Purchasing Credits in a Retirement Plan


By Dr. Don Taylor, Ph.D., CFA, CFP, CASL for Bankrate.com

Dear Retirement Adviser,

Would there be a penalty or interest charged against our Roth individual retirement account if we used a portion of it to buy years in another retirement plan? The Roth was begun with an IRA rollover in 1997. Since retiring from the military in 2010, my husband has been a teacher. He will be able to buy five years toward his teacher's retirement fund at the end of the next school year.

We believe it would be more beneficial to us to have the additional five years compared with drawing against the Roth at retirement. The teacher's plan would give us more monthly income in retirement. My husband will be 65 in 14 years. Buying five to seven years worth of credits, he could retire at age 60 and get approximately $2,200 per month in teacher's retirement benefits.

Thank you,
-- JoAnn Jumpstart

Dear JoAnn,

Every plan I've looked at does not allow funds from a Roth IRA to be used to directly purchase service credit by direct rollover or a trustee-to-trustee transfer from the account. Your husband can double-check with the plan administrator to confirm this for his plan, but I expect this is the case.

Contributions to a Roth IRA are made with after-tax dollars. For early distributions before age 59 1/2 that meet the IRS seasoning requirement of five years, only the investment earnings are subject to taxation and the 10 percent penalty tax. Raiding the account to help fund the lump-sum or installment payments is possible. But you can't transfer the funds to avoid these taxes. The IRS rules for distributions from of a Roth IRA allow your husband to manage the tax impact by taking earnings on contributions out of the account last, if the money is withdrawn over time.

I'd suggest working with an accountant to determine whether it's better to raid the account all at once to help with the lump-sum payment. The alternative is to take the money out over time to finance the installment payments.

Note: I'd like to thank Kay Bell, Bankrate's tax columnist, for her help with my reply.

Read the original article at Bankrate.com.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Personal Finance , Retirement , Basics , Investing Ideas

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