Should I cash my IRA to pay my creditors?
by Leonard Wright, CPA I have a lot of debt and was recently laid off from my job. Would it be a good idea for me to cash in my IRA and pay off my creditors? I have awhile to go before retiring. Many Americans have faced the dilemma you describe. There are always multiple demands for the cash we have. Unfortunately, there is no right answer for your situation. You could cash the IRA, pay the taxes and the penalty (if withdrawing before age 59½) on the money, satisfy your creditors and keep your credit intact. Doing so likely will be at a great future cost to you, however. Let’s say you are 35 years old and are cashing a $25,000 IRA. If you had left that money in the IRA, it likely would have earned almost $300,000 (assuming an 8 percent annual return and no further additions to the IRA) by the time you reach the retirement age of 67, which is full retirement for Social Security benefits. At that time, you decide to take out $27,000 annually from your IRA. Doing so will deplete your IRA by the time you reach age 93, assuming the funds remaining in the IRA continue to earn 8 percent interest annually. So for cashing a $25,000 IRA now, you will be losing $27,000 per year at retirement. That’s a lot of money! (Note that you may start withdrawing funds from a traditional IRA at age 59½ without penalty and must start making minimum withdrawals at age 70½. The amount withdrawn will be subject to ordinary income tax. There are circumstances, however, in which you can take money out without penalty before age 59½, but the rules are complicated and do not apply for the scenario discussed here. Roth IRAs have no such requirements.) If you must cash your IRA, I recommend that you analyze your financial situation to reduce the possibility of your needing to do this again. Read a book or two regarding financial topics or check the financial articles on the website of the California Society of CPAs. Once you’ve gained some financial knowledge, determine what you and your family actually need as opposed to what you want. As long as you are out of work, buy only what you really need. When you get a job, your first priority should be to set aside cash in case you should suffer another layoff. Start a regular savings program to ensure that you will have enough money available to cover essential expenses (e.g., mortgage payments, food, utilities) should you be laid off again. (Most of my clients like to have enough cash in the bank to cover between three to 12 months of expenses.) After you have your safety net, you can begin to execute your wants in order of their importance. You should also consider working with a financial professional, such as a CPA, who can guide you through your financial journey. He or she can examine appropriate risk management strategies for your family, assess your risk tolerance, make recommendations as to how to invest in your company’s 401(k) plan or your IRA, and answer your financial questions. You can locate a CPA in your area by going to Find a CPA on the website of the California Society of CPAs. If you live outside California, check the website of your local state CPA society. Leonard C. Wright, CPA/PFS, CFP, CLU, ChFC, is a principal of Strategic Financial Group, a Los Angeles-based financial planning firm. You can reach him at (213) 243-7045 or wrightplanners@hotmail.com. Have a question for a CPA? Ask it here.
|  |
