With 2011 winding down, many older Americans are dragging their feet on a major year-end checklist item, according to a large IRA provider.
Among Fidelity Investments’ roughly 600,000 customers who are required to take distributions from their accounts by year’s end, two-thirds had not completed them by Nov. 11, according to data released by the company.
Fifty-five percent hadn’t taken any distributions this year, said Ken Hevert, Fidelity’s vice president for personal retirement products. The financial services giant has rolled out services intended to help retirees automate and manage these distributions and their overall retirement income strategy. “As with any deadline-driven activity, we tend to see a surge right before,” Hevert said.
Generally, when savers reach age 701/2, they must gradually draw down their 401(k) and traditional (tax-deferred) IRA accounts annually and include the income on their next tax bill (though they get a break the first year and can delay the distribution until April of the following year, which also delays the taxes owed.)
The annual amount, known as a required minimum distribution, is determined by dividing your account balance by the distribution period based on your remaining life expectancy. Distribution tables can be found at irs.gov/publications/p590/ar02.html. IRS Publication 590 details all the rules, including an exception for people still working for the employer where their 401(k) is held.
To calculate your own required distribution, divide your total balance at the end of 2010 by the distribution period. Most 71-year-olds have a distribution period of 26.5 years. So a typical person age 71 with a $50,000 IRA would divide 50,000 by 26.5, for a required distribution of $1,887, which would be included in the person’s 2011 taxable income. For people using their accounts heavily for living expenses, this is a moot point because they have already taken out more than the minimum in any given year.
If you still need to take a required distribution this year, check with your IRA provider to make sure of the deadline. While distributions need to be made by Dec. 31, it may take time to sell securities and settle the accounts, experts said. And be aware that if you fail to take the distribution, the amount not withdrawn will be taxed at 50 percent instead of your highest marginal rate.
Sweet spot
The required distribution brings up another year-end checklist item for retirees: deciding whether to convert funds over and above the required distribution for the tax year 2011 to a Roth IRA.
The conversions require upfront payment of taxes, but they continue to grow and are withdrawn tax-free, assuming certain qualifications are met, and no distributions are required before the account owner’s death. (Though if you’re converting this year and are required to take a distribution, do that before converting to a Roth).
IRA expert Ed Slott is an unabashed fan of converting tax-deferred accounts to Roths as early as possible, using outside funds to pay the tax bill, in order to get the income tax hit out of the way before retirees are living on a fixed income. This is much like the argument for paying off a house before retirement, though Slott says paying off the mortgage is a higher priority. If you can swing both, you’ve knocked out two major retirement expenses, he said.
“I’ve converted my accounts already,” said Slott, an accountant who offers seminars on IRA planning for financial advisers. “I believe there will be higher taxes down the road.”
The opposite argument is to preserve tax-deferred money, reaping the benefits of tax-deferred growth on the money.
Finding the right balance between those two goals is a personal decision, Hevert said, and depends on your overall retirement assets, whether you want to leave an inheritance and other factors.
Give it or lose it
Finally, remember that the ability to donate IRA assets to charity without paying income taxes on the money expires at the end of this year, barring additional legislative action.
These donations are for people 701/2 or older and are capped at $100,000.
“If you’re charitably inclined, this is the last chance to take advantage” of a way to withdraw IRA assets tax-free, Hevert said.
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