Hold On to Roth IRAs While You Ride Out Investing Ups and Downs

Question: My wife and I each contributed $2,000 to our Roth IRAs in 1999 and 2000. The accounts are worth less than what we contributed. Because they have lost money, is there a penalty for cashing them out? Are there tax repercussions?

Answer: The penalty is about $215,000 for each of you.

That’s not a fine that’s levied by the IRS, which couldn’t care less if you withdraw your principal from a Roth IRA. The penalty you really pay is the loss of potential tax-free growth over the next 40 years, assuming your returns are something close to the stock market’s historical average.

Roth IRAs are an incredible deal for many taxpayers. Although your contributions aren’t tax deductible, all your withdrawals can be tax-free in retirement. That’s in contrast to most other retirement accounts, which require you to pay income taxes on at least part of your withdrawals.

What’s more, there’s no requirement that you withdraw the money starting at age 70 1/2. You can pass this tax-free loot to your kids if you don’t need it.

Roth IRAs are so popular that Congress finally responded to taxpayer pressure by increasing contribution limits, starting next year. Instead of $2,000 a year, you’ll be able to contribute $3,000. Many people who have Roth IRAs would like to contribute far more.

And here you are, wanting to take out money.

Once that money is withdrawn, you can’t put it back. And once the market rebounds, you’ll wish you hadn’t touched it. A premature Roth IRA withdrawal is a permanent solution to a temporary problem.

Ups and downs come with investing, and you’ll need to get used to it. If you took too much risk with your previous contributions, this time invest your contribution in a bond or money market fund to achieve a bit more balance.

Sometimes Bankruptcy Is the Best Option

Question: I read your recent column about the couple who had depleted their retirement funds and home equity to pay medical bills and was somewhat disturbed with your advice. The way I read the question, it seems we have a couple with a strong sense of responsibility, something that is quite lacking in today’s environment. Here they are, willing to do what is necessary to pay their bills, and you’re saying they should have avoided payment and declared bankruptcy. I just hate to see this type of thinking in the business section of the local newspaper. I wonder how many people will take the easy way out the next time they get in a tight spot.

Answer: Bankruptcy shouldn’t be the easy way out, but sometimes it’s the best of bad options. And there’s a big difference between being responsible and being ignorant. People need to know that certain assets are protected from creditors, so they can make informed decisions about how best to proceed when they’re facing huge bills.

Many people who get into debt can dig their way out without declaring bankruptcy. If you’ve read this column for a while, you know that I typically advise people to seek the help of Consumer Credit Counseling Service, which can help them work out a repayment plan.

In fact, bankruptcy can be the wrong option for people with gambling or overspending problems. Without the pain of repayment, they may never learn to reform their ways.

But sometimes bad things happen to good people--illness, death, divorce, job loss. Our lawmakers understood this when they created bankruptcy laws to give people a fresh start. Certain assets were made off-limits to creditors so people wouldn’t be forced to drain their retirement money or make themselves homeless just to pay an unsecured debt such as medical bills.

Yes, we should pay our debts and be responsible. But we should also have compassion for people who face difficult circumstances, and not condemn them to an old age in poverty.

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Liz Pulliam Weston is a personal finance writer for The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at moneytalk@latimes.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 http://161.35.110.226/moneytalk.