5 Retirement Plan Moves To Make Before Year-End

When it comes to retirement plans, there are certain transactions that must be done by the end of the year to avoid IRS-assessed penalties. If these transactions are handled by your financial institution, it may be wise to submit your request early, as many financial institutions implement a deadline of a few weeks before December 31. Generally, requests submitted after that deadline are handled on a best-efforts basis, which means volume may determine whether it is processed. Here, we highlight some of these transactions.

1. Make Required Minimum Distributions
You may be required to withdraw a certain amount from your retirement account each year if you are at least 70.5 years old or if you are the beneficiary of retirement assets. This amount is referred to as a required minimum distribution (RMD). Failure to withdraw your RMD by the deadline will result in your owing the IRS an excess accumulation penalty of 50% of the shortfall. (See Avoiding RMD Pitfalls for more information, including how to handle excess accumulation penalties.)

If you have assets in a non-Roth IRA, qualified plan, 403(b) account or 457 plan, you will need to take RMDs from the account(s) if you are at least age 70.5 in 2011. If 2011 is the year you reached age 70.5, you have the option of deferring this year's RMD until April 1, 2012. This option to defer until April 1, 2012, applies only to your first RMD. For qualified plans, 403(b) and 457 plans, you may defer beginning your RMD past age 70.5 until after you retire, provided the option to defer is allowed under the plan.(For more on RMDs, see Strategic Ways To Distribute Your RMD, Preparing For The RMD Season - Part 1 and Part 2.)

If you have not already been provided with the calculated RMD amount for your IRA, check with your IRA custodian. Your custodian is required to provide you with the calculated RMD amount, provided that you were holding your account with them on or before December 31, 2010. For qualified plans, check with your plan administrator.

If you are the beneficiary of a retirement account, the following may apply to you:

  • If you inherited retirement assets and are taking distributions under the life expectancy method, you must begin receiving RMD amounts by December 31 of the year following the year the account owner dies. For instance, if the owner died in 2010, you must begin life expectancy distributions by December 31, 2011. Also, if the account owner was of RMD age and died this year, but failed to satisfy the RMD for this year before death, you must withdraw that RMD amount by year-end. The RMD for the year of death that was not satisfied by the decedent is treated as ordinary income to you.
  • If you are subject to the five-year rule, which is one of the options available if the retirement account owner died before the required beginning date (RBD), you must fully deplete the account by December 31 of the fifth year following the year the owner dies. For instance, if the owner died in 2005, the account balance would have to be fully distributed by December 31, 2010*.

    *Note: RMDs were waived for 2009. As a result, the five-year period is extended one year, resulting in this deadline being December 31, 2011.

    Some financial institutions provide calculations for inherited accounts as an added service. However, because of the amount of data that must be factored into the calculation, and the fact that most of it is not readily available to financial institutions, many do not provide such calculations. (For more on distribution options for beneficiaries, see Inherited Retirement Plan Assets - Part One: Options for Beneficiaries.)

  • If you are one of multiple beneficiaries, you may want to separate each beneficiary's share into his or her own inherited account, so that each can use his or her own life expectancy to calculate post-death RMD amounts. This separation must be done by December 31 of the year following the year the account owner dies. If the deadline is not met, each beneficiary must use the oldest beneficiary's life expectancy to calculate post-death RMDs. (For more on separate accounting, see IRS Modifies Separate Accounting Rules.)

2. Convert Roth IRAs
If you plan to convert your non-Roth retirement account to a Roth IRA this year, the assets must leave the non-Roth retirement account by December 31. If you change your mind about the conversion, you can have it reversed by recharacterizing the amount by October 15 of next year. (To learn more about recharacterizations, see Recharacterizing Your IRA Contribution or Roth Conversion.)

3. Use Withholding From Retirement Plan Distributions to Pay Estimated Taxes
You may be required to pay estimated taxes to the IRS to avoid a penalty for underpayment of taxes. Estimated tax payments are usually required if you expect to owe at least $1,000 in tax for 2011 after subtracting your withholding and credits and you expect your withholding and credits to be less than the smaller of; (a) 90% of the tax to be shown on your 2011 tax return, or (b) 100% of the tax shown on your 2010 tax return. (To read on about year-end taxes, see Money Saving Year-End Tax Tips.)

Generally, estimated tax payments must be made on a quarterly basis. However, withholding from income you receive on an ad-hoc basis satisfies this requirement, even if the amount is withheld at the end of the year. For instance, if your IRA distribution is processed later in the year and you have taxes withheld from that distribution that are meet your estimated tax requirements, you will not owe any penalties for failure to have the taxes paid quarterly. (For more on estimated tax, see IRS Publication 505.)

4. Establish a Qualified Plan
If you plan to establish a qualified plan for your business this year, this must be done by the end of the plan year. This means that if the plan will be maintained on a calendar year basis, the adoption agreement must be completed by December 31. If the plan will be maintained on a fiscal year, the deadline is the last day of that fiscal year. Failure to establish the plan by year-end will result in your business being ineligible to deduct any contributions for that year. (To read more about qualified plans, see A Closer Look At The Roth 401(k) and Tough Times ... Should You Disturb Your Qualified Plan's Assets?)

5. Allow Time to Process and Reprocess
A large number of requests are not processed because they are not in good order, as determined by the financial institution's operational standards. These usually can be rectified in a timely manner if the request is submitted early, allowing sufficient time for you to receive the notification and make the changes necessary to satisfy the financial institution's requirements. A thorough check of your request will help to make sure it meets the financial institutions requirements, but just in case something is overlooked, it may be beneficial to submit your request in advance of the firm's deadline.

Submitting your request to your financial institution does not mean that it was received and/or that it was processed. Check your account statement for related activity, and contact your financial institution if you do not see the transaction being reflected properly. Due diligence will help to ensure that you avoid penalties that apply to transactions not processed in a timely way and help you to take advantage of tax benefits from Roth conversions and other transactions that you want to have done by year-end.