IRAs aren’t the simple vehicles they seemed when they were new.
What’s more, Baby Boomers have reached the stages of life when the rules are more complicated and full of pitfalls.
Here’s a guide to the top questions my readers are asking about IRAs, and mistakes many are making.
Required minimum distribution mistake #1.
Most taxpayers have to take a required minimum distribution (RMD) each year after turning age 70½.
In some cases you can consider retirement accounts together (aggregate them) when taking required minimum distributions; in other cases you can’t aggregate.
Traditional IRAs you opened can be aggregated. You separately compute the required minimum distribution for each IRA.
Then, you add the total RMDs to arrive at one required minimum distribution for the year for all the IRAs.
You can take this aggregated RMD from the IRAs in any ratio you want. Take it all from one IRA; take it equally from each IRA; or take it in any other ratio.
Some people use it to rebalance their portfolios, such as by taking most of their required minimum distributions from an IRA that’s heavy with stocks when their overall stock allocation is too high.
But you can’t aggregate employer accounts, such as 401(k)s.
The RMDs have to be calculated and taken separately from each employer account.
You also can’t aggregate inherited IRAs with other IRAs. The RMD for each of these must be taken separately.
When in doubt, check with an expert, or don’t aggregate.
Required minimum distribution mistake #2.
Some people don’t have to take required minimum distributions at age 70½. They can wait a little longer.
None of the exceptions applies to traditional IRAs, but they do apply to employer retirement accounts.
When you’re still working for an employer, required minimum distributions don’t have to be taken from retirement accounts sponsored by that employer until April 1 of the year after the year you are separated from the service of the employer.
The exception doesn’t apply when you own 5% or more of the employer. (Ownership by family members is attributed to you when calculating whether you own 5% or more.)
The exception applies only for accounts sponsored by that employer. You still must take RMDs from IRAs and any accounts you have at other employers.
A Roth IRA exists for those with higher incomes.
As you know, you can’t make contributions to a Roth IRA when your income is too high.
The adjusted gross income ceilings in 2018 for Roth IRA contributions are $189,000 for married couples filing jointly and $120,000 for individuals.
But there is a way you might be able to create a Roth IRA using a back door.
When you participate in a 401(k) plan at work, there are two contribution limits.
Everyone knows about the annual maximum salary deferral of $18,500 for 2018.
Taxpayers age 50 and over can increase that by $6,000. You can have up to that amount deducted from your salary and deposited in your 401(k).
The amount isn’t included in gross income for federal income tax purposes, but it is subject to payroll taxes.
Many people aren’t aware that if your 401(k) plan allows it, you can make additional after-tax contributions.
The additional amount you elect to have contributed counts as taxable income for the year. But it is deposited in the 401(k) account, where income and gains compound tax deferred.
The maximum contributions to a 401(k) in 2018 are $55,000. You can make $18,500 of tax-deferred contributions and an additional $36,500 of after-tax contributions.
Even better, the IRS changed the rules a few years ago. When you decide to roll over the entire account to IRAs, you can roll over the after-tax contributions directly to a Roth IRA.
You roll the rest of the 401(k) to a traditional IRA. So, when you leave the employer you have a Roth IRA, and the balance can be higher than if you’d made regular annual Roth IRA contributions because of the higher contribution limit.
Making after-tax contributions to your 401(k) can be a better deal than putting the savings in a taxable account during your working years.
The 401(k) money eventually can be rolled to a Roth IRA, where income and gains become tax free to you and your heirs.
In next week’s issue of Retirement Watch Weekly: Unconventional IRA investments, rules for the 5-year waiting period, and a guide to Roth IRAs for all ages.