Investment

As the end of the year approaches, most of us have a lot of things on our to-do lists, from gift shopping to donating to our favorite charities to making New Year’s Eve plans. For taxpayers “of a certain age” with a tax-advantaged retirement account, as well as younger taxpayers who’ve inherited such an account, there may be one more thing that’s critical to check off the to-do list before year end: Take required minimum distributions (RMDs).

A huge penalty

After you reach age 70½, you generally must take annual RMDs from your:

• IRAs (except Roth IRAs), and
• Defined contribution plans, such as 401(k) plans (unless you’re still an employee and not a 5%-or-greater shareholder of the employer sponsoring the plan).

An RMD deferral is available in the initial year, but then you’ll have to take two RMDs the next year. The RMD rule can be avoided for Roth 401(k) accounts by rolling the balance into a Roth IRA.

For taxpayers who inherit a retirement plan, the RMD rules generally apply to defined-contribution plans and both traditional and Roth IRAs. (Special rules apply when the account is inherited from a spouse.)

RMDs usually must be taken by December 31. If you don’t comply, you can owe a penalty equal to 50% of the amount you should have withdrawn but didn’t.

Should you withdraw more than the RMD?

Taking only RMDs generally is advantageous because of tax-deferred compounding. But a larger distribution in a year your tax bracket is low may save tax.

Be sure, however, to consider the lost future tax-deferred growth and, if applicable, whether the distribution could: 1) cause Social Security payments to become taxable, 2) increase income-based Medicare premiums and prescription drug charges, or 3) affect other tax breaks with income-based limits.

Also keep in mind that, while retirement plan distributions aren’t subject to the additional 0.9% Medicare tax or 3.8% net investment income tax (NIIT), they are included in your modified adjusted gross income (MAGI). That means they could trigger or increase the NIIT, because the thresholds for that tax are based on MAGI.

For more information on RMDs or tax-savings strategies for your retirement plan distributions, please contact us.

A tried-and-true tax-saving strategy for investors is to sell assets at a loss to offset gains that have been realized during the year. So if you’ve cashed in some big gains this year, consider looking for unrealized losses in your portfolio and selling those investments before year end to offset your gains. This can reduce your 2017 tax liability.

But what if you expect an investment that would produce a loss if sold now to not only recover but thrive in the future? Or perhaps you simply want to minimize the impact on your asset allocation. You might think you can simply sell the investment at a loss and then immediately buy it back. Not so fast: You need to beware of the wash sale rule.

The rule up close

The wash sale rule prevents you from taking a loss on a security if you buy a substantially identical security (or an option to buy such a security) within 30 days before or after you sell the security that created the loss. You can recognize the loss only when you sell the replacement security.

Keep in mind that the rule applies even if you repurchase the security in a tax-advantaged retirement account, such as a traditional or Roth IRA.

Achieving your goals

Fortunately, there are ways to avoid the wash sale rule and still achieve your goals:

• Sell the security and immediately buy shares of a security of a different company in the same industry or shares in a mutual fund that holds securities much like the ones you sold.
• Sell the security and wait 31 days to repurchase the same security.
• Before selling the security, purchase additional shares of that security equal to the number you want to sell at a loss. Then wait 31 days to sell the original portion.

If you have a bond that would generate a loss if sold, you can do a bond swap, where you sell a bond, take a loss and then immediately buy another bond of similar quality and duration from a different issuer. Generally, the wash sale rule doesn’t apply because the bonds aren’t considered substantially identical. Thus, you can achieve a tax loss with virtually no change in economic position.

For more ideas on saving taxes on your investments, please contact us.

One important step to both reducing taxes and saving for retirement is to contribute to a tax-advantaged retirement plan. If your employer offers a 401(k) plan, contributing to that is likely your best first step.

If you’re not already contributing the maximum allowed, consider increasing your contribution rate between now and year end. Because of tax-deferred compounding (tax-free in the case of Roth accounts), boosting contributions sooner rather than later can have a significant impact on the size of your nest egg at retirement.

Traditional 401(k)

A traditional 401(k) offers many benefits:

• Contributions are pretax, reducing your modified adjusted gross income (MAGI), which can also help you reduce or avoid exposure to the 3.8% net investment income tax.
• Plan assets can grow tax-deferred — meaning you pay no income tax until you take distributions.
• Your employer may match some or all of your contributions pretax.

For 2017, you can contribute up to $18,000. So if your current contribution rate will leave you short of the limit, try to increase your contribution rate through the end of the year to get as close to that limit as you can afford. Keep in mind that your paycheck will be reduced by less than the dollar amount of the contribution, because the contributions are pre-tax so income tax isn’t withheld.

If you’ll be age 50 or older by December 31, you can also make “catch-up” contributions (up to $6,000 for 2017). So if you didn’t contribute much when you were younger, this may allow you to partially make up for lost time. Even if you did make significant contributions before age 50, catch-up contributions can still be beneficial, allowing you to further leverage the power of tax-deferred compounding.

Roth 401(k)

Employers can include a Roth option in their 401(k) plans. If your plan offers this, you can designate some or all of your contribution as Roth contributions. While such contributions don’t reduce your current MAGI, qualified distributions will be tax-free.

Roth 401(k) contributions may be especially beneficial for higher-income earners, because they don’t have the option to contribute to a Roth IRA. On the other hand, if you expect your tax rate to be lower in retirement, you may be better off sticking with traditional 401(k) contributions.

Finally, keep in mind that any employer matches to Roth 401(k) contributions will be pretax and go into your traditional 401(k) account.

How much and which type

Have questions about how much to contribute or the best mix between traditional and Roth contributions? Contact us. We’d be pleased to discuss the tax and retirement-saving considerations with you.