Your Money : It’s Best Not to Tap Your IRA Early

Q. We are trying to decide whether we should take an early distribution from our individual retirement account of $55,000, which is currently paying interest at 5.2%, to pay off a $47,000 second trust deed on our house account that is costing us 10.5% interest. We owe a total of $205,000 on the house, but it is worth only about $180,000. Our annual income is $45,000. We realize that we will have to pay a 10% early-withdrawal penalty on the IRA, plus taxes. Does this plan make sense?

--W. P.

For the record:

12:00 a.m. Feb. 4, 1996 For the Record
Los Angeles Times Sunday February 4, 1996 Home Edition Business Part D Page 5 Financial Desk 3 inches; 82 words Type of Material: Correction
Capital gains--An embarrassed and apologetic spokesman for the IRS called Monday to say that incorrect information had been supplied for the response in last week’s column to the question about reporting short-term capital gains distributions.
The correct answer should have said that short-term capital gains distributions from mutual funds are included in the ordinary dividends reported by the fund to the IRS and to shareholders on Form 1099-DIV. Thus, these distributions are normally included in the amount entered on Line 5 of Schedule B and, if required, on Line 9 of Form 1040.


A. According to our calculations, which are based on the assumption that you are in the 15% federal tax bracket and the 7% California state bracket, your second trust deed is costing you about $3,900 a year after taking into account the mortgage interest tax deduction. Meanwhile, your IRA is earning you about $2,860 a year. The difference is slightly more than $1,000 a year. However, since the IRA income is tax-deferred, this calculation understates its real value to you.

By withdrawing from your IRA early, you face a 10% federal penalty as well as a 2.5% state penalty in California, giving you total penalty payments of $6,875. In addition, your withdrawal will be subject to ordinary income tax. Because of the size of the withdrawal, you will probably find yourselves in the 28% federal bracket; the state tax bite will increase as well. In the end, you will be required to dip into your other savings to make up the difference between what you ultimately realize from your IRA and the $47,000 you need to retire the second trust deed. Do you have this money? If not, your whole plan faces serious obstacles.


Perhaps a better alternative would be to stick with your existing mortgages, praying the whole time that California real estate will improve, and transfer your IRA into a higher-paying investment. Surely you can do better than 5.2% in today’s investment environment. Once you increase your IRA return, you will reduce, if not entirely erase, the difference between the net cost of your second trust deed and the earnings generated by your IRA.

Where Do Capital Gains Get Reported?

Q. I received several short-term capital gains distributions last year and am wondering where I should report them on my income tax filing. Is there a specific line for this?

--S. N.


A. All your capital gains distributions should be reported on line 14 of Schedule D. Although this line is part of the section labeled “Long-Term Capital Gains and Losses,” the IRS instructions for the 1040 clearly state on Page D2 that all capital gains distributions are considered long-term.

If you don’t otherwise have to file a Schedule D, you may report your capital gains distributions on line 13 of the 1040.

Drawing on a Former Spouse’s Social Security

Q. I am a 55-year-old divorced woman. I was married for 31 years. My former husband has remarried and began receiving Social Security at age 62. What are my Social Security prospects? May I draw on his benefits? May I still draw on his benefits if he dies before I do?

--S. L.


A. A divorced woman is entitled to receive Social Security benefits accumulated by her ex-husband if they were married for at least 10 years and he is already drawing benefits. However, if he is still working, she may draw benefits if the couple has been divorced for at least two years and the wage earner is at least 62. (By the way, the Social Security Administration treats ex-husbands equally; they may collect on their former wives’ benefits as well.)

If your ex-spouse is alive, you may start collecting benefits at age 62. However, your monthly benefits will be just 37.5% of the wage earner’s benefits. If you wait until age 65 to claim benefits, the payment is 50% of the wage earner’s benefits, the full spousal benefit. If your former spouse is dead, you may start collecting benefits at age 60. However, your monthly payments will be just 72.5% of what the wage earner was entitled to receive. The percentage increases the longer the ex-spouse waits, reaching 100% at age 65.

However, if the deceased had started collecting benefits at age 62, the amount the former spouse is entitled to receive is pegged to the amount the recipient had been getting at the time of death. If you are disabled, you may start collecting at age 50 if your former spouse is dead. If the ex-spouse if alive, 62 is the minimum age at which a disabled spouse may start collecting benefits.

By the way, benefits paid to an ex-spouse in no way reduce the amount available to the primary wage earner and his or her current family. For more information about ex-spouse benefits, order the Social Security Administration’s pamphlet No. 05-10084, titled “Survivor’s Benefits,” by calling (800) 772-1213.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest.

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