Conduct a Year-End IRA Review

Each year you should review your IRAs with your tax advisor to ensure you're on track with your retirement planning. Here are some issues to focus on:

Don't miss required minimum distributions (RMDs)

Traditional IRA owners must start receiving RMDs from their IRAs by April 1 following the year they turn age 70½. (Roth IRAs do not require minimum distributions.) Failure to receive an RMD can result in a 50% IRS penalty tax on the amount of money you should have withdrawn, but did not.

Consider using IRA withdrawals to cover tax payment shortfalls

If you haven't paid enough income tax to the IRS for the 2011 tax year, you may be able to use your IRAs to help cover these underpayments. For example, if you're already taking withdrawals from your IRA, you can have additional withholding tax taken from these withdrawals to cover the amount you owe the IRS — thus avoiding the underpayment penalty tax you otherwise would owe.

Consider a Roth IRA conversion

When compared with a Traditional IRA, the Roth IRA offers the ability to withdraw earnings completely federal income tax-free, provided the IRA has been in place for at least five years and the withdrawal meets at least one of these qualifying events:

  • The withdrawal is made after you reach age 59½
  • You become disabled
  • The distribution goes to the beneficiary of your estate after your death
  • You use the withdrawal to pay for first-time homebuyer expenses of up to $10,000.

If a Roth IRA withdrawal doesn't meet these requirements, the withdrawn earnings are subject to ordinary income taxes and, if applicable, an IRS 10% early withdrawal penalty tax. Note also that Roth IRAs provide another advantage previously discussed — unlike Traditional IRAs, Roth IRAs do not have RMDs. Because of these advantages, many people decide to convert funds they have in a Traditional IRA to a Roth IRA (keep in mind this is a taxable event).

Keep an eye on the five-year IRA conversion "clock"

If you're under age 59½ and determine you could benefit from a Roth IRA conversion, think about doing the conversion this year to get started on reaching the five-year holding period necessary to qualify for federal tax-free withdrawals. The countdown to this five-year "clock" begins on the first day of the first tax year in which you open and fund a Roth IRA. You'll still need to meet at least one of the qualifying events mentioned in the bullet point above to qualify for federal tax-free withdrawals, but it may be a good idea to get the five-year clock ticking as soon as you can.

The tax information contained herein (including any attachments) is not intended to be used, and cannot be used, by any taxpayer for the purpose of avoiding any tax penalties that may be imposed on the taxpayer. It was written to support the promotion of the products and services addressed herein. Taxpayers should seek advice based on their own particular circumstances from an independent tax advisor.

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