Q. I’ve been a good saver in my 401(k) plan, but I don’t have much else. Now I have an inherited IRA that I need to take distributions from. Am I better off putting the money in an IRA or saving in a different account that I can access any time? I’m 42.
A. This is a multi-part question, so let’s walk through this a step at a time.
First, saving a portion of your salary in your company’s 401(k) plan is a great financial habit to help prepare for your non-working years, said Jodi Cirignano, a certified financial planner with Lassus Wherley in New Providence.
She said the government strongly supports this habit and offers tax incentives to encourage people to save in 401(k)s and in other retirement accounts such as IRAs.
“However, the government also imposes penalties to discourage use of the funds prematurely, so it’s important to have a cash reserve so you don’t have to tap retirement accounts for living expenses or emergencies,” she said.
Before you set aside additional dollars into an individual IRA, Cirignano recommends you evaluate your cash needs and reserves.
“As a general rule of thumb, maintaining a reserve of three to six months of expenses is a sound practice,” she said. “You may need more or less than this level depending on your individual circumstances, such as job stability and your financial responsibilities, so it’s important to review your cash needs periodically.”
As you correctly point out, Cirignano said, you must take distributions from the account, which are subject to federal and state income taxes.
“In general, as a non-spouse IRA beneficiary, you can take a lump sum distribution, withdraw the entire amount by the end of the fifth year after the IRA owner passed away or take distributions over your life expectancy (`stretch IRA’),” she said. “Since you mentioned that you don’t have much outside of retirement accounts, you should consider setting aside all or at least a portion of your distributions from the inherited IRA in a non-retirement account.”
Depending on your situation, Cirignano said, the stretch IRA option can be an attractive choice for you. You will receive the minimum required distribution amount each year from the inherited IRA, but the remaining account balance will continue compounding tax-deferred to help you further grow your assets, she said.
“And, if circumstances changed and you needed access to additional funds, you can take distributions above the minimum required amount at any time from the inherited IRA,” she said. “By stretching the IRA, you may be able to meet your goal of optimizing tax-deferred assets as well as having flexibility to access funds as needed.”
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