Early Distributions From IRA Can Be Penalty-Free

Question: I am 56 and will retire in January after 36 years with an auto company. I would like to start taking equal monthly payments from my individual retirement account but was told I couldn’t do this without incurring a 10% penalty because I am not at least 59 1/2. I thought the IRS had changed its rules on this issue, or am I incorrect?

Answer: Boy, did you get bad advice, and twice over.

Because you will be at least 55 at the time you are “separated from service” (which, in IRS-speak, means you quit or are fired, laid off or retired), no penalty will apply to your IRA withdrawals. You’ll still have to pay income tax on the money, of course.

But even if you weren’t 55, you could avoid the penalty by taking equal monthly payments from your IRA based on your life expectancy.

This is nothing new. What changed was the way the IRS allows you to calculate those payments. The tax agency essentially updated its mortality tables, allowing people to take smaller distributions from their retirement accounts.

You can find out more about tapping your retirement fund from the latest edition of “IRAs, 401(k)s & Other Retirement Plans: Taking Your Money Out” by Twila Slesnick and John C. Suttle (Nolo Press, 2002). The IRS also has information on its Web site at www.irs.gov.

Do make sure before tapping your funds early that your IRA won’t run out of money before you run out of life.

Once you take this money out, you can’t put it back, and you’re losing the tax-deferred earnings you could make had you left the retirement account alone.

Insurer Inquiries Won’t Hurt Credit

Q: I understand that more insurers are using credit scores to make underwriting and rating decisions. How would you suggest dealing with the negative impact on my credit report caused when prospective insurers look at my credit before providing me with a premium quote?

A: You don’t need to deal with the negative effect because there probably isn’t any.

Credit scores are three-digit numbers used to evaluate your credit-worthiness. The leading scoring formula, known as FICO, ignores inquiries by all insurers, says Craig Watts, spokesman for FICO creator Fair Isaac.

The same is true of Fair Isaac’s insurance risk scores, which are used by hundreds of insurers in lieu of or in addition to credit scores.

This issue confuses some people because the insurers’ inquiries show up on their credit reports, which are maintained by the credit bureaus and are used to compile FICO scores. But unlike “hard” inquiries -- those made by lenders when you apply for credit -- inquiries made by insurers, and by you when you want to see your own credit history, don’t hurt your FICO score.

FICO is not the only credit-scoring formula out there, and there may be others that do not distinguish among the types of inquiries listed on a report.

But because the FICO score is by far the most commonly used, you probably don’t need to worry about insurance inquiries hurting your ability to get credit.

Deciding What to Do With a Windfall

Q: My husband and I just received a small inheritance. We’re unfamiliar with investments and don’t know which way to turn. Can you give us any guidance?

A: Usually, the best use for a windfall of any kind is to pay off debt, particularly nondeductible consumer debt such as credit cards and car loans. Once your debt is retired, the next best course is to make sure you have an adequate emergency fund -- three to six months’ worth of expenses is usually good.

If you still have money left over, then you need to make a few decisions. What’s the purpose of this money? Many people focus on how they got it -- “It was an inheritance,” “I won the lottery!” -- which is pretty much irrelevant when it comes to financial planning. What counts is what you want to do with it.

If you plan to use the cash in a few years for a down payment on a house, say, or a great vacation, you’ll want to keep the money safe and liquid. Good choices would be a money market account or certificates of deposit with varying maturity dates (with the oldest coming due before you’ll actually need the money).

If you want this money for your retirement 30 years from now, then you can afford to take more risk. You might want to invest it in a diversified portfolio of stocks, bonds and cash.

If you have no clue what you want to do, then stick it in a money market account or savings account until you make up your mind.

Meanwhile, pick up a good book on investing such as Eric Tyson’s “Investing for Dummies” and educate yourselves so you’ll have a better idea of the course you should take once you decide what you want this money to do for you.

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Liz Pulliam Weston is a contributor to The Times and a graduate of the personal financial planning certificate program at UC Irvine. She is also a columnist for MSN.com. Questions can be sent to her at asklizweston@hotmail.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times’ Web site at www.latimes.com/moneytalk.