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Q: In the book "You Can Retire Sooner Than You Think" there is a section on Roth IRAs that says, "Contributions are made with after-tax dollars and can be withdrawn at any time without penalty." Recently, I visited a Financial Advisor who told me there is a 10% penalty even for contributions. Can you tell me who is correct?
A: Distributions from Roth IRAs are designed to be tax-free in retirement. A distribution from a Roth IRA is not included in the owner’s gross income and is not subject to the 10 percent early withdrawal penalty if it is a “qualified distribution.” Distributions that do not meet the definition of a qualified distribution may be subject to income tax and the early withdrawal penalty.
Qualified Distributions – are distributions from a Roth IRA that satisfies both the following tests:
1. The distribution must be made after a five-taxable year period, and
2. The distribution satisfies one of the following four requirements:
a. Made on or after the date on which the owner attains the age of 59½
b. Made to the beneficiary or estate of the owner on or after the date of the owner’s death
c. Is attributable to the owner being disabled, or
d. For first time home purchase (lifetime cap of $10,000 for first time homebuyers)
Nonqualified Distributions – Any amount distributed from an individual’s Roth IRA that is not a qualified distribution is treated as made in the following order
· From regular contributions
· From conversion contributions on a first-in-first-out basis, and then
· From earnings
In the event a distribution is not a qualified distribution, the first layer will be return of adjusted basis (from after-tax contributions), followed by post-tax conversion contributions. Since these contributions have already been taxed there will be no income tax consequences (although there may be a penalty). The final layer consists of tax-deferred earnings on contributions and conversions within the Roth IRA, which will be subject to tax and penalty if the distribution is not a qualified distribution.
Distributions will generally not be taxable to the extent that total distributions do not exceed total contributions and conversions.
Q: I just rebalanced my Rollover IRA investments and I have my cash allocation sitting in a money market fund that has a very low return. Where can I invest that in a very low-risk fund (such as an ETF) to get a better return?
A: A lot of people have been searching for ways to increase the yield or interest they earn on their cash in this low-rate environment. The more yield investors stretch for, the more risk you take on. You might consider a short duration bond fund or something similar.
Q: I am 55 years old with a portfolio that has 75% in stocks and 25% in an Intermediate Bond Fund. Should I move more to the bond fund?
A: One rule of thumb many investors use is to own your age in bonds. As such, using that rule you would have 55% of your investment portfolio in bonds.
Q: I am almost 62 and about 5-8 years away from retirement. About half of my retirement funds are in my employer-sponsored 401(k) with limited investment options. The other half is in IRAs with Fidelity. As I get closer to retirement, what kinds of mutual funds should I be moving my investments into? Do you have any specific fund recommendations, especially those available through Fidelity?
A: Please be advised we are regulated by the SEC which strongly prohibits advisors from providing specific recommendations to individuals without fully engaging in a due diligence process to determine suitability and appropriateness of a recommendation.
However, as our clients are nearing retirement we try to recommend the appropriate mix of income generating investments including a balance of fixed income, equity and alternative investments. This will include bonds, dividend paying stocks, REITs, MLPs, closed end funds etc. so you can create an income stream to live on.
I recommend speaking with your Fidelity advisor to see if they can offer you some advice. Alternatively, you can schedule an appointment to come in to our office and speak with me for some guidance.