Updated: May 3, 2013 12:14PM
As tax day nears, everyone will be reminding you to make an IRA contribution if you qualify based on income. But here's another message: It's a warning to avoid the temptation to dig into your existing IRA -- or 401(k) plan -- during these tough times. Ultimately, it's likely to be your only meaningful source of retirement income.
While the stock market is scary, the outlook for Social Security is even more frightening. The recent rise in unemployment translates into a sharp drop in payroll "contributions."
As soon as Congress "fixes" the banking, housing and auto crises, it'll be forced to turn its attention to Social Security. Most likely, Social Security will become a "needs-based" payout to low-income, elderly recipients -- not a return of the "investments" you made with all those FICA deductions from your paycheck every month.
So you owe it to yourself to continue contributing to that 401(k) or IRA -- and to avoid touching a penny of your personal retirement money.
Even if you're annoyed that a good portion of it has melted away in the stock market decline, you must resist the temptation to withdraw what's left. Any shares you sell now deny you the possibility of gains if and when the market recovers.
Even worse, if you're in a company retirement plan, such as a 401(k) or 403(b), you'll have to abide by their rules for withdrawals. Most -- but not all -- of those plans will allow loans against your account, for reasons ranging from the purchase of a first home, to college for yourself or your children, or just for hardship reasons.
The real problem arises when you lose your job. If the loan isn't repaid promptly (check your company's plan documents for the specific number of days after separation), then it is considered a "deemed withdrawal." That mean you'll owe ordinary income taxes -- and if you're under age 59½, a 10 percent federal tax penalty on the amount of the loan that is not repaid.
There is one special provision for company retirement plan early withdrawals without penalty. If you are "separated from service" (fired, quit, resign) in the year you turn 55 or older, and if you leave the money in the plan, you can get taxable distributions of any amount without penalty. You'll still owe ordinary income taxes on those withdrawals.
(Another way to tap a retirement account is a Rule 72T withdrawal -- which requires that "substantially equal" withdrawals be taken, based on your life expectancy, for at least five years and until after you reach age 59½. Calculate carefully -- or you'll be liable for penalties dating back to the first withdrawal.)
It's almost impossible to withdraw money early from an Individual Retirement Account without incurring taxes and penalties. While there are provisions for IRA withdrawals for education expenses (an unlimited amount) and for the purchase of a first home ($10,000), you'll still have to pay taxes on the amount withdrawn. But there is no such thing as a "hardship withdrawal" from an IRA. If you take the money out before age 59½, you'll pay that 10 percent federal penalty, as well as ordinary income taxes.
The notable exception to that rule is a Roth IRA. While you don't get a tax deduction when you contribute to a Roth, you do get more tax-free liquidity. You can always withdraw your contributions at any time, for any reason -- tax- and penalty-free. Any earnings come out without penalty after five years and after the account holder has reached age 50½. (I always try to avoid mentioning that possibility, because it's so tempting to touch that Roth.)
A Roth IRA is particularly attractive -- aside from this liquidity feature -- because you can put away $5,000 (or $6,000 if age 50 or older) to grow tax free. Of course, you must qualify to make that contribution, with income under $105,000 on a single return or $166,000 on a joint return.
In an era of great uncertainty about future tax rates, it might be better to pay the taxes now and get tax-free growth -- especially if tax rates rise between now and your retirement. (Plus, if you don't need the cash, you aren't required to make withdrawals, as with traditional IRAs.)
Finally, let me direct you to a great Web site -- www.IRAHelp.com, hosted by IRA expert Ed Slott. There you can find answers to all your IRA questions.
Ed's special report this week (www.irahelp.com /SavCredit4-5-09.pdf) is about the "Saver's Credit" -- for low income people who contribute to a retirement plan. In effect, the program puts up to $1,000 back in your pocket if you earn less than $32,000 on a joint return -- and still manage to save some money in a retirement plan.
Tough to save at that income level? Yes, but then again, you also paid into Social Security! You're much more likely to see value in those private investments than in your Social Security "contributions." And that's The Savage Truth!
Terry Savage is a registered investment adviser. Distributed by Creators Syndicate.