Whether you’re pre-distribution or post-distribution age and have an IRA, tax-wise, things can get complicated fast. There’s a lot that goes into getting taxes ready for some of us, so why not save yourself the panic in April and get prepared now?
Is a Roth IRA for you?
With a traditional IRA, contributions are made up of pre-tax dollars, but you’ll pay taxes on future withdrawals, and traditional IRAs are subject to required minimum distribution, or RMD. In a Roth IRA, contributions are made with post-tax dollars, but future withdrawals are tax free and aren’t subjected to required minimum distribution rules.
If you hold an asset in your IRA that could have significant growth potential, like real estate or a startup, it might make sense to convert to a Roth IRA. You will pay taxes on the amount you convert, but your earnings will then grow tax free indefinitely.
Don’t forget about your business
Contributions to SEP-IRAs, SIMPLE IRAs and solo 401Ks reduce your tax bill now and help you rack up tax-deferred investment gains for later. For example, in the 2014 tax year, you could feasibly contribute as much as $17,500 in deferred salary ($23,000 if you were 50 or older) plus another 25% of your net self-employment earnings after deducting one-half of self-employment tax and contributions for yourself, up to a maximum of $52,000 total for both contribution categories, with a self-employed 401K, for example. Contribution limits vary by plan type and the IRS adjusts the maximums annually. Just this year, for example, the solo 401(k) contribution limit increased to $53,000.
If you’re turning 70½ this year, you have to take your 2015 required minimum distribution (or RMD) by April 1 of 2016, and you also have to take your 2016 RMD by the end of the year, Dec. 31, 2016. That means you could be taking two RMDs in 2016, which might result in a higher tax bill. It is best to consult with a tax planning professional to determine how best to approach your RMD this tax season.
If you’re 70½ or older this year, you must take a 2015 required minimum distribution by Dec. 31, 2015. Remember, there are significant penalties for not taking your RMD during the correct timeframe, including potentially having the undistributed portion taxed at 50%.