How Timing Impacts RMDs, Roth Conversions, And Year-End Taxes

A common theme across personal finance literature is that the end of the year brings important financial housekeeping tasks. Budgeting and insurance reviews are important, but can be tackled throughout the year. The true housekeeping that should be done by the end of the year centers around an old saying in personal finance, “It’s not about what you earn, it’s about what you keep.” This saying stems from the idea that saving and tax strategies are key to a successful financial picture and future.

Required minimum distributions (RMDs) vary based on age and registration of an account. Although RMDs can be combined across IRA’s, a separate one must be taken from any employer sponsored plans and any inherited IRAs. Although a cutoff day for the IRS is December 31st of the current year, it is imperative to contact the custodian of your account early in the month. Due to administrative processing and workload many custodians have a cutoff date earlier in December which moves the request to “best efforts”. A best practice is to have the RMD set up for automatic distribution. Not taking the RMD can create up to a 25% penalty of the shortfall of the RMD not taken. This penalty can be reduced to 10% if corrected within the following two years. When philanthropy is intended, the RMD from a traditional IRA can be taken tax-free when donating to a qualified charity. Contact your custodian to review the amount of your RMD along with the options when taking it early in December. One exception to the December 31st cutoff date for RMDs is the first year an RMD is required. The IRS gives an extension to April 1st of the following year for those taking their first RMD.

Along with RMDs, Roth conversions are required by December 31st. The conversion will increase the current year tax burden, however may help to reduce taxes on future RMDs or help create a tax advantageous legacy. A common misconception is that all or most traditional retirement money should be converted to Roth, when in actuality, the amount of a Roth conversion is based on individual circumstances and calculations must be done on an individual basis. Consider the amount of future RMDs, the current tax bracket versus the expected future tax bracket, income-related monthly adjustment amounts (IRMAA) effects on Medicare, and income needs within the next 5 years. Similar to RMDs, Roth conversions must be fully processed by December 31st of the current year.

While Health Savings Accounts (HSA) allow for unused funds to be rolled over indefinitely, employer sponsored Flexible Spending Accounts (FSA) typically have a December 31st cutoff date. Depending on plan rules, an FSA may have a grace period into the next year. Thus, knowing plan rules around an FSA is imperative to not lose these highly tax advantageous funds.

Employee contributions to certain employer sponsored retirement accounts must be done by December 31st. If current income allows, consider increasing contribution amounts for the last few pay periods. If non-retirement savings are increasing throughout the year, consider creating a budget for the following year to increase contributions throughout the year. Dollar-cost averaging reduces timing risk by spreading investment purchases across market conditions. While using tax-advantaged strategies throughout the year is ideal, certain actions must be completed by December 31 and should be reviewed annually. Contacting the custodian of accounts and evaluating current tax status is vital to the successful execution of these strategies.

As always, it is important to consult a tax or investment professional before making these important decisions.

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This document is for educational and informational purposes only and does not constitute an advertisement or solicitation of any securities or investment services provided Mainstay Capital Management, LLC (“MCM”). This document should not be construed as investment, tax, or legal advice, or a solicitation, or a recommendation to engage in any specific strategy. MCM is an independent investment adviser registered with U.S. Securities and Exchange Commission. MCM specializes in workplace savings plan portfolio management and retirement planning advice for active employees and retirees. This document was prepared by MCM primarily based on data collected and analyzed by MCM. The opinions expressed herein are those of MCM alone and are for background purposes only. MCM does not purport the analysis to be full or complete or to constitute investment advice and should not be relied on. In addition, certain information contained herein or utilized to draw the conclusions contained herein has been provided by, or obtained from, third party sources. While MCM believes that such sources are reliable, it cannot guarantee the accuracy of any such information and does not represent that such information is accurate or complete. All materials and information are provided “as is” without any express or implied warranties by MCM. MCM charges its fee based on a percentage of assets under management, which creates an incentive and conflict of interest to increase assets in that account. Furthermore, MCM has two different fee schedules, and therefore has a conflict of interest when assets or accounts move from the lower fee schedule to the higher fee schedule. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Consult your financial professional before making any investment decision. Please see MCM’s Form ADV Part 2A and Form CRS for additional information.