Your IRA, your own piece of your retirement puzzle, requires some tender loving care. Here’s a list of what you might need to do before December 31, 2011.
1. Take your required minimum distribution
Make sure all Required Minimum Distributions (RMD) are taken for the year 2010.
Look at all owned IRA accounts and employer plans (401(k), TSA and SEPs) for individuals age 70 ½ or older this year or inherited IRAs.
Beneficiaries, no matter what their age, must take distributions from all inherited accounts beginning in the year after the death of the account owner. Also, inherited accounts must be split before year end so beneficiaries can use their own life expectancies to calculate their RMDs.
Remember to take any 72(t) distributions that are required for 2010. If you fail to do this, you will pay penalty and interest retroactively to the first year you started taking these distributions.
2. Check for excess contributions
It might seem unlikely, given that the average IRA contribution is $3,798, but it’s possible that you contributed too much to your IRA during the year. If so, remove any excess contributions before the end of the year or you will be charged a 6% penalty for any excess contributions.
3. Is everything in place?
Take nothing for granted when it comes to your IRA. Before year end, double check on all IRA funds that you moved from one account to another during 2010, make sure that IRA funds went into IRA accounts, not non-IRA accounts or Roth IRAs and be sure that Roth IRA funds went into Roth IRA accounts.
4. Can you do a stretch IRA?
Check whether your IRA custodian or 401(k) plan administrator will allow for the so-called “stretch” for beneficiaries.
The stretch means that beneficiaries can use their own life expectancy for distributions. In addition, check whether the custodian or plan administrator will accept a durable power of attorney, and disclaimers.
The answer to these questions will have substantial impact on the success of your estate plan. If the custodian or 401(k) (plan administrator) doesn’t accept a durable power of attorney or disclaimer, you might consider another custodian.
5. Who’s your beneficiary?
Here’s some well-worn but can’t be repeated often enough advice: Review your beneficiary designations. Make sure there is both a primary and a contingent beneficiary named on the beneficiary designation form.
If there is no beneficiary named, the IRA proceeds will go to the estate and lose the tax advantage of the stretch benefits. If there is no contingent beneficiary, and the primary beneficiary has died, then the assets also go to the estate with the same negative result.
It’s especially worth checking your beneficiary designations if you’re divorced. Make sure your ex-spouse has been deleted as a beneficiary, unless you want them to remain as a beneficiary. The U.S. Supreme Court has recently ruled that the beneficiary named on the beneficiary designation form trumps divorce.
Don’t name your living trust as your beneficiary. A living trust should not be the beneficiary because the living trust must qualify as a ‘designated beneficiary’ to receive favorable stretch and tax treatment. I find that most living trusts do not qualify, or can lose their designated beneficiary status through later changes to the trust.
Make sure your custodian has a written copy of your beneficiary designations.
6. One last chance for Roth conversions
If you plan to do a Roth conversion in 2010, the funds must leave the IRA by Dec. 31 to be reported and taxable as a 2010 distribution and conversion. The funds can then be rolled over to the Roth IRA up to 60 days after they are received by the account owner.
Contrary to what some might believe, you do not have until April 15, 2011 to do a 2010 Roth conversion.
Here’s another reason why you might want to convert some or all of your IRA to a Roth IRA: the Roth IRA could fund a credit shelter or by-pass trust.
Remember, anyone can convert their traditional IRAs to a Roth IRA in 2010 regardless of income. What’s more, you can pay the taxes over two years, instead of one.
7. Turn wealth into income
Right about now, the Social Security Administration is sending you a report that tells you how much income you’ll receive in today’s dollars when you retire. Write down that number on a piece of paper.
Now, total up the value of all IRA and 401(k) accounts in your household and multiple that number by 0.04. That number is the amount some experts say you could withdraw from your retirement in today’s dollars.
Now, add that number to your Social Security benefit figure, and then subtract that amount from your income. The results are roughly the amount of money you’ll need from other sources (such as work, pensions, reverse mortgages, life insurance or inheritances) to enjoy a lifestyle similar to what you have today. If you are not working you will no longer be paying your social security taxes, roughly 6.5% of your earned income each year.
Let’s use some round numbers as an example. Say you have household income of $100,000. You expect to receive $25,000 per year from Social Security and withdraw $5,000 per year from your retirement accounts. If you do not work you will no longer be paying $6,500 in social security taxes. Somehow you’ll need to come up with another $63,500 per year to live the life to which you are accustomed.
For some, the best way to close the gap will be to contribute more to their IRAs and 401(k)s wile working, work longer, or lower their standard of living.
8. Review your investment plan
Consider updating your investment policy statement or plan. Make sure your asset allocation remains appropriate given your financial goals.
Rebalance your IRA’s asset allocation, if you haven’t done so within the past year. It’s best to rebalance your IRA in a holistic manner. That is, look at all your assets in all your accounts, taxable and tax-deferred.
In many cases, consider putting your fixed-income investments in your tax-deferred accounts and those investments that produce capital gains and dividend income in your taxable accounts.
Since IRAs are tax-deferred vehicles, it makes no sense for them to hold ‘tax-preferenced’ investments such as municipal bonds and annuities.
You can also use your RMDs to rebalance. It could save on transaction costs.
9. Roll old 401(k)s to an IRA
If you have one or more 401(k)s sitting with former employers, consider rolling that money over to an IRA. You should get better investment choices, lower costs and more control of your investment assets.
10. Recharacterize your Roth IRA
If you converted a traditional IRA into a Roth IRA during 2010 and now realize that your income taxes were higher than expected due to the conversion, or you’re short money to pay the income tax or you’re unwilling to pay the income tax, consider a recharacterization. That is, consider putting the money in the Roth IRA back into your traditional IRA.