7 Critical Year-End Actions to Take with IRAs and 401(k)s

Last update on: Jun 16 2020

This is not the year to procrastinate about year-end retirement account and tax planning.

In the last weeks of every year, I receive a stream of emails from readers asking about transactions they are considering by the end of the year. In most cases, even if they can analyze the situations and decide on the best course of action by the end of the year, it’s too late.

Often, IRA custodians need time to take certain actions, and at the end of the year, they’re inundated with requests. Many IRA custodians don’t accept requests for certain actions in the last few weeks of the year. You also might find that any tax or financial advisor you want to consult is booked through the end of the year.

You especially don’t want to be in that situation in 2019. People still are adjusting to the 2017 tax law, and the law might change again before the end of 2019. Plus, market volatility and uncertainty have increased. Don’t wait until later in the year. There are issues you need to consider and act on now. Make your decisions and take any necessary action well before the end of the year.

Consider a conversion.

Every year, you should consider whether to con-vert all or part of a traditional IRA to a Roth IRA.

The 2017 tax law changed the rules to make the decision irrevocable. Before that, you had a limited time to reverse a conversion. You know that the cost of a conversion is that the converted amount is

included in gross income as though it were distributed to you. You pay the taxes now and, after a five-year waiting period, future distributions of principal and investment returns from the Roth IRA are tax free.

There are two times to take a hard look at a conversion. One time is near the end of the year. Because we’re no longer allowed to reverse a conversion, it’s often best to wait until near the end of the year to decide whether or not to convert all or part of an IRA. By then, you’ll have a good idea of your tax situation for the year and the cost of the conversion.

The other good time is during a stock market dive, such as we’ve seen recently. The taxes on a conversion are based on the value of the converted amount on the day of the conversion. If your IRA is primarily in stocks and stocks decline, the taxes on the conversion are less than they would have been before the decline. You can afford to convert more than before the decline. Plus, after the stocks recover, the payoff for converting will be higher than it would have been before.

As we’ve discussed in past issues, a number of factors need to be considered before deciding whether to convert an IRA.

The factors include a comparison of your current and likely future income tax rates, how long the money will stay in the Roth IRA to earn compounded returns, your expected investment rate of return, the source of the cash to pay the conversion taxes and more. You can read

details in the back issues and articles in the Archive on the members’ section of the website at www.RetirementWatch.com and in my book, The New Rules of Retirement-Revised Edition.

Because there are a lot of factors to consider, it’s best to use software to make the decision. When you plan to leave the Roth IRA to children or other heirs, a conversion can be a good idea because you’re essentially making a tax-free gift to them by paying the income taxes on the conversion. They will receive tax-free distributions from the Roth IRA instead of taxable distributions from a traditional IRA.

Plan current RMDs.

When you’re over age 70½, it’s time to take annual required minimum distributions (RMDs) from IRAs and most 401(k)s. Be sure you do this before Dec. 31, which often means putting in the request with your IRA custodian well before that date.

Keep in mind tips for optimizing RMDs, such as carefully considering the IRA that is the source of the

RMD, having the distribution made in property instead of cash, and other strategies. See our March 2017 and November 2017 issues for details.

Plan for the SECURE Act and to reduce future RMDs.

You can solve two problems with one set of moves. Many people don’t need the RMDs to fund their retirement spending, because they have other assets and income sources that generate sufficient cash flow.

They intend to leave the IRAs to their heirs and have the heirs benefit from the IRA over decades through a Stretch IRA. But they find as they enter their late 70s and beyond, the RMDs trigger higher and higher distributions, which trigger higher income taxes.

On top of the tax issues, the SECURE Act would upset the plan to leave IRAs to heirs. The law, which passed the House of Representatives by a wide margin in May and is likely to pass the Senate later this year, would eliminate Stretch IRAs for most heirs. After being inherited, an IRA would have to be distributed and taxed within 10 years. Fortunately, there are strategies that can increase family after-tax wealth, reduce lifetime RMDs, and create the equivalent of Stretch IRAs if the SECURE Act becomes law. For details about the SECURE Act and the strategies to consider, review our July 2019 issue.

Review charitable contributions.

IRA owners older than 70½ should consider making their charitable contributions through qualified charitable distributions (QCDs).

You direct the IRA custodian to make a distribution to a charity or issue you a check made payable to the charity. The gift counts as part of your RMD for the year but isn’t included in your gross income. You receive no charitable contribution deduction for the gift.

QCDs are limited to $100,000 annually per taxpayer. Only contributions to public charities qualify, not gifts to donor-advised funds or private foundations. See our April 2019 issue for more details.

Have you made maximum contributions?

For IRAs, you have until April 15, 2020, to make contributions for 2019. But it’s usually better to make the contributions earlier. The contributions will be invested and earning tax-sheltered returns within the IRA.

Review beneficiary designations.

Many people haven’t looked at their retirement plan beneficiary designations in years. The designations should be reviewed every year or so. Are the named beneficiaries still the best choices? Should the choices change in light of the SECURE Act?

When you plan to leave part of your estate to charity, consider making the gift through an IRA by naming the charity as an IRA beneficiary. The other assets in your estate that would have gone to the charity should be left to your loved ones. The charity won’t owe taxes on the IRA Distribution, but your family would if they inherited it.

Do you want taxes withheld?

Many retirees don’t pay the proper amount of estimated taxes during the year and owe penalties after the year closes. Estimated taxes have to be paid as income is earned during the year to avoid penalties. You can’t avoid the penalty by making one large lump sum estimated tax payment late in the year, or after the year closes.

One way you can avoid the penalty is to have income taxes withheld from IRA distributions made late in the year. Withheld taxes are treated as paid evenly during the year, even if the with-holding was bunched late in the year. If you’re taking a large IRA distribution in the last part of the year, consider directing the custodian to withhold for income taxes enough to cover any shortfalls in your estimated taxes.

How will you pay annual fees?

Often, taxpayers were urged to pay any fees associated with their IRAs separately using non-IRA funds. This created the potential to deduct the fees as miscellaneous itemized expenses on Schedule A of Form 1040.But the 2017 tax law eliminated the miscellaneous itemized expense deduction for investment fees and expenses.

But few taxpayers were able to deduct their IRA fees as miscellaneous itemized expenses before the law change because their total miscellaneous itemized expenses had to exceed 2% of adjusted gross income to be deductible.

Not many taxpayers exceeded that threshold. Some advisors say it is better to have traditional IRA fees paid directly from the IRA. The payment isn’t treated as a distribution. You receive the equivalent of a tax deduction, because pre-tax money in the IRA is used to pay the expense.

I think it’s better to pay the fees using money outside of an IRA, whether it’s a traditional or Roth IRA. That’s because the IRA is tax-advantaged. Let as much money as possible stay invested in the IRA to generate returns that compound free of income taxes. Pay your fees from non-IRA accounts.

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