IRAs

It's that time of year (tax time) when IRAs are in people's thoughts more than usual. While a small percentage of my clients make annual IRA contributions, a much larger percentage use them to roll over their 401(k) balance upon retirement.

The primary reason few people fund IRAs annually is because so few individuals max out on the 401(k) contribution, and that is an easier contribution to make, as it is payroll deducted, versus having to manually make the IRA contribution. Additionally, if one is earning enough to contribute the maximum to the 401(k), the chances are good that the deductible IRA phaseout rules will apply.

Most of the people I work with that have large IRA balances have them as a result of rolling over their 401(k) upon separation of service. Unfortunately, most of them have not managed their IRA optimally. The rules governing IRAs are complex and the IRS spells them out in Publications 590-A and 590-B.

There are several items of which every IRA owner should be aware. First, there should always be a secondary beneficiary on every IRA. Individually named beneficiaries generally have more options than if they received it from the estate.

The SECURE Act, passed in December 2019, changes the age at which individuals must take required minimum distributions (RMDs) from 70½ to 72. That's good! The bad news is if you turned 70½ prior to December 31, 2019, you are still subject to the old rules.

Failure to take RMDs will result in a 50% penalty. For most people taking the minimum is not a problem, but if the only reason you're taking the RMD is to avoid the penalty, i.e., you don't need the income, a Qualified Longevity Annuity Contract (QLAC) could reduce the RMD.

Another technique to reduce the tax bite of RMD is to make a Qualified Charitable Distribution (QCD). That is where the IRA contributes directly to the charity. That QCD will count toward the IRA owner's RMD but will not be taxable to the IRAowner. However, the QCD must be made prior to taking the current year RMD. This strategy would be particularly helpful to those who no longer itemize their deductions.

Special rules also apply to employer stock in a 401(k) that is rolled over into an IRA. Know as Net Unrealized Appreciation (NUA), this technique has the potential to have the stock taxed at capital gains rates as opposed to ordinary income, but one size doesn't fit all and an individual analysis should be done by a person very familiar with the rules.