Year-End Retirement Tax Planning

July 7, 2016

One relatively easy way to reduce exposure to a possible stock market correction without taking taxable gains is to sell equities held in a tax-advantaged retirement account such as an IRA or a 401(k). Transactions inside these accounts don’t generate taxes.

Example 1: Sue Taylor has $200,000 in her 401(k) and $200,000 in a taxable investment account. In both places, $120,000 (60%) is in stocks and stock funds, for a total of $240,000: 60% of her investments. Sue wants to cut back on equities, fearing the market will retreat.

As a result, Sue sells $60,000 of the stocks in her 401(k), reinvesting the money in bond funds and other asset classes besides equities. Now, Sue still has a $400,000 portfolio but only $180,000 (the original $240,000 minus the $60,000 she sold) in stocks and stock funds. Thus, her allocation to equities has dropped from 60% to 45%, leaving Sue less exposed to a steep setback. What’s more, Sue owes no tax on the sale inside her 401(k).

To further reduce her allocation to stocks, Sue can reset her 401(k) contributions to reduce or eliminate equities. The last quarter of the year, when employees typically go over their company benefits, can be an excellent time to reset retirement plan asset allocations and future contributions.

Traditional tactics

Some perennial year-end tax planning moves for retirement make sense in 2015, as usual.

  • If you’re not already maximizing your contributions to 401(k) and similar plans, see if you can add some pretax salary deferrals this year. The 401(k) ceiling for 2015 is $18,000, or $24,000 if you’re 50 or older.
  • Execute Roth IRA conversions. You must have the account for at least five years (and be at least age 59½) to take totally tax-free withdrawals, but any conversion in 2015 gets a January 1, 2015, start date for the five year requirement. Your wait might be barely more than four years.
  • If you’re 70½ or older, make sure you take at least the 2015 required distributions from retirement accounts by December 31, in order to avoid a 50% penalty on any shortfall.

Planning for premiums

Some high-income retirees face a stealth tax: extra premiums for Medicare Part B, which covers medical costs. Although most Medicare enrollees pay about $105 a month for Part B in 2015, those with high incomes pay from $147 to $336 a month.

The Medicare Access and CHIP Reauthorization Act of 2015, signed into law in April, raises the stakes. Starting in 2018, Medicare enrollees with modified adjusted gross income (MAGI) over $133,500 ($267,000 on a joint return) will pay about $273 a month, plus inflation adjustments, versus around $210 a month this year. Those with MAGI over $160,000 ($320,000 jointly) will pay $336 a month, up from $272 now.

If the new rates take effect in 2018, why pay attention at year-end 2015? Because the 2018 Medicare premiums will be based on the income you report for 2016 on the tax return you file in 2017. Shifting income from 2016 to 2015, with year-end moves, may result in lower Part B premiums when those costs rise.

Planning for lower premiums shouldn’t include shifting to municipal bonds, however, because tax exempt interest income is counted in your MAGI for this purpose. Instead, you might consider a Roth IRA conversion in 2015, rather than in 2016, to avoid boosting taxable income for next year. Converting a traditional IRA to a Roth IRA will reduce future required taxable distributions, and those distributions might push you into higher Part B premiums in future years. Our office can help you evaluate full and partial Roth IRA conversions, to see if they likely will help your total tax position, including lesser known pseudo taxes such as higher Part B premiums.