As the New Year approaches, it is time to look at your most recent IRA statement and assess how well your account met your expectations this year. December can be a good time to make changes or take other actions with your IRA, because this will affect your taxes for this year when you file in the spring. (For more, read It's December - Do You Know Where Your IRA Statements Are?)
TUTORIAL: Retirement Plans
Here are several things that you can do with your IRA at year-end to make it work harder for you:
Convert It to a Roth IRA
If your tax advisor (or your own preliminary calculations) tells you that you are going to have deductions or credits that will go unused when you file your return, then you might be wise to convert at least a portion of any traditional IRA that you own into a Roth IRA. This may be a wise option even if you have to pay tax on some or all of the conversion; once you convert to a Roth IRA, all distributions from then on are unconditionally tax-free, provided that you are at least age 59.5 and have had a Roth account open for at least five years.
Reverse Your Roth IRA Conversion
If you have converted your traditional IRA to a Roth IRA and then discover that your tax bill is going to be much higher than you previously estimated, then you do have the option of undoing the conversion and placing the money back in your traditional IRA before the end of the year. However, don't wait too long to start this process; it can take several days to accomplish. And, of course, you can always redo your conversion in a future year when your tax liability is more favorable. (For related reading, check out Did Your Roth IRA Conversion Pass or Fail?)
Make a Charitable Donation
The IRS has given IRA owners a double incentive to gift money directly from their IRAs to charity. Not only do the donors avoid having to report their distributions as taxable income, they also get to deduct their donations on Schedule A of the 1040. If it appears that you are close to being able to itemize deductions on your tax return, then making a charitable donation in this manner may provide you with the additional deduction that you need to do this.
Evaluate Your Investment Performance
If the markets rose substantially over the past year and your IRA balance dwindled, then it may be time to reallocate at least a portion of your assets. This is also a good time to stop and evaluate your own risk tolerance and time horizon. Even if your investments performed well last year, do they still match up with your current needs? If you just turned 60 and your IRA is invested entirely in small cap stocks, then it may be time to start shifting some of your assets into more conservative holdings, even if (and perhaps especially if) your funds performed well this year.
Make an IRA Contribution
If it looks like you're going to owe when you file next year, then a traditional IRA contribution may be just the thing to reduce or eliminate your pending tax liability. A maximum contribution to your IRA can reduce your adjusted gross income by as much as $5,000 (or $6,000 if you are over 50 and make the additional $1,000 "catch-up" contribution), subject to certain limitations such as your total income and the level of your contributions to an employer-sponsored retirement plan.
The Bottom Line
These are just some of the things that you can do with your IRA at the end of the year. For more information on IRAs, download Pub. 590 from the IRS website at www.irs.gov or consult your financial advisor. (For more help, read 10 Money-Saving Year-End Tax Tips.)