End-of-Year Financial Planning: Roth IRAs and RMDs

As the end of the year approaches, it can be an ideal time to review your financial plans and help ensure you’re making the most of your retirement savings. 

Two key areas to consider in your year-end planning are Roth IRAs (Individual Retirement Accounts) and Required Minimum Distributions (RMDs). Understanding the rules surrounding these accounts can keep you compliant with tax regulations and help ensure your savings continue to grow effectively. Here’s what you should know.

This blog is for educational purposes only and not intended as specific financial advice. It is always recommended that you consult with a licensed financial advisor or tax professional for specific guidance tailored to your unique financial situation.

What Is a Roth IRA?

A Roth IRA is a retirement account that offers the benefit of tax-free growth and tax-free withdrawals, as long as certain conditions are met. Unlike traditional IRAs, where contributions are made pre-tax and taxed when you take them out, Roth IRA contributions are made with after-tax dollars.

The big advantage? Your investments can grow tax-free, and when you reach retirement (after age 59½ and having held the account for at least five years), you can withdraw your money without paying any taxes on it. This can make a Roth IRA a powerful tool for helping build tax-free income in retirement.

End-of-Year Considerations for Roth IRAs

  1. Contribution Deadlines: While Roth IRAs offer attractive tax benefits, contributions must be made by the tax-filing deadline (typically April 15) for the previous year. Starting your year-end planning now can help ensure you’re able to contribute up to the annual limit ($6,500 for individuals under 50 in 2024, and $7,500 for those over 50 with the catch-up contribution).
  2. Income Limits: Not everyone is eligible to contribute directly to a Roth IRA. For 2024, if your modified adjusted gross income (MAGI) exceeds $153,000 as a single filer or $228,000 as a married couple filing jointly, your ability to contribute is reduced, and you may not be eligible to contribute directly at all. However, there may be other strategies worth exploring, such as a backdoor Roth IRA, where you convert a traditional IRA into a Roth IRA.
  3. Consider Roth Conversions: If your income exceeds the limit for direct Roth contributions, you may consider converting funds from a traditional IRA to a Roth IRA. This is known as a Roth conversion. A Roth conversion involves moving assets from a tax-deferred account, like a traditional IRA, into a Roth IRA, which can lead to tax-free growth in the future. Keep in mind that the converted amount is subject to income tax in the year of conversion, so it's crucial to consult with an advisor to evaluate how this might affect your overall tax situation.

Required Minimum Distributions (RMDs)

RMDs are the minimum amount you must withdraw each year to avoid penalties, and they are considered taxable income. If you have a traditional IRA, 401(k), or another tax-deferred retirement account, you must start taking RMDs once you turn 73 (or 72, depending on your birth year). 

Unlike traditional IRAs, Roth IRAs do not have RMDs during the account holder’s lifetime. This makes Roth IRAs a popular option for those looking to minimize their taxable income in retirement.

End-of-Year Considerations for RMDs

  1. Avoiding Penalties: If you’re required to take RMDs, it’s important to do so by December 31st each year. Missing the deadline can result in a penalty of up to 50% of the amount not withdrawn. To avoid this, make sure to calculate your RMD and take the appropriate distribution before the deadline.
  2. Tax Planning with RMDs: Since RMDs are considered taxable income, taking your distribution can push you into a higher tax bracket. If you're concerned about the impact on your taxes, it may be helpful to consult with a professional to discuss strategies for managing your RMDs. Some individuals spread their distributions over multiple withdrawals throughout the year to help minimize the tax impact.
  3. Qualified Charitable Distributions (QCDs): If you are 70½ or older, you may be eligible to make a Qualified Charitable Distribution (QCD). This allows you to donate up to $100,000 per year directly from your IRA to a qualified charity, and the amount can count toward your RMD without being included in your taxable income. Be sure to discuss this option with your tax advisor to understand how it might benefit your tax situation.

Balancing Roth Conversions and RMDs

For those who are required to take RMDs and are also considering a Roth conversion, it's important to understand how these two actions interact.

  • RMDs First: If you’re subject to RMDs, you must take your RMDs before converting any remaining funds to a Roth IRA. You cannot use your RMD to fund a Roth conversion. Failing to take your RMD before a Roth conversion could result in penalties.
  • Managing Tax Implications: When considering a Roth conversion, it can be beneficial to consult a professional. Converting too large an amount could push you into a higher tax bracket, increasing your overall tax liability. An advisor can help you plan for this by reviewing your current tax situation and helping you determine the best time and amount for conversion.

When to Seek Professional Advice

While general information about Roth IRAs and RMDs can be helpful, decisions related to retirement accounts and taxes should be made with the guidance of a professional. Here are some key points where seeking advice from a financial advisor or tax professional is essential:

  • Roth Conversions: Converting funds from a traditional IRA to a Roth IRA can have significant tax implications. Working with a financial professional can help you determine if this strategy aligns with your long-term goals and tax situation.
  • Tax Planning: Both Roth IRAs and RMDs have tax considerations that vary based on individual circumstances. A professional can guide you in navigating these complexities and develop a plan that helps minimize your tax liability.
  • Financial Advice: Every individual’s financial situation is unique. An advisor can provide recommendations based on your income, assets, and retirement goals. If you're unsure about whether to contribute to a Roth IRA, convert a traditional IRA, or how to handle RMDs, an advisor can offer the best guidance.

Final Thoughts

As the year draws to a close, now is the time to review your retirement accounts and make sure you're taking the necessary steps to help optimize your savings. Whether you're contributing to a Roth IRA, managing your RMDs, or considering a Roth conversion, thoughtful planning can help ensure your retirement savings grow in the most tax-efficient way possible.

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This blog is for educational purposes only and not intended as specific financial advice.