Here’s our second part in our year-end retirement planning series, all about IRA year-end planning. There are many different types of IRAs, including the traditional IRA, Roth IRA, SIMPLE and SEP IRAs. All IRA plans share many of the same characteristics, however, there are some notable differences. Here, we will take a look at each one and what you should do before the new year.
A traditional IRA allows you to save for retirement in a tax-deferred plan, meaning you don’t pay taxes until you withdraw money from the plan during retirement. All traditional contributions are subtracted from your earned income for the year, so you don’t pay taxes on them. For example, if you earned $50,000 in 2018 and contributed $5,000 to your IRA, you will only be taxed on $45,000.
Opening and Funding an IRA – We’ll start off with some good news first. You don’t have to open or fund your IRA before the end of the year, as is the case with 401(k) plans. You have until Tax Day of next year (which is April 15) to both open and fund an IRA for 2018.
Contribution limits are as follows:
- For 2018, you may contribute up to $5,500, or $6,5000 if you are age 50 or older
- For 2019, you may contribute up to $6,000 or $7,000 if you are age 50 or older
Obviously, it’s always best to open and contribute to any retirement plan as soon as possible. Opening an IRA before the tax deadline allows you to contribute to both 2018 and 2019.
Required Minimum Distributions (RMD) – One thing you must do before the end of the year is take your RMD(s). Once you reach age 70 1/2, the IRS requires you to start withdrawing money from any traditional IRA you own. You haven’t paid taxes on that money yet and the IRS wants its share!
Some more good news if you just turned 70 1/2 this past year. You are not required to take your first RMD until April 1, 2019. However, you must still take your second distribution by December 31, 2019, meaning you would have two RMDs due next year.
Obviously, if you reached age 70 1/2 before this year, you must take your RMD before the new year. RMDs are calculated for each IRA your own (excluding Roth IRAs), but you are allowed to withdraw from one or several of them. Check out the RMD Worksheets on the IRS website.
Excess Contributions – Again, this is not required before the end of the year, so you have until your due date of your tax return (including extensions) to remove any excess contributions you may have made to your IRA. Failure to do so will will result in a six percent tax each year on the excess amount.
A Roth IRA differs from a traditional plan in that you don’t receive an immediate tax break on your contributions. Roths are funded with after-tax money, however all qualified distributions are tax-free, including earnings! However, not everyone can contribute to a Roth IRA. There are income restrictions that prevent high earners from contributing.
Opening and Funding a Roth IRA – The same rules apply to Roths as they do for traditional plans. You have until April 15, 2019 to both open and fund a Roth. The same contribution limits also apply. As we talked about earlier, you can choose to fund your Roth for 2018 first, before contributing to 2019.
Required Minimum Distributions – More good news for Roth IRA owners – you don’t need to take RMDs! Since Roths are funded with after-tax money, the IRS has already gotten it’s share and does not require to withdraw funds if you don’t want to. This allows your Roth to continue to grow and may be passed on, in full, to your beneficiaries.
Excess Contributions – The same rules apply to Roth IRAs as they do for traditional plans.
A Simplified Employee IRA, or SEP, is a retirement plan for self-employed individuals or small businesses. They’re easy to maintain and require little paperwork and filing requirements. Unlike another popular self-employed retirement plan, the Solo 401(k), a SEP allows for additional employees other than yourself. Though, it is not necessary to have any other employees to open a SEP IRA.
Opening and Funding a SEP IRA – Typically, you have until the tax deadline to open and fund an IRA. However, you have even more time to open a SEP. You can start a SEP up until the tax deadline, including extensions. Assuming your taxes are due April 15, you have until October 15, 2019 to open a SEP for yourself or your business.
Further, you have until this day to contribute to your SEP IRA. Contributions are made by the employer only. Contributions do not have to be made every year (i.e. you had a bad year financially), but every eligible employee must receive the same percentage contribution.
Contribution limits are the lessor of:
- 25% of the employees compensation, or
- $55,000 for 2018 and $56,000 for 2019
Note: if you are a self-employed individual with a SEP IRA, you may contribute 20% of your net adjusted annual self-employment income.
Required Minimum Distributions – As with all non-Roth IRA accounts, you must take RMDs from your SEP IRA as outlined previously.
The Savings Incentive Match Plan for Employees, or SIMPLE IRA is another useful retirement vehicle for the small business owner and self-employed individual. The SIMPLE plan allows for both elective deferrals by the employee and/or non-elective contributions by the employer.
Opening and Funding a SIMPLE IRA – Typically, an established business must set up a SIMPLE IRA before October 1. If you are a new employer, you can open your SIMPLE plan as soon as “administratively feasible after your business comes into existence”, as per the IRS.
Contributing to a SIMPLE IRA is much different than any other workplace/self-employed plan. As stated above, a SIMPLE plan offers contributions by both the employee and employer. An employee may choose to make elective deferrals (also known as salary reduction contributions). The limit for elective deferrals is $12,500 for 2018 and $13,000 for 2019. Note: if you contribute to more than one employer plan, the contribution limit for all plans is $18,500 for 2018 and $19,000 for 2019.
The employer has two choices for making contributions on behalf of his employee(s). First, is the employer match, where the employer must match each employee’s contribution on a dollar for dollar basis up to three percent of the employee’s compensation. Alternatively, the employer may choose instead to offer non-elective contributions. This allows for an across-the-board two percent contribution based on each employee’s compensation. Whether or not the employee chooses to make contributions is irrelevant with this choice.
Required Minimum Distributions – RMDs are required for SIMPLE IRAs and must follow the rules outlined above.
IRA Year-End Planning Summary
As you can see, December 31 is not as an important of a date for IRAs as it is for 401(k) plans. The only major concern is to take care of your required distributions. However, we wanted to share this info so that you’re prepared in the coming new year. Utilizing an IRA as part of your retirement plan is vital to put aside money for the future. It’s important that you start contributing as early as you can and put aside as much as possible so that your money continues to grow.
Be sure to check out our 401(k) year-end planning guide as well!