Last minute tax moves: IRA tax strategies

Key Points

  • With legislative changes on the docket, IRA tax strategies may not be as straightforward when it comes to your 2016 tax bill.
  • Those in or near retirement should carefully consider their tax bracket and any potential changes that could reduce their tax rate before withdrawing funds from a Roth IRA
  • If you are nearing retirement and tax rates are lowered by new leadership in Washington, reducing your 2017 tax bill and benefiting from lower future tax rates than you may have planned for could be a win-win.

With legislative changes on the docket, IRA tax strategies may not be as straightforward when it comes to your 2016 tax bill. There are two primary actions you could take before April 18, 2017 to boost your retirement savings while lowering your 2016 tax bill:

  • Open a Roth IRA
  • Invest in a traditional IRA

Here are key questions to consider before meeting with your financial advisor and tax planner to do a cost-benefit analysis for your individual situation.

 

How have Roth IRAs been affected?

The conventional wisdom around a Roth IRA is that if taxes are going to be higher when you retire, it makes sense to invest as much as possible in a Roth IRA. Why? While there are no pre-tax savings up front, such as with a 401(k), funds from a Roth IRA are not taxed when you withdraw them.

But with new tax brackets being proposed, the equation is not so simple, according to Bob Keebler, CPA and Partner at Keebler & Associates, LLC. “You don’t want to invest in a Roth at a higher bracket only to see your tax rate go down when it comes time to take withdrawals,” Keebler says.

For those nearing or in retirement

If new leadership in Washington lowers tax rates, investing in a Roth IRA now could lose some of its advantages for those closer to retirement — depending on income and tax rate.

Already retired? You may want to wait to see if tax rates do go down before withdrawing funds, as Roth IRAs are not subject to required minimum distributions. However, if you’re thinking purely in terms of legacy planning, it’s important to remember that Roth IRAs still pass on to heirs tax-free.

"Leaving a Roth IRA to children or grandchildren is a powerful wealth transfer strategy." — Bob Keebler, Partner, Keebler & Associates

For those with higher incomes

So what about Roth IRA conversions that allow higher earners to convert a traditional IRA to a Roth? “Conversions had to be done by December 31, 2016, but if you’ve already converted, you can undo or recharacterize before April 18, 2017 if you decide you converted too much based on projected tax implications,” Keebler says. If you undo a conversion by the due date for your tax return, you can treat the contribution as a traditional IRA for that year.

Roth IRA income limits

"The rule of thumb is never to convert to a Roth if you are going to be in a lower tax bracket in the future." — Bob Keebler, Partner, Keebler & Associates

Impacts for traditional IRAs

Is your income too high to contribute to a Roth IRA? Traditional IRA contributions may also be deductible from last year’s taxes. While a traditional IRA has fewer income limits, you will be required to begin taking distributions at age 70 ½, and you will pay taxes on those withdrawals.

That said, if you are nearing retirement and tax rates are lowered by new leadership in Washington, reducing your 2017 tax bill and benefiting from lower future tax rates than you may have planned for could be a win-win. “Unless you are in the 15% tax bracket, it may be wise to defer distributions,” Keebler says.

Combined traditional and Roth IRA contribution limits

What if I’ve reached my contribution limits?

Remember, tax-advantaged limits don’t mean you can’t save more for retirement. “If you are contributing the maximum to your employer plan such as 401(k) and to your IRAs, you can still invest in non-deductible accounts such as mutual funds or annuities,” Keebler says.

Talk to your advisor about Roth IRA conversions and other ways to get your money in a place where it’s working for you.