McKinley.

A few weeks ago, I wrote about how to figure out how much money you need to become financially independent, and how the process could help you teach your kids to reach the same goal.

But talking the talk only goes so far. You can walk the walk by helping them start saving for retirement in…drumroll, please…a Roth IRA.

Why a Roth IRA?

For most younger workers, the Roth IRA is preferable to a traditional IRA for two reasons.

The first is that contributions to a Roth IRA can be withdrawn at any time for any reason with no taxes or penalties whatsoever. Therefore, that portion of the account can be taken out for other expenses, such as college or a down payment on a house, without a severe cost.

The second reason the Roth IRA rules is that younger workers typically are in a low tax bracket, and therefore don’t need the deduction that a traditional IRA provides. But once they get to retirement, all the money in the Roth can generally be withdrawn with no taxes at all.

How much your kid can save

Children of any age can open a Roth IRA account—as long as they have legitimate earned income. Flipping burgers and bagging groceries certainly counts, but so does self-employment like babysitting and yard work, especially if it’s done for someone other than you.

Just make sure to keep track of what your kid makes so you know how much can be deposited in to the Roth IRA. For 2014 the contributions to a Roth IRA are limited to the lesser of the kid’s earnings, or $5,500.

Technically, for the 2104 tax year, the money doesn’t have to be deposited until April 15, 2015, the usual deadline for the federal income tax filing.

What you can do to encourage him

Congratulations to you—and your child—if you can convince her straightaway to put her hard-earned paychecks into an account that isn’t meant to be tapped for another 50 years.

But even if you can’t immediately get your teen into the savings habit, you may be able to motivate her by using some of your own money. The money for the Roth IRA doesn’t necessarily have to come from her. She can spend her earnings, and you can deposit into the Roth on her behalf.(Just remember that your deposits then become her money, and she’s free to do with it as she pleases once she reaches adulthood.)

Also, keep in mind that the source of the deposit to your child’s Roth IRA doesn’t have to be an all-or-nothing proposition. You may want to tell your kid that you will match every dollar she contributes with one of your own.

For further motivation, try showing your child how time can turn a relatively-small amount of money into a small (or large) fortune.

For instance, let’s say you and your child deposits $5,000 into a Roth IRA when he’s 15 years old, and it grows at a hypothetical annual rate of 6% per year.

By the time he’s 65 (and it will happen sooner than he thinks), the account would be worth over $92,000.

But if he has the earnings and discipline required to set aside $5,000 in to the same account every year until he turns 65, the Roth IRA will provide him with a tax-free total of $1.6 million.

And if that doesn’t get his attention, no amount of walking and talking will.

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Kevin McKinley is a financial planner and owner of McKinley Money LLC, a registered investment advisor in Eau Claire, Wisconsin. He’s also the author of Make Your Kid a Millionaire. His column appears weekly.

Read more from Kevin McKinley

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