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The last quarter of the year is a good time for investors to take stock of how things stand with their retirement funds. Changes to life situations, coupled with government-mandated rules, may alter the approach individuals should take with regard to their retirement accounts. Prudent investors will review their retirement accounts with their financial advisors each year, with these questions in mind:
1. Is your IRA (including Roth IRAs) fully funded up to the $5,500 limit—$6,500 if you turned or were age 50 or older during 2013?
A. Yes, you can wait until April 15, 2014, but if you have the money, why not fund it now and have the money working for you on a tax-favored basis?
2. Can you make an IRA contribution even if you received or made a contribution to a qualified retirement plan?
A. Having earned income and being under 70½ is all that is required to make an IRA contribution. Eligibility for Roth IRA funding is determined solely based on having earned income and that income being below statutory thresholds. If you are covered by a qualified plan, the IRA contribution may or may not be deductible. Lord Abbett's website can be referenced to determine whether the contribution is deductible or Roth IRA eligible.
3. Did you turn 70½ in 2013?
A. When you turn 70½, IRS rules stipulate that a required minimum distribution (RMD) be made each year from any non-Roth IRA. You are, however, permitted to postpone your first minimum IRA distribution until April 1, 2014. If you do, you must take a second distribution before the end of 2014. Taking two distributions in 2014 might affect your tax rate, in which case you should consider taking your first distribution before the new year.
4. If you are older than age 70½, did you take your required minimum distribution from your IRAs in 2013?
A. Based on IRS rules, the RMD figure becomes available each January 1. This is important, because there is a 50% tax on amounts not taken. For example, if you had to take $10,000 by December 31, 2013, but only took $2,000, you would owe an excise tax of $4,000 on the $8,000 shortfall, plus would have to pay taxes on the $8,000 when distributed. You can always take more than the minimum.
5. If you are 70½ or older and have several IRAs, do you have to take money from each IRA to satisfy the minimum distribution rules?
A. The sum of all your IRAs, excluding Roth IRAs, and your age determine the minimum distribution. Once determined, the minimum can be taken from just one or several IRAs.
6. Are all beneficiary designations in order?
A. People often have several IRAs, established at different times. Marriages, divorces, children, and other life events occur in the ensuing years. Is the correct person still positioned to receive the benefit? IRAs do not pass through probate, so the beneficiary designation on file with the IRA provider governs.
7. Did you inherit an IRA or employer-sponsored retirement plan account from a non-spouse in 2012?
A. If you did, you must begin taking distributions, even if it’s a Roth account, before the end of 2013. If you miss the deadline, IRS rules require the account to be paid out in full before the end of 2017 rather than over your lifetime. You can take more than the minimum.
8. Why is it important to create separate IRAs for each beneficiary?
A. When multiple beneficiaries inherit an IRA, it's often wise to "split" the account into multiple separate IRAs, established for each beneficiary. This strategy, when finalized by December 31 of the year following the year of the IRA owner's death, offers the ability for each beneficiary to use their own life expectancy for future minimum distributions.
9. How can you optimize the tax implications of converting a traditional IRA to a Roth IRA in 2013?
A. Each taxpayer's situation is somewhat unique, so we cannot offer specific tax advice. However, in general, each of these strategies could potentially help lower taxes:
10. What happens if you convert to a Roth IRA, but do not have the money to pay the taxes?
A. Taxpayers should be careful about this "strategy." There are no penalties on IRA dollars converted to a Roth IRA. However, if you convert and do not have the assets to pay the taxes outside the IRA, the under age 59½ penalties will be added to your tax bill on the dollars used to pay the taxes, and the size of your Roth IRA account will be less. There are no penalties on the dollars used to pay the taxes if you are over 59½. In addition, if you decide to reverse your Roth IRA conversion (see question 9), you cannot recover the taxes paid as part of the conversion.
11. What should you consider when making an IRA distribution?
A. If the distribution is taxable, make sure you have sufficient tax withholding taken at the federal and the state levels, and, if applicable, the local level. There may be penalties for under-withholding.
When establishing systematic withdrawals from a particular fund, make sure you know what happens if that fund runs out of money. For example, let's say someone needs to take out $5,000 to satisfy their age 70½ minimum withdrawal by December 31, 2013. The individual established a procedure with his or her investment company to have the payment drawn from a money market account. However, there is only $1,500 in the money market account. From which other investments will the remaining $3,500 be drawn? Many IRA custodians do not default to any particular fund, but simply wait to receive further instructions.
12. What do you need to know about charitable donations from IRAs?
A. Congress, as part of the American Taxpayer Relief Act of 2012, reinstated qualified charitable distributions (QCDs) for 2013 only. QCDs are tax-free IRA distributions—up to $100,000—that are sent directly to a qualifying charity. QCDs can be made from traditional IRAs, Roth IRAs, and inactive SEP and SIMPLE IRAs whose account owners or beneficiaries are age 70½ or older.
Glossary of Terms
Roth IRA—This is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.
SEP IRA—A Simplified Employee Pension Plan is a retirement plan specifically designed for self-employed people and small-business owners. When establishing a SEP IRA plan for your business, you and any eligible employees establish your own separate SEP IRA; employer contributions are then made into each eligible employee's SEP IRA.
SIMPLE IRA—A Savings Incentive Match Plan for Employees' IRA is an IRA-based plan that gives small-business employers a simplified method to make contributions toward their employees' retirement and their own retirement. Under a SIMPLE IRA plan, employees may choose to make salary reduction contributions and the employer makes matching or non-elective contributions. All contributions are made directly to an individual retirement account (IRA) set up for each employee (a SIMPLE IRA). SIMPLE IRA plans are maintained on a calendar-year basis.
Traditional IRA—This is an individual retirement savings account in which contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.
Minimum distributions must be taken from traditional IRAs by April 1 following the year that a person turns 70½. A minimum distribution must be taken from the IRA in each subsequent year. Failure to take the required minimum distribution will result in a 50 percent penalty on the amount that was not distributed. Mandatory distributions that represent deductible contributions and all earnings are taxed as ordinary income. Mandatory distributions based on nondeductible contributions are tax-free.
An investment in a money market fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in a money market fund.
The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.
Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett funds. This and other important information is contained in each fund’s summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388 or visit us at www.lordabbett.com. Read the prospectus carefully before you invest.