Individual Retirement Accounts: What You Need to Know

 

The 2023 income tax filing deadline is only days away (April 15, 2024 in most of the U.S.). It will be a busy weekend for many taxpayers and tax preparers who are filing tax returns or tax filing extensions.

One of the few things that taxpayers can do to reduce their income taxes after a calendar year ends is to make a tax-deductible contribution to a traditional individual retirement account (IRA) or a SEP-IRA (for small business owners and/or their employees). The maximum contribution for traditional IRAs for 2023 was $6,500 for workers under age 50 and $7,500 for those age 50+.

 

I recently attended a Financial Planning Association (FPA) webinar about traditional and Roth IRAs presented by Ed Slott, a nationally recognized expert on IRAs and frequent presenter at conferences for financial advisors. Below are nine take-aways from his presentation:

Roth IRA Contributions- Roth IRA contributions are funded with after-tax dollars (i.e., money that has been taxed) and can be withdrawn at any time for any reason tax-free and penalty-free.

 

Taxpayer Services- There is a big difference between tax preparation and tax planning. Tax preparation is based on past history; i.e., what already happened during the previous calendar year. Tax planning involves looking ahead and projecting future income and tax write-offs.

 

Baby Boomer Challenges- Baby boomers (born 1946-1964) were the first generation with the ability to save money for retirement in 403(b)s, 401(k)s, and IRAs for decades (their parent’s generation had pensions). Many have accumulated significant sums and need tax planning help.

 

Roth Conversions- Any pre-tax dollar funds that are converted (e.g., from a traditional IRA to a Roth IRA) must be included as ordinary income in the year that a Roth conversion is made.

 

RMD Inevitability- Required minimum distributions (RMDs) are inevitable if you have a traditional IRA (unless you make qualified charitable distributions), SEP-IRA, or qualified employer retirement plan (i.e., 401(k), 403(b), 457, or Thrift Savings Plan). There is no way out.

 

Five-Year Clock- The five-year clock to determine tax-free withdrawals of earnings on a Roth IRA starts on January 1 of the year of the first contribution or conversion to any Roth IRA.

 

Roth Conversion Opportunity- Between 1944 and 1963, the top U.S. tax bracket was over 90%. Mr. Slott noted that we are currently at some of the lowest tax rates ever and that people should consider moving money from traditional to Roth accounts now- before tax rates rise again.

 

Strategic Planning- Taxpayers with large tax-deferred accounts were described as “sitting ducks.” Two proactive strategies to mitigate taxes are 1. elective withdrawals between age 59½ and 73 (or 75) to spread taxes out over more years and 2. a series of small Roth conversions. Do Roth conversions near the end of a year when you have a better idea of your income for that year.

 

Charities As Beneficiaries- People may decide to name a charity as the beneficiary of their tax-loaded retirement savings accounts and gift money in taxable accounts (with a stepped-up basis) to family members. This relieves family members of RMD hassles and the only loser is the IRS.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.