Year-end IRA tidying
The end of the year is a good time for wise investors to take the opportunity to review, among other things, their retirement accounts. To help you consider what to do about your IRAs (Individual Retirement Arrangements), Debi Rybicki answered some frequently asked questions.
Why should I be contributing to an IRA?
Especially if you don’t have an employer-sponsored retirement savings account, your IRA may be your most important investment vehicle for retirement.
Do not underestimate the power of tax-deferred compound earnings in your IRA. Make sure your IRA is fully funded up to the limits set by the Internal Revenue Service. Have as much money as possible work for you on a tax-favored basis. The more you contribute each year, the more you save in taxes, and the larger your retirement savings. Because of the magic of compound growth, shorting your IRA even a few hundred dollars can mean the difference of thousands of dollars later on.
When should I contribute?
The best time to make an IRA contribution is the first business day of each year. Savers who choose to invest their IRA contributions at the beginning of the year have much better long-term results. There are negative consequences to delaying your IRA contributions until the end of the year or waiting until the filing deadline in April.
Annual IRA contributions can be made between Jan. 1 and April 15 of the following year. Because of the extra three and a half months, when you send in a contribution for your IRA between January and April, be sure to indicate the year of the contribution.
Can I deduct my contributions?
Many savers can deduct their IRA contributions from their gross income. Eligibility for this deduction is determined by your modified adjusted gross income and whether you are eligible to participate in an employer-sponsored pension plan or contributory plan such as a 401(k). (Please see IRS Publication 590-A for further details.)
If you can’t deduct your contribution, see if you qualify for making a contribution to a Roth IRA.
Although not typically recommended, you can make a non-deductible contribution to a traditional IRA in any calendar year. However, once you make a non-deductible contribution, you’re committed to doing the paperwork when you take any money out of the IRA. You cannot separate deductible and non-deductible IRA contributions by keeping separate IRA accounts.
Can my spouse and I both contribute, even if only one of us works?
Married couples with only one wage earner may each contribute the full amount to their respective IRA accounts. Note that total contributions are limited to your total gross income. You may not contribute more than you earn.
Are there age limits for making contributions?
If you are 70½ and older, even if you are still working and earning income, you are not eligible to contribute to a traditional IRA. You can still contribute to a Roth IRA after 70½, provided the contribution does not exceed your earned income for the year and you meet adjusted gross income eligibility guidelines.
What about minor children?
As long as a minor child has taxable compensation income, he or she can contribute to a minor traditional or Roth IRA (although the traditional IRA does not likely provide much tax benefit). The maximum contribution for 2016 is $5,500 or 100% of earned income, whichever is less. The account must be opened and held by an adult, as guardian, in the name of the minor. While the adult is the individual authorized to perform transactions on the account, the minor is considered the registered owner for tax purposes.
How soon can I withdraw money from my IRA?
IRAs are designed not to be touched before the magical age of 59½. Doing so incurs the wrath of the IRS, which can force you to pay taxes on the withdrawal as well as a 10% early-distribution penalty. Here are some possible exceptions to the penalty (Please refer to IRS Publication 590-B for details.):
- You have unreimbursed medical expenses that are more than 10% (or 7.5% if you or your spouse was born before January 2, 1950) of your adjusted gross income.
- The distributions are not more than the cost of your medical insurance due to a period of unemployment.
- You are totally and permanently disabled.
- You are the beneficiary of a deceased IRA owner.
- You are receiving distributions in the form of an annuity.
- The distributions are not more than your qualified higher education expenses.
- You use the distributions to buy, build, or rebuild a first home.
- The distribution is due to an IRS levy of the qualified plan.
- The distribution is a qualified reservist distribution.
What about IRA withdrawals after I’m 59½?
Distributions from a traditional IRA can be made penalty-free at 59½. Required minimum distributions begin the year you turn 70½.
You can take withdrawals from a Roth IRA once you are 59½ as long as the account has been in existence for at least five years. Unlike traditional IRAs, there are no required distributions with a Roth. You can withdraw your contributions (but not earnings) from a Roth IRA at any time for any reason without penalty.
So I have to take out money after a certain age?
IRS rules stipulate that required minimum distributions (RMDs) from a traditional IRA must begin by age 70½. The custodians of your IRAs must report these distributions to the IRS to be sure Uncle Sam gets his share of taxes from those withdrawals.
In the year that you turn 70½, you may postpone your first distribution until April 1 of the following year (Note: That is prior to the tax-filing deadline of April 15.). If you postpone your first distribution, you must take two distributions in the following year. If that double distribution would affect your tax rate, consider taking your first distribution in the year you turn 70½.
Generally, the minimum amount you’re required to withdraw from your retirement account is based on your age and the value of your account. Please click here for an RMD calculator from the Financial Industry Regulatory Authority.
If you are older than age 70½, be sure you take your RMD each year. This is important because there is a 50% penalty imposed on any shortfall. You can always take more than the minimum required. We do our best to work with clients, but the responsibility for IRA withdrawals rests on the account holders.
If your distribution is taxable, be sure you have sufficient tax withholding at the time of your distribution to avoid penalties for under-withholding. Check with your accountant if you choose not to withhold at the time of the distribution.
Also, when setting up systematic withdrawals from a particular fund within your account to meet your RMD, make sure you know what happens if that fund runs out of money. You want to be sure you have enough to fund the distribution. Many IRA custodians do not notify the advisor or the client if there is not enough to cover the distribution needed. They simply wait to receive further instructions. Consider taking proportional distributions from multiple funds to avoid this problem.
How does it work if I have more than one IRA?
If you have multiple IRAs, it is the sum of all your IRAs (excluding Roth IRAs) and your age that determine the minimum distribution. Once determined, the minimum can be taken from just one or multiple IRAs. This is helpful if there is an investment you would like to avoid touching. Please note that 401(k)s and 403(b)s must be done separately.
What if I don’t need to spend the money I’m required to take out?
If you do not need the proceeds from your distribution, consider re-registering the asset. In many instances, there are no costs associated with transferring a security in-kind from your IRA account into your retail account (individual, joint, or trust). Please keep in mind that any tax withholding you request is required to be paid in cash, so there may be transaction fees associated with making the cash available. Also, you must have an existing account established to accept the asset.
Can I donate my required minimum distribution to charity?
Yes. Using what are known as Qualified Charitable Distributions (QCDs), the owner of an IRA who is over age 70½ can directly transfer IRA funds – including RMDs – up to $100,000, to a charity without having to declare the distribution as income. This rule is attractive not only because it avoids having to pay taxes on the distribution, but also because increased income can push retirees into higher tax brackets for Social Security tax purposes and can make them liable for higher Medicare payments.
Under the QCD rules, the IRA owner must be 70½ or older on the date of the distribution. A beneficiary of an inherited IRA can be eligible for a QCD as well, as long as the beneficiary is at least age 70 ½ on the date of the distribution.
While the process of completing a QCD to a charity is fairly straightforward, the key administrative requirement is that the distribution check must be made payable directly to the charitable entity. If the funds go to the IRA owner and are then passed along to the charity, it is considered a taxable distribution to the IRA owner and not a QCD. The check can be mailed to the IRA owner, as long as the check is payable to the charity.
Please note: Signed paperwork is required to process this request.
Can I ever borrow money from my IRA?
You have a 60-day grace period to pay back IRA withdrawals – except for required minimum distributions, which must be removed permanently from the account. You can use this provision only once per 12-month period, including rollovers from one IRA to another.
This means that you can withdraw money from one IRA with no tax effect as long as you re-deposit it within 60 days of the withdrawal. Funds not re-deposited are considered a distribution and subject to income tax and the penalty tax, if applicable.
This provision does not apply to inherited (beneficiary) IRA accounts.
How do RMDs work for inherited IRAs?
You must take annual RMDs if you inherit an IRA or an employer-sponsored retirement plan account from someone who wasn’t your spouse – even if the IRA is a Roth IRA. This calculation is based on the life expectancy of the beneficiary who inherited the account. If the beneficiary neglects taking the required distributions, IRS rules require the account to be paid out in full before the end of the fifth year – rather than over the beneficiary’s lifetime.
IRAs simply are one of the best ways to save for retirement, but they are not simple arrangements. The general information here may not apply to your specific situation. See your advisor and tax professional for more information.
Debi Rybicki is a registered representative at Landaas & Company.
initially posted Nov. 29, 2012; revised - Dec. 3, 2015; Nov. 15, 2016