6 Year-End Strategies for IRAs and 401(k)s

Retirement plans are in the news a lot these days, and it’s more important than usual this year for many owners of IRAs and other retirement plan accounts to focus on year-end strategies.

Congress is considering raising income tax rates and eliminating many long-time retirement planning strategies. You need to consider the potential changes in your retirement planning.

Even if Congress doesn’t push the changes through next year, they will be on the agenda in the future.

Here are 6 critical issues regarding retirement plans you need to review as this year comes to a close:

1. Optimize contributions

The annual contributions are limited by the tax code, and you can’t carry forward unused contribution amounts to future years.

Be sure each year you contribute the optimum amount for you. A big change in recent years is traditional IRA contributions can be made at any age.

Previously, contributions weren’t allowed after 70½, but now there’s no age limit for contributions for both traditional and Roth IRAs.

You still can contribute to IRAs only to the extent you have earned income (not investment or pension income).

The contribution limit is $6,000 in 2021 and another $1,000 for those ages 50 and older. You can divide it between traditional and Roth IRAs or put all of it into one type.

For 401(k) plans, be sure to review how much will be deferred from your paycheck to your account next year.

You aren’t limited to tax-deferred 401(k) contributions, which are capped at $19,500 in 2021.

You can make additional after-tax deferrals to a 401(k) until your total contributions are $58,000 in 2021 ($64,500 if you’re 50 or older).

The 2022 limits will be announced sometime in December. You can use the 401(k) limits to build a large Roth IRA.

I’ll let Retirement Watch members know if the proposal to eliminate the strategy after 2021 is enacted. Include health savings account (HSA) contributions in your planning. HSAs are the best retirement saving tool.

It often is good to maximize HSA contributions before contributing to an IRA or 401(k) because of the triple tax-free benefits of HSAs, though you might want to contribute enough to a 401(k) to maximize employer matching contributions.

2. Review beneficiary forms

I’ve warned in the past about the dangers of not reviewing beneficiary designation forms and ensuring the designations are up to date.

There are many cases in which this failure caused retirement accounts to be inherited by people who weren’t intended to receive them, and the preferred beneficiaries were disinherited.

When a trust is named as a retirement account beneficiary, it’s important to reconsider that choice.

The SECURE Act, enacted in late 2019, significantly and unfavorably changed the taxation of trusts as retirement account beneficiaries.

Review the consequences of your current arrangement with your estate planner and decide if a change should be made. Take any required minimum distributions.

Required minimum distributions (RMDs) were suspended for 2020 only.

They have to be taken in 2021. The 2017 law changed the rules so RMDs begin after age 72, not 70½, for anyone turning 70½ after 2019.

In the year an IRA owner passes away, the RMD has to be taken. If the owner didn’t take the RMD before passing away, the beneficiary must take the RMD and include it in his or her income.

3. Consider qualified charitable distributions

When someone over age 70½ makes charitable contributions, the qualified charitable distribution (QCD) often is the best way to make those gifts.

Instead of writing a check to charity, have the IRA custodian make a distribution directly to a charity or give you a check made payable to the charity.

The distribution isn’t included in your gross income, yet it counts toward your RMD for the year. (QCDs can begin after age 70½, though RMDs now don’t have to start until age 72.)

You can make up to $100,000 of QCDs annually.

Through the end of 2021, taxpayers of any age have the unique opportunity to make what’s been called a Mega QCD.

A special COVID-19 tax provision allows charitable contribution deductions of cash donations of up to 100% of adjusted gross income. Normally, the limit is 60% of adjusted gross income.

In a Mega QCD, you take a large distribution from a traditional IRA or 401(k) and donate it to charity.

The distribution is included in your gross income. If you itemize expenses on your income tax return, the charitable contribution deduction should offset all or most of the income.

It’s a good strategy for a charitably inclined person whose IRA exceeds lifetime spending needs.

This isn’t a real QCD, so it can be used by taxpayers of any age.

4. Plan to minimize future RMDs (Required Minimum Distributions)

As owners of significant traditional IRAs age, RMDs – required minimum distributions – can become a significant tax problem. A higher percentage of the IRA must be distributed each year and often exceeds what the owner needs to meet expenses.

In addition, beneficiaries who inherit traditional IRAs must distribute the IRAs within 10 years and pay income taxes on the distributions.

There are strategies to reposition the IRA that can reduce future RMDs and thereby reduce lifetime income taxes for you and your family, increasing the family’s after-tax wealth.

The strategies include converting a traditional IRA to a Roth IRA, using distributions from the IRA to buy permanent life insurance, using IRA distributions to fund a charitable remainder trust, and more.

5. Make up for low estimated tax payments

When income taxes aren’t withheld from your income, which is the case for many retirees, you must make estimated tax payments four times during the year.

But you can’t make one big, estimated tax payment near the end of the year. You have to make the payments during the year as the income is earned.

When the estimated tax payments don’t meet required minimum levels or weren’t paid evenly during the year, you’ll owe a penalty when filing your income tax return.

But when taxes are withheld from a payment, they’re treated as being withheld evenly during the year.

If you didn’t make adequate estimated tax payments earlier in the year, you can direct your IRA custodian to make a distribution to you near the end of the year and withhold enough for income taxes to meet your estimated tax requirements.

You even can direct that the entire distribution be withheld as income taxes. Not all IRA custodians are flexible enough to allow this strategy.

When yours is, it’s a good way to avoid penalties for underpaying estimated taxes.

6. Plan distributions with tax brackets in mind

Too many retirees take distributions from IRAs and other financial accounts by considering only the amount of money they need.

It is important to consider the tax consequences of taking distributions from different sources. Distributions from traditional IRAs are taxed as ordinary income.

Distributions from Roth IRAs and HSAs usually are tax free. Selling assets in taxable accounts usually results in a low-tax, long-term capital gain.

Before taking an additional distribution from an account, estimate the taxable income you already have this year and how the distribution would affect that.

If a taxable distribution might push you into the next tax bracket, you might want to take the distribution from a tax-free account.

You also might want a tax-free distribution when a taxable distribution or capital gain would increase the taxes on Social Security benefits or the Medicare premium surtax.

When you’re in the 0% long-term capital gains bracket, selling some investments with gains might be the best move.

But if you’re in a low tax bracket or have a lot of deductions this year, a distribution from a traditional IRA might be the best move.

Editor’s Note: Have you heard of the “IRA Trap Door?” It’s what I call Congress’ newest tax scheme. It’s set to spring open, as early as January 2022. So I’ve gone on the record in my new video podcast… to explain the exact steps you can take to protect your IRA, and even your 401(k). Click here to watch.