Nobody goes into retirement expecting drug and alcohol abuse, mental illness, or criminal charges to eat a significant portion of their retirement savings. It can be a toxic blow with both personal and financial implications.
From a pure dollars-and-cents perspective, the tax repercussions are downright horrifying. The client requesting the $58,000 IRA withdrawal stands to net only between $45,000 and $38,000 because of taxes and penalties for not reaching the age of 59½. Unfortunately, the financial pain doesn’t stop there. An IRA distribution is considered income; therefore, a distribution of this size will undoubtedly bump them into a higher tax bracket. That’s a harsh penalty for making sure a loved one gets the necessary legal counsel and can make a pre-retiree or existing retiree feel imprisoned by the rules that guard their tax-deferred savings.
A secondary challenge for both advisor and client is the inevitable emotional toll. In this case it may have been more beneficial from a tax perspective to tap into their home equity rather than dive head first into an IRA. However, when clients are facing life-altering dynamics, they can shut down, wall themselves up, and seek the most expedient financial solution, no matter what the consequences. Since most people allocate the largest portion of their retirement savings toward tax-deferred accounts, the government benefits from their heartache.
The problem is, once withdrawn, the money has to be put back into the IRA within 60 days. Plus, having enough time and savings to catch back up to the level can be challenging, primarily because of the limits placed on how much people can save inside an IRA.
It’s a heartbreaking set of circumstances no one wants to face. Yet it’s becoming more and more common as instances of drug and alcohol abuse continue to rise, and as more states pass laws to convict those who deliver drugs that result in an overdose.
In fact, states like Wisconsin are taking dramatic action. State prosecutors charged 71 people with first-degree reckless homicide by drug delivery in 2013, up from 47 in 2012. The tally was on track to jump again in 2014, with subsequent charges expected to reach 80 or more based on early estimates.
From a planning perspective it sends a clear message. Investors with a family history of mental illness and/or addiction need to diversify their savings beyond the traditional tax-deferred vehicles such as the 401(k), 403(b), or IRA. Allocating all or most of one’s retirement savings to these options alone can have adverse consequences when a family tragedy occurs. That makes after-tax and taxable saving plans, including the Roth IRA, Roth 401(k), traditional brokerage account, or even a basic savings account, essential considerations. Having access to one or more of these resources can provide crucial support when a family is in a pinch, potentially saving them thousands of dollars.
For example, consider a different family who may have a son facing a similar murder charge. If they had $20,000 in a savings account, $15,000 in an old Roth, and access to some home equity money, they could use a portion from each account type and avoid the tax bite all together. A similar plan could be used in a situation where a client needs to pay for an adult child’s drug rehabilitation.
Situations like these come up in retirement on a regular basis. No one expects it to happen to them, and all the preparation in the world won’t totally eliminate the emotional toll.
However, by being more aware of the possibility, and the potential financial ramifications, investors and advisors can work together to develop retirement saving plans that reduce or minimize the overall costs and long-term effects of a tragic family situation. Rest assured that at some point during retirement everyone comes to understand that money is secondary to family, friends, health, and well-being.
Therefore, a truly comprehensive retirement plan must include discussions and plans that go beyond the dollars and cents.
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About the Author:
As the Retirement Activist, Robert Laura created the Retirement Coaches Association and RetirementProject.org. He is the leading voice for the retirement coaching industry and has pioneered many tools and resources to help people prepare for the non-financial aspects of retirement including the Certified Professional Retirement Coach CRPC training and designation.
He is the author of several books and guides including Naked Retirement and Retirement Rx. He is also a nationally syndicated columnist for Forbes.com and Financial Advisor Magazine. Robert is a sought-after corporate trainer, speaker, consultant, and financial expert witness. He can be reached at here