Don’t let the year slip away without doing a little tax planning – the financial benefits will be worth your time. All of the below tips and reminders must be done by December 31, or you either forfeit the opportunity or pay penalties.
1. Max Out Qualified Plan Contributions
If your cash flow can stand it and you haven’t maxed out your 401(k) or 403(b) yet, talk to your payroll department to increase your contribution before December 31st.
For those under 50, the maximum contribution is $18,000, and for those over 50, the maximum contribution is $24,000. At the very least, be sure you’ve contributed up to any employer match.
2. Take Minimum Required Distributions (MRD’s) from Inherited IRA’s
If you have inherited an IRA from someone other than your spouse, you must take minimum required distributions beginning the year after the death of the original owner and by December 31st of that year.
To calculate the MRD, the IRS has a Single Life Expectancy table you can find by searching the IRS website. Or, Schwab and Fidelity and other custodians have on-line calculators to help you with the calculation. Be sure to have on hand the date of death and birthdate for the original owner and the balance of the account on December 31 of the previous year.
3. Take Required Minimum Distributions RMD’s from your Retirement Accounts.
As an owner of a traditional IRA, SEP, Simple IRA or company retired plan (401(k), 403(b) or 457 plan, you must start receiving distributions by April 1 of the year following the year in which you reach age 70½. You figure your required minimum distribution for each year by dividing the account balance of December 31 of the preceding year by the applicable life expectancy. Life expectancy tables are located on the IRS website. You must calculate the RMD separately for each IRA that you own, but you can withdraw the total amount from one or more of the IRAs.
Similarly, a 403(b) owner must calculate the RMD separately for each 403(b) contract that he or she owns but can take the total amount from one or more of the 403(b) contracts. However, RMDs required from other types of retirement plans, such as 401(k) and 457(b) plans have to be taken separately from each of those plan accounts.
If you don’t need the money and want to avoid tax, some or all of your required RMD can be donated directly to a charity. The donation counts as your required minimum distribution but doesn’t increase your adjusted gross income, which can be beneficial if you don’t itemize and can’t deduct charitable contributions.
Also, keeping some or all of your RMD out of your adjusted gross income could help you avoid the Medicare high-income surcharge or make less of your Social Security income taxable. The money needs to be transferred directly from the IRA to the charity to be tax-free.
If you withdraw it from the IRA first and then give it to the charity, you can deduct the gift as a charitable contribution (if you itemize), but the withdrawal will be included in your adjusted gross income.
4. Roth IRA Conversions
If you have a traditional IRA, you might want to consider converting some or all of the balance to a Roth IRA. Roth IRA’s are a valuable tax-planning tool due to the favorable tax status once the money is inside the Roth IRA.
If all the rules are followed, you may never pay tax on your Roth balance and your heirs may not either. However, tax is due when you convert an IRA to a Roth, so the conversion makes sense if your income is lower than usual or you believe that your tax rate will be higher in future years. For example, if your income dropped in 2016 due to a job change, you might consider converting some of your IRA to a Roth because you will be in a lower tax bracket and pay fewer taxes than you might in future years. Be sure and take note that under Trump’s new tax plan, your tax rate maybe lower next year.
The deadline for conversions is December 31, 2016, but you will want to do this by at least December 22nd to make sure the paperwork gets processed with your custodian.
5. Establishing a New Qualified Retirement Plan
If you are self-employed and want to establish a qualified plan such as a 401(k), money purchase, profit-sharing or defined benefit plan, it must be set up by December 31st. Many people confuse this deadline with the SEP IRA deadline that can go into the next year, including extensions.
You can set up a SIMPLE IRA plan effective on any date between January 1 and October 1, provided you (or any predecessor employer) didn’t previously maintain a SIMPLE IRA plan. If you’re a new employer that came into existence after October 1 of the year, you can establish the SIMPLE IRA plan as soon as administratively feasible after your business came into existence.
6. Review Your Charitable Contributions
If you itemize deductions and are charitably minded, you will want to donate what you plan to before December 31st. You may deduct an amount up to 50% of your adjusted gross income, but 20% and 30% limitations apply in some cases. Good to know: donations made by check are considered delivered on the day you mailed it.
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