Two of the most common topics of year-end tax planning revolve around traditional IRAs – Contributions and Required Minimum Distributions (RMDs). For those who are still in the accumulation phase and can take advantage of the opportunity, it’s important that they consider maximizing their IRA contributions – although you have until April 17, 2017 to make your contribution for 2016. The contribution limits for 2016 are $5,500 for investors under the age of 50 and $6,500 for investors age 50 and above. Not only does this allow you to invest more towards retirement, but it allows you to lower your adjusted gross income (AGI) for the year. Roth IRA contributions do not offer a deduction as the contributions are made with after-tax funds.
For those individuals who are over the age of 70 ½, it is important they take their required minimum distribution, or RMD, by December 31st. It’s important to note that if you are retired, 401(k)s are also subject to RMDs. Failure to take your RMD by the end of the year will result in a penalty of 50 percent of the amount that should have been distributed, which is in addition to the income taxes owed.
If you turned 70 ½ this year, you may defer your RMD for 2016 until April 1, 2017. However, that means you will have to take two RMDs in 2017. Deferring one’s RMD is typically not the best practice, but there are some situations where it does make sense to the individual. For example, if you are currently still working, but plan on retiring at the end of this year; then deferring your RMD will allow you to take two RMDs the following year when your income is presumably lower.
Another option for those with a traditional IRA is a Roth conversion. A Roth conversion is simply converting the pre-tax funds in a traditional IRA into after-tax funds which will be placed into a Roth IRA. Converting a traditional IRA has tax consequence as you will have to pay income taxes on most or all of the amount converted. Roth conversions are not right for everyone, but, looking at conversions in a tax planning context allows investors to minimize that tax impact. This is especially true, when coupled with charitable giving.
That wraps up part one of this series on tax-planning. If you have questions on how you can apply these tactics to your year-end tax planning, be sure to get in touch with your Investment Counsellor and Tax Adviser.