Year-End Strategies for IRA and 401(k) Owners

As 2023 winds down, you need to engage in end-of-the-year IRA manage- ment, plus develop a multi-year strategy for your retirement plans that acknowledges the 2017 tax law will expire after 2025. Here are critical questions about retirement plans you need to review.

Should a traditional IRA be repo- sitioned? Individuals with substantial traditional IRAs plus other assets and sources of income should consider whether to reposition the IRAs. Often, they don’t need all the IRAs to fund their retirement and plan to take only required minimum distributions (RMDs) and leave the rest to their heirs.

But the RMDs become inconvenient and expensive over the years. Under the life expectancy tables used to com- pute RMDs, a higher percentage of the IRA must be distributed each year. The RMDs often exceed what the owners need to meet expenses and increase income taxes. The income taxes will increase more if the 2017 tax law expires. In addition, most beneficiaries must distribute inherited IRAs within 10 years and pay income taxes on dis- tributions from the traditional IRAs.

The 10-year rule increases the income taxes and reduces the after-tax amount inherited by the beneficiaries. If you’re in this situation, consider re- positioning the IRA. This can increase lifetime after-tax wealth for both you and the family. Repositioning strategies include converting a traditional IRA to a Roth IRA, using distributions from the IRA to buy permanent life insurance, funding a charitable remainder trust with IRA distributions, and more.

For details about the strategies and when to consider them, review our March and April 2023 issues. Have you optimized required mini- mum distributions?

You’re required to take RMDs from traditional IRAs and 401(k)s by Dec. 31 each year. RMDs must start at age 73 for anyone born from 1951 through 1959. There are ways to reduce the taxes, cost and inconvenience of RMDs. For example, 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. RMD optimization strategies in our May 2023 issue can be used to create a plan for the rest of 2023 and for 2024. Consider qualified charitable distributions The qualified charitable distribution (QCD) often is the most tax-efficient way for someone older than age 70½ to make charitable gifts. Have the IRA custodian make a distribution directly to a charity or give you a check payable to the charity.

The distribution isn’t included in your gross income, yet it counts toward the year’s RMD. (QCDs can begin after age 70½, though RMDs don’t begin until age 73.) You can make up to $100,000 of QCDs annually. Details about QCDs are in our April 2022 issue. Also, con- sider the new Legacy IRA, discussed in our June 2023 issue. Plan retirement account distributions with tax brackets in mind Distributions from traditional IRAs are taxed as ordinary income. Distribufrom Roth IRAs and health savings accounts (HSAs) usually are tax free. The taxes vary for assets sold in taxable accounts based on the asset sold.

You receive some income each year over which you have no control, such as Social Security, RMDs, and interest and dividends in taxable accounts. When that income doesn’t meet your spending needs, you can choose the sources of the additional cash. To minimize your income taxes, estimate the taxable nondiscretionary income you’re likely to receive this year. Then, consider the tax effects before deciding on the sources of additional income. If a taxable distribution, such as from a traditional IRA, might push you into the next higher tax bracket, you may want to take the distribution from a tax-free account, such as a Roth IRA or HSA.

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, consider selling appreciated investments until you reach the top of the 0% bracket. Taking additional distributions from a traditional IRA might be the best move when you’re in a low tax bracket this year because of reduced income or increased deductions.

A more detailed discussion of tax bracket management is in our April 2019 issue. Are beneficiary designations correct? I mention this at least once a year, because it’s important. As demonstrated in a number of IRS rulings and court cases, a retirement account is inherited by whoever is named as beneficiary in the IRA custodian’s records, 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. Be sure you’ve designated at least one individual beneficiary and it’s who you still want to inherit the account. Consider naming contingent beneficiaries in case something happens to the primary beneficiary. When you plan charitable bequests, make them by naming the charity as an IRA or 401(k) beneficiary. Your heirs end up with more after-tax wealth if the charity’s inheritance is an IRA or 401(k) beneficiary.

If you named a trust as a retirement account beneficiary, be sure to review with your estate planner the significant and unfavorable changes made by the SECURE Act in 2019. See the July 2023 issue for details. Have you optimized contributions? The best strategy often is to maximize health savings account (HSA) contributions first when you’re eligible, though contributing enough to a 401(k) to maximize employer matching contributions before giving to an HSA also is a good strategy.

Remember there’s no longer an age limit on contributions to either traditional or Roth IRAs, though contributions still can’t exceed your earned income for the year. When you’re still working and can participate in a 401(k) plan, review how much of your 2024 paychecks to defer to the 401(k). Also, consider using the Mega Roth IRA and Back Door Roth IRA strate- gies discussed in our September 2021 issue. The 2024 limits for IRA contributions and 401(k) deferrals will be announced sometime in December.