Thursday, October 16, 2008

The Candidates' Economic Proposals: IRA & 401k Withdrawals

The New York Times had a good side-by-side comparison yesterday of Obama and McCain's economic recovery plans and tax proposals. It's pretty much reproduced here.

One thing that struck me was that both candidates are proposing to make some changes to the penalties to early withdrawals from 401ks in 2008 and 2009:

Obama:
Temporarily suspend mandatory annual withdrawals from Individual Retirement Accounts and 401(k)s. Current rules require investors to start selling stocks at age 70½. Exempt withdrawals made up to the required minimum amount from taxation. Allow savers to withdraw 15 percent, up to a maximum of $10,000, without paying a penalty as the law currently requires for withdrawals before age 59½. These withdrawals are subject to normal taxes.

McCain:
Temporarily suspend mandatory annual withdrawals. Current rules require investors to start selling stocks at age 70½. Allow savers who are younger than 59½ to withdraw up to $50,000 at the lowest tax rate of 10 percent in 2008 and 2009.


I guess the thinking is that people are hurting and might really need this money right away, and that if they spend it, it will stimulate the economy. But I couldn't help thinking, do we really want to encourage people to spend their retirement savings early? Americans save so little as it is-- 401ks are one of the few things that successfully force automatic savings (once you opt in), and then give a big disincentive to taking the money back out again before you retire, via taxation and penalties. This doesn't strike me as a particularly valuable part of either candidate's overall plans. What do you think?

23 comments:

Curtis said...

Even worse than that. They want to encourage people to pull MORE money out of the stock market. You think people are freaking out now with the big dips, wait until you see what happens when everyone can pull money out with no penalty. I can't imagine that someone thought this would be a good idea

Caleb Nelson said...

Encouraging people to withdraw from their IRAs early is a risky idea. You are encouraging these folks that are in bad financial situations to destroy the one thing that they did right - and that's saving their money. It's common sense that if people get easier access to their money they won't do the right things with it. That's the whole reason there are so many regulations on IRAs now. I think that this will just cause a larger problem in the future when these same folks have no money for retirement.

Caleb
www.mefinanciallyfree.blogspot.com

Shawnna said...

they're just trying to get votes, that's all its about.

Amy K. said...

I like Obama's "you can take SOME out, and we're only waiving the penalty" approach. It's not quite encouraging people to take their money out, but it does take away some of the sting if you have to break the piggy bank.

Then again, people who have money saved for retirement are already a leg up on those that don't, or don't have much.

The "You can take your Required minimum distribution tax-free" worries me more.

Anonymous said...

If I had a chance to take out some of the money that I have been saving for years, for free, I think I'd do it. I've always wanted to go to the Superbowl, but haven't saved up enough in my extra savings pile. This would be a perfect opportunity to congratulate myself for having such a large retirement. Although, I may get screwed in the long run for taking out $5000, but I could die tomorrow too. :)

-Tasha

Anonymous said...

Its that continuing policy of pushing the problem into the future ... just like our national debt and social security. The really sad part is that we can't get our act together to save and 'repay' when the economy gets cooking. Perfect example ... in the 90s when the stock market was gaining and incomes were better we spent more than we needed. Premium coffees, BMWs and Mercedes, giant houses and even bigger mortgages -- not to mention both government and the privates sector encouraging 100% or interest only mortgages based on 'optimistic' future home values. We're idiots.

Fianna Fianna said...

It is a horrible idea. For those that are only contributing to their retirement plans in order to receive a match from their employers or if their employers automatically place $$ in their account (safe harbor contributions), they likely make bad financial decisions all around. Allowing irresponsible people access to these funds is akin to giving drugs to addicts. Insane.

Kady said...

Madam X,

Do you have a contingency plan in place for if you lose your job? Would you share? I just posted mine at my blog: Wonkess

Middle Class Hick said...

The funny thing about what is being said in the previous 8 comments is that everyone is not being told "not to save" but that you can dip if you need to. If I had a way to get my money out of my roth, without consequences, I would it it in a heartbeat. I hate the restrictions of the roth. However - it works in my advantage as long as I (an it is a big if) live to 59.5 years old. Then I can touch my money without taxes. Same thing for a 401k. If my company did not require 6% to get their 3% - I would put zero in there. I would put it in an account I could have access to if I need it. Liquidity is your friend. Being in retirement accounts is not liquid.

I am thinking of not putting anything in my roth this year (I have to check the taxes on it) as I really don't want to do have to wait forever to get access to the money. I plan on retiring at 45 anyways .. so the 15k I am putting into retirement (5k in 401k, 5k into roth, and 5k leftover savings in the year), I am going to put 10k in my regular investments account, and leave the 5k going to the 401k since I have to.

Oh well call me irresponsible or what not, I am just looking at future liabilities. Why should I pay fines on getting money out of my "retirement" account when I retire because it does not meet some government regulation that I have to retire when my life expectancy is expired?

Oh well. Bring on the change. I will take it all out of my Roth if I have no taxes/fines to worry about for doing such. If I still have fines/taxes, I will not touch it.

savvy said...

If I could withdraw all my retirement savings without penalty, I would be tempted to liquidate the whole thing and eliminate my mortgage. Of course I wouldn't (mainly because that would push me into a crazy tax bracket) but I'd be tempted.

@ Middle Class Hick - There are many ways to withdraw "retirement" savings even if you plan to retire before the typical retirement age without being penalized. The key is to have a good tax advisor or other professional to assist you.

Middle Class Hick said...

I know all about SEPP, the big 4 (health care, education, buy first house, start a business), as well as the life expectancy (government charts) methods. However each one has their problems. The big 4 are more loans than true withdrawals, and you have to pay them back, with interest typically. Life expectancy withdrawals are great - if you are on the back end of the scale, but suck if you are on the front end. Say you have cancer, expect to live two years, and want to go to Europe? You cannot take money out except for the medical expenses.

Finally the SEPP. This is the best compromise, however, you still have to do predictive analysis and guess at some values (like how early are you taking the money, plus expected increase rate) and get only 1/x amount of the money. So lets say you wanted to go to Europe or on a around the world cruise at 45 when you retire, and you have a million in your account. You get your 66,666 dollars, but have to pay the taxes on that, prior to using it. Yeah it might technically be enough, but I would want full access to the money. I know how to save.

For more info .. go to the following:

http://www.retireearlyhomepage.com/wdraw59.html

Anonymous said...

I think, unless I'm mistaken, that neither candidate wants to change the penalty regulations forever. I that both agree that this is a temporary measure to get peoples' own money into their hands when they really need it. I don't think I would ever do it unless I was really, really in a tight spot, but at the same time this is peoples' own money that they chose to save. If they then choose to withdraw it, I don't really think anyone can quip too much...

Anonymous said...

I don't think the intent is to ENCOURAGE people to pull out money. Rather, I think they're acknowledging that people may need extra cash due to job loss or other unforeseen pressures. The effect may be another thing entirely.

nyjim said...

Middle Cladd Hick,

You CAN withdraw contributins to the Roth at ANY time, tax free and penalty free. It's the contributions that have a restriction.

So if you're worried about the economic downturn, contribute the full amount to a safe money market fund or a CD. Not great for long-term growth, but preserves the capital in case you need it and you get a little extra return with the interest.

nyjim

Optioned Unarmed said...

Ah, so under McCain's proposal the very rich could put $15,500 in their k plan in 2009, thereby avoiding paying the usual 35% tax on that amount, and then withdraw it the same year and pay only 10% tax. (Even better, they could withdraw an entire $50,000 and pay only 10% tax.) Great deal for anyone with a lot of money, whether they need it or not. In this proposal I see a hidden tax cut for the wealthy hidden inside a proposal which may also happen to help some regular folks in need.

Meanwhile, both proposals would be detrimental to long term savings and would go against the goal of promoting retirement security.

Tim said...

These are really non-proposals. Please let's start analyzing things a bit more. First, anyone who is 70.5 or older shouldn't be in stocks to begin with, and their 401k's are probably not in stocks (if some are, they are the very small minority and they should get their head examined for having high allocation in stocks to begin with at 70.5+). so, the vast, vast majority 70.5+ yrs old aren't being affected by the stock market down turn. second, anyone 70.5 or older probably depends on withdrawals from 401k and ira's anyways, so what is the point of suspending when they are already withdrawing because they need it?

for everyone else, people are going to scream foul complaining that it was the govt's fault for making it easy to empty their retirement accounts. Just like people are blaming the govt and everyone else for making credit available. Yes, people will always blame others for not saving us from ourselves.

what neither proposals address is whether you can make up for the withdrawals of contributions in the future.

You can already withdraw roth contributions penalty and tax free. you can take a 401k loan which is far less than 10% (mccain) or obama (normal tax). I just don't get the need for these non-proposals other than to make people think that these proposals are one necessary, and two are useful. Neither is the case.

Kate@LivingTheFrugalLife said...

Given the chance to do it without penalty, I would take at least $10k out of my IRA and throw it at my mortgage principle. Given my opinion of the stock market's long-term prospects, it would be the smart bet to simply pay down our debt.

What would the effects be on the larger economy? I couldn't begin to say; I'm not an economist. But $10k less in my retirement accounts wouldn't make too much difference for me personally in the long run. Those accounts are very decently funded, and my home looks like the best investment in my portfolio right now.

Daniel said...

The best tax policy change involving saving and investing would be not taxing interest, dividends, and capital gains. The Armey-Shelby flat tax would do that for everyone. When running for President earlier this year Mitt Romney said repeatedly that the first act he would push Congress to pass would be to exempt all interest, dividends, and capital gains from taxation for anyone with adjusted gross income under $200,000.

The problem with 401(k)'s, IRA's, etc. is that with only some exceptions, you pay significant penalites for withdrawing money before turning 59 and a half. Sadly, studies show a large percentage of people do this, especially when they change jobs.

Exempting ivestment income from taxation altogether would make it so much easier to save for oneself. It would make 401(k)'s, IRA's, etc. irrelevant. It would also greatly simplify the process of planning for and paying income taxes every year. No one would have to pay a tax accountant to keep track of the frequently changing rules. No one would run into maximum contribution limits. Calculating Required Minimum Distributions would become a thing of the past.

Finally, taxing dividends, interest, and capital gains never really made much sense in the first place. Dividends received logically shouldn't be taxed because the corporation paying it isn't getting a tax deduction for it. Similarly, interest expense is often not tax-deductible, especially for individuals so why tax it on the income side. Capital gains are really the right to receive the after-tax profits from an investment. It makes no sense to tax the gain a second time when you sell this right. Plus part of the "gain" really reflects monetary inflation anyway. Lots of other countries with higher tax rates in general actually don't tax or only lightly tax savings. We should do the same.

Anonymous said...

I don't think I would ever do it unless I was really, really in a tight spot, but at the same time this is peoples' own money that they chose to save. If they then choose to withdraw it, I don't really think anyone can quip too much...

It's money they got to grow tax free on the belief that we'd prefer people save for their own retirement instead of relying on others to do it for them. And now we're going to let them withdraw the tax-advantaged retirement money, making it more likely they'll be back looking for a handout come retirement time?

Anonymous said...

I am 84 years old have been making IRA withdrawals and paying taxes on the amount withdrawn. My IRA has topped out at approximately $300,000. on 12-31-07. due to my investment in non-speculative stocks. Since 12-31-07 my IRA has lost $200,000. This year 2008 the regulations say I have to withdraw approximately $18,000. and pay taxes on it. In order to meet the $18,000. requirement I will have to cash in some of my stocks that are at a long time low. It would seem to me Iam being penalized and forced to sell an excessive amount of my IRA savings at this time when the market is low.

Anonymous said...

Give people a break. The people that need to withdraw are going through a hardship. They are not doing this to go take a luxury spa retreat. Most people only access out of economic necessity and the government penalizes them with a penalty tax. Perhaps, the govt could make things easier by allowing the portability of 401K loans to IRA administators when people lose their jobs and their plan drops them and forces them to repay the loan. Most people can't and get the double whammy of a penalty. For those that have the luxury of not being in this situation, great for them. They will have a better retirement, but many are concerned with surviving as best they can today. Maybe, the gov't might actually allow catch up contributions in times of economic prosperity ? Let's stop being mother hen's and actually help people survive this financial crisis without resorting to foreclosure. This may be one means to do so.

retirement communities said...

People are only investing for making there money tax free. They dont have much expectations with this. n all it was a good effort.

Anonymous said...

I'm self employed, and haven't had work in 3 months. I will need to tap into my SEP IRA in another month if I can't find work. The fact that I can't borrow against that money sucks. I don't think anyone ever thinks about the self employed and what we are going through in this economy. I worked for 12 years at the same company, got laid off, and have been self employed since - 3 years. I can't find full time work, and can't collect unemployment. There are millions out there like me.