Whether saving toward retirement or managing income in retirement, it’s important to review your plan to make sure you’re on track to meet your goals. Year-end is an opportune time to assess progress and determine if any adjustments are needed, especially since inflation-related adjustments on certain limits for 2023 are historically high.
Here are some year-end planning considerations for retirement savings.
1. Review your retirement savings
Is there an opportunity to increase savings in a retirement plan or IRA? In 2023, the maximum amount for salary deferrals into a 401(k) plan increases to $22,500 (an additional $7,500 if age 50 or older). Those eligible for catch-up contributions can increase their savings by $3,000 next year.
If your income is too high to contribute to a Roth IRA, consider a “backdoor” Roth IRA contribution before the end of the year. This strategy does not work if you own other IRAs consisting of pretax funds that you do not wish to convert to a Roth IRA. However, this can be an effective strategy if retirement savings are held in non-IRA accounts like a 401(k). While there has been discussion in Congress of eliminating this strategy, it is still available.
2. Make sure to take your RMD
Given the significant penalty — 50% of the required amount — it’s imperative to take a required minimum distribution (RMD) from IRAs and other retirement accounts once you reach age 72. You must generally take your first required minimum distribution for the year in which you turn age 72, although you can delay your first distribution until April 1 of the following year. However, the second RMD would have to be taken by the end of that calendar year, resulting in two RMDs for the year.
There is a “still working” exception (only for retirement plans in which a worker is currently a participant). This exception applies to individuals at age 72 who are participating in their employer plan and meet other requirements (for example, not a 5% or more owner of the company). These individuals can delay the first RMD until April 1 following the year they separate from service.
For those with several IRAs, only one RMD is needed. There is no need to take separate distributions from each account as long as the RMD is based on the aggregate value of all IRAs as of December 31 of the prior year. However, separate RMDs are required for employer-sponsored plans, including 401(k)s.
If you have inherited a retirement account recently from someone other than your spouse (and the owner died after 2019), it is important to note that, unless an exception applies, you need to liquidate the account by the end of the 10th year following the year the owner died.
Under proposed regulations issued in 2022, some beneficiaries subject to the 10-year rule would need to also take (at least) annual distributions for the first nine years followed by a full distribution in the tenth year. However, these are proposed regulations and have not been finalized yet. The IRS recently issued guidance clarifying that heirs do not have to take annual distributions for 2021 or 2022 while these regulations are still pending. We expect to see final regulations in 2023.
3. Consider a qualified charitable distribution (QCD) if over age 70½
If you are not relying on an RMD to meet current income needs, and if you are planning to claim the standard deduction, consider donating IRA assets to a qualified charity. A special provision of IRAs allows account owners to donate up to $100,000 tax free each year to charity. For more details, read "Donating IRA assets to charity."
4. Review beneficiary designations
This review is key to avoid potential mistakes. It is important that designations reflect current wishes and keep up with life changes (deaths, births, marriage, divorce, etc.)
Additionally, since most non-spouse beneficiaries of IRAs and retirement plans will have to fully distribute inherited accounts within a 10-year period following the death of the owner, it makes sense to review current designations to determine if changes are needed. Does it make sense to leave a greater proportion of traditional (pretax) retirement savings to heirs who may fall in lower tax brackets? Drawing down an inherited account with a large amount of assets within a 10-year period may cause a significant amount of income to be realized over that period. This could have a negative impact on other areas such as Medicare Part B premiums or filing for federal financial aid.
5. Consider a Roth conversion
If you are not in one of the highest tax brackets, it may make sense to add income before year-end and create a source of tax-free income in the future.
A Roth conversion may provide an opportunity for tax efficiency when considering the risk of higher taxes in the future. A Roth can support greater tax diversification that can help manage tax liability in retirement. The Roth may also appeal to those who want to leave a tax-free legacy to the next generation. To explore this strategy further, read "Converting a traditional IRA to a Roth IRA."
Review tax planning with a financial professional
It is important to discuss tax strategies with a tax and financial advisor to determine if any changes are appropriate for an overall financial plan.
For informational purposes only. Not an investment recommendation.
This information is not meant as tax or legal advice. Please consult with the appropriate tax or legal professional regarding your particular circumstances before making any investment decisions. Putnam does not provide tax or legal advice.