3 Tips for Protecting Your Pension and IRA
You’ve worked hard for your money. You’ve invested, put in the hours and saved. You want to do whatever you can to ensure that your money is working as hard as you are and is in a safe place. You need to be able to rely on your retirement accounts and pension when you are ready to transition to retirement.
But, you may not know the right moves to make to protect these huge assets. While the answer is slightly different for everyone, you can use these tips to help point you in the right direction.
1. Understand and Take Advantage of Tax-Savings Plans
If you have an IRA or pension, you may have already done some research about which plan will work best for your tax situation. However, many people don’t start thinking about how taxes will affect them in retirement until they begin nearing retirement age.
Regardless of which camp you belong to, knowing how your funds will be taxed can help you plan effectively for the future and take steps to protect your funds from Uncle Sam as much as possible.
- Roth IRAs: A Roth IRA uses after-tax contributions. The funds grow tax-free. When you are ready to take the money out after age 59½, you will receive the funds income-tax-free, assuming the account has been open for at least five years.
- Traditional IRAs and Tax-Deferred Plans: A traditional IRA uses pre-tax contributions. You are taxed on the money that you pull out later, but your contribution (up to a dollar limit and subject to income restrictions) is a tax deduction that you can take on your income taxes now. A 401(k) plan is a common tax-deferred plan offered by many employers.
- Pensions: These retirement tools vary; you should check the terms of the pension in the documents used to establish the account. You will generally start receiving payments on a specified date, and they will be taxed if you did not pay any tax before the funds went into the pension account. Most pension accounts will be at least partially taxed.
Planning correctly ahead of time can help you avoid having to pay additional taxes in retirement.
2. Avoid Tax Penalties and Fees for Early Withdrawals
Most retirement plans, including your IRA and many pension plans, will allow you to take out funds earlier than age 59½ or whenever your pension begins to be payable. However, you sometimes face tax penalties and fees if you take out the funds too early.
Traditional IRAs and 401(k)s have a 10% tax penalty on early withdrawals, in addition to ordinary income taxes. For the Roth IRA, you can withdraw your principal without penalty at any time, but withdrawing earnings before age 59½ and before the account is at least five years old will subject you to both ordinary income taxes and a 10% penalty.
For some, that can mean that you are wasting thousands of dollars simply by asking for the funds too soon.
Penalties and availability of funds for pensions vary a great deal, so check with your employer or another account holder to learn more about the terms.
3. Consider Relocating Your Pension
Most states have state income tax as well, but a few do not. Some states also do not tax pension payments.
If you are relying heavily on income from your pension in retirement, you may want to consider relocating yourself — and your pension fund — to a state that does not tax pensions. Florida and Alabama, for example, do not tax pensions. Making that type of switch can save you hundreds or even thousands of dollars in some situations.
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