It is the last quarter of the year, so there are some critical questions about IRAs and 401(k)s that should be asked and answered. And that could potentially mean key actions to take the rest of this year, and early in 2023.
Retirement plans are among the most valuable assets of most people, so it’s important to manage them well and take advantage of opportunities.
Here are my seven most urgent retirement planning questions you should review, as the close of this year approaches.
1. Are beneficiary designations correct?
I mention this at least once a year because it’s that important. There can be dreadful consequences to not designating beneficiaries or having outdated beneficiary designations.
The account is likely to go to the wrong person or people, or it might go to the individuals you intended but at a higher tax cost.
As demonstrated in a number of IRS rulings and court cases, the account goes to whoever is named as the beneficiary, regardless of what the will or other documents say.
(Do an internet search for “pension pickle” for an example.) If there’s no beneficiary designation, the custodian’s policies determine who inherits the IRA.
Review the beneficiary designation, whether it’s a paper form or online. Be sure you’ve designated at least one beneficiary and it’s who you still want to inherit the account.
Also, be sure to name contingent beneficiaries in case something happens to the primary beneficiary.
If you plan to leave part of your estate to charity, consider naming the charity as an IRA or 401(k) beneficiary. That leaves your heirs with more after-tax wealth than if the charitable gift were made with other estate assets and the heirs were the only retirement account beneficiaries.
If you named a trust as a retirement account beneficiary, be sure to review the consequences with your estate planner.
The SECURE Act, enacted in late 2019, made significant and unfavorable changes. You might want to change the strategy. (Paid-up members of my Retirement Watch newsletter have access to these changes as well as my favorite strategies.)
2. Have you optimized contributions?
If you’re under age 65 and qualify to make health savings account (HSA) contributions, consider maximizing HSA contributions before IRA and 401(k) contributions. 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 first might want to contribute enough to a 401(k) to maximize employer matching contributions.
You can make contributions to IRAs at any age. A recent law removed the prohibition on contributions to traditional IRAs after age 70½, and there never was an age limit on Roth IRA contributions. You still can contribute only to the extent you have employment or self-employment income (not investment or pension income).
The contribution limit is $6,000 in 2022, and another $1,000 for those ages 50 and older. You can divide the contribution between traditional and Roth IRAs or put all of it into one type of IRA.
When you’re still working and can participate in a 401(k) plan, review how much of your paycheck to defer to the 401(k) next year. Tax-deferred 401(k) contributions are capped at $20,500 in 2022.
Remember you can make additional after-tax deferrals to a 401(k) until your total contributions are $61,000 in 2022 ($67,500 if you’re 50 or older). You can use the 401(k) after-tax deferrals to build a large Roth IRA.
There were proposals to eliminate this strategy in 2021, but they weren’t enacted and there’s little prospect they’ll be enacted anytime soon.
The 2023 deferral and contribution limits will be announced sometime in December.
3. Should you make 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. 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 (required minimum distribution) for the year. Qualified charitable distributions can begin after age 70½, though RMDs don’t begin until age 72. You can make up to $100,000 of QCDs annually.
If you like the strategy, it’s important to plan to implement the QCD early in 2023. The first distributions from a traditional IRA are automatically earmarked as RMDs.
If you’re taking IRA distributions to pay for living expenses, you might satisfy the year’s required minimum distribution before you can schedule a qualified charitable distribution.
Make the QCD early in the year.
4. Have you optimized required minimum distributions?
Of course, you want to take any required minimum distributions (RMDs) by Dec. 31. RMDs were suspended only for 2020. RMDs are required after age 72 for anyone who turned 70½ after 2019.
You don’t have to sell assets and distribute cash. A distribution can be made in kind by having the custodian transfer shares of stocks, mutual funds, or other investments to a taxable account.
The distribution amount is the value of the asset on the day of the distribution.
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, a beneficiary must take the RMD and include it in his or her income.
5. Should an IRA be repositioned?
Under the life expectancy tables, a higher percentage of the IRA must be distributed each year.
When the owner has a substantial IRA and has other assets and sources of income, the RMD often exceeds what the owner needs to meet expenses.
Increasing RMDs can create income tax problems for the IRA owner. In addition, most beneficiaries who inherit IRAs must distribute the IRAs within 10 years and pay income taxes on the distributions from traditional IRAs.
Consider repositioning your IRA to reduce future RMDs and avoid the 10-year distribution rule for heirs.
This will increase lifetime after-tax wealth for both you and the family. 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.
6. Can you avoid estimated tax penalties?
Most retirees must make estimated income tax payments four times during the year, because they don’t have paychecks from which taxes are withheld. The payments must be made during the year as income is received.
You can’t avoid the penalties by making one big, estimated tax payment near the end of the year. An alternative is to have income taxes withheld from a traditional IRA distribution made before the end of the year.
When taxes are withheld from a payment, they’re treated as being withheld evenly during the year, even if one large amount was withheld near the end of 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.
7. Are distributions planned with tax brackets in mind?
Distributions from traditional IRAs are taxed as ordinary income. Distributions from Roth IRAs and HSAs usually are tax free.
Selling assets in taxable accounts can have different tax consequences, depending on the asset sold.
When you have discretion on the source of additional cash, estimate the taxable income you already have this year and the income you anticipate receiving the rest of the year over which you have no control.
Then, consider how the choice of your distribution would affect your tax bill. If a taxable distribution might push you into the next higher 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.