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10 Retirement Account Strategies for the Year's End

Here are 10 retirement account actions that every financial adviser should have on their to-do list as the year comes to a close.

By Sarah Brenner

It’s that time of year again. The holidays are upon us, and the end of the year is quickly approaching. With family gatherings, shopping, and other festive activities, your clients are busy, and the last thing on their minds is their retirement accounts. Now is the time for proactive advisers to show real value. Here are 10 retirement account actions that every adviser should have on their to-do list as 2021 comes to a close.

1. Pay out 2021 RMDs. Funds in retirement accounts can’t stay there forever. Uncle Sam wants his tax revenue. That’s why we have required minimum distributions (RMDs).

Retirement savers caught a break last year when the CARES Act waived RMDs for 2020, but no such luck in 2021. RMDs have returned. For many clients, the combination of markets bouncing back from the pandemic plus no 2020 RMD means their 2021 distribution will be larger than expected. The deadline for taking a 2021 RMD is Dec. 31, 2021 (unless 2021 is the first year for which an RMD is required). Advisers must monitor this deadline carefully as there is a hefty 50% penalty applicable to missed distributions.

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2. Don’t forget RMDs for beneficiaries. Beneficiaries of retirement accounts are subject to RMDs too. While the SECURE Act did away with the stretch payout for most inherited accounts, beneficiaries who qualify as eligible designated beneficiaries (and those who inherited before 2020) can still use it. These beneficiaries must take any RMD due for 2021 by the end of the year. And don’t overlook Roth IRA beneficiaries. They are also subject to RMDs, even though the distributions are usually not taxable. No client will be happy paying a 50% penalty on a missed nontaxable distribution.

3. Do Roth IRA conversions. Time is running out to convert traditional IRAs to Roth IRAs. The deadline for a 2021 conversion is Dec. 31, 2021. That means the funds must be distributed from the traditional IRA by the end of this year for the conversion to be taxable this year. There is no such thing as a prior-year conversion.

4. Do backdoor Roth conversions. For high-income clients looking for a workaround for the income limits on Roth IRA contributions, the backdoor Roth conversion is attractive. A nondeductible contribution can be made and then converted tax-free to a Roth IRA. This works because there are no income limits on non-deductible traditional IRA contributions or on Roth IRA conversions. (However, be careful of the pro-rata rule discussed in item 5 below. You cannot cherry-pick the after-tax dollars in an IRA and only convert those.)

The deadline to do a backdoor conversion for 2021 is Dec. 31. This deadline may be more critical than ever as Congress has shown an interest in possibly eliminating this strategy for future years.

5. Avoid pro rata pitfalls. A special pro rata formula normally applies whenever an IRA owner has nondeductible funds in any of his traditional IRAs. When applying the pro rata formula, all of the IRA owner’s traditional, SEP and SIMPLE IRAs are aggregated. Each dollar withdrawn from the IRA will contain a percentage of tax-free and taxable funds based on the percentage of after-tax funds vs. the entire balance in all the IRAs.

The pro rata formula looks at the end of the year IRA balances. A large rollover from a company plan to an IRA late in the year would be included in the pro-rata calculation. Such a mistimed rollover could mean a larger than expected tax bill on a 2021 IRA distribution, including a backdoor Roth IRA conversion. Advisers must stay vigilant for pro rata pitfalls as year-end approaches.

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6. Leverage the net unrealized appreciation (NUA) strategy. For clients with highly appreciated stock in a company plan, the NUA strategy can be a good move. When properly executed, this strategy allows eligible plan participants to pay taxes on the appreciation at long term capital gains rates as opposed to ordinary income tax rates if the NUA strategy was not implemented.

One way to blow up this strategy is by failing to take a lump-sum distribution, which means failing to empty the entire account by the end of the year (with minor exceptions). Advisers can help clients leverage the NUA strategy by monitoring these accounts and ensuring that no balance remains in the company plan at year end.

7. Take qualified charitable distributions (QCDs). Do you have clients who are charitably-inclined? Now is the time to discuss the potential benefits of a QCD. QCDs allow a tax-free transfer directly from an IRA to a charity. A client must be age 70½ to be eligible. A QCD for 2021 must be done by Dec. 31, 2021. While many IRA owners do not think about QCDs until tax season, that is too late for this year. There is no such thing as a prior-year QCD. Be sure your clients don’t miss out on this great tax break.

8. Monitor 72(t) payments. By using the 72(t) rules, clients can tap an IRA before 59½ without a 10% penalty. The payments must be calculated using specific formulas and must continue for at least five years or until age 59½, whichever period is longer. For those clients who have calendar year 72(t) schedules, the 2021 payment must be made by the end of the year.

As the Dec. 31 deadline approaches, advisers should check to make sure that annual payments are made and calculated correctly. The penalties for missing this deadline are serious. A modification in the payment plan would result in the 10% penalty applying retroactively to all payments already taken before age 59½.

9. Take advantage of 2021 tax rates and breaks for distribution planning. Tax rates are historically low in 2021. Now is the time to lock in the current low tax rates by doing distribution planning and paying taxes now at today’s low rates to avoid higher ones in the future. The funds can then be invested outside the IRA in alternative investments like life insurance, and worries about future tax rates can be minimized or eliminated.

10. Get ready for 2022. For proactive advisers, it is not too soon to be thinking about the new year. Tax season will soon be upon us. Be on the lookout for account statements and tax forms clients will need to prepare for their 2021 taxes.

Also, be ready for 2022 changes for retirement accounts. The IRS has released new life expectancy tables. Advisers will want to be sure they are using these new tables to calculate 2022 RMDs.

Finally, make a New Year’s resolution to keep a close eye on Washington. Multiple legislative proposals are under consideration in Congress and, if passed, they could upend many retirement account rules. Advisers will want to be up-to-date and ready to respond to client questions on any breaking developments.

About the author: Sarah A. Brenner, JD, has worked for almost 20 years helping clients solve complex technical IRA questions. She has been a contributing writer for many IRA texts, articles and training manuals and has been quoted in national financial and tax publications such as CCH IRA Guide. She is an experienced speaker who has educated thousands of professionals in the financial industry including attorneys, CPAs, bankers, financial advisers, and brokers on retirement plan rules. Sarah has won praise for her ability to communicate complex laws in an easy-to-understand way and provide practical strategies for clients. She is a contributing writer and editor for Ed Slott’s IRA Advisor newsletter, distributed to thousands of financial advisers nationwide, and writes for several areas of the company’s website, irahelp.com.

Ed Slott and Company's 2-Day IRA Workshop, Instant IRA Success, will be on Thursday, February 17th, and Friday, February 18th, 2022 at The Hyatt Regency Orlando Airport Hotel, in Orlando, FL. Visit www.irahelp.com/2-day-IRA-workshop for more information.