IRA And 401(k) Year-End Moves To Cut Taxes


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You still have time to maximize the benefits you get from retirement plans . Such moves can cut your taxes, this year and beyond.

For 401(k) plans, make sure your 2013 contributions are at the level you want. And re-set the contributions for 2014 if you need.

Most important: Be sure you're getting the full employer match, if one is offered. If you don't, you're losing free money.

Pay special attention if you switched employers in 2013 and you participated in two plans. You can contribute up to $17,500 altogether to the 401(k)s for this year, or up to $23,000 if you'll be 50 or older on Dec. 31.

For IRAs, convert traditional IRAs to Roths by year-end if you expect your tax bracket to rise or stay the same in retirement. Converting now, you'll gain nearly a year in the quest for tax-free withdrawals.

After a conversion, all Roth IRA distributions are tax-free after five calendar years and after age 59-1/2. All 2013 conversions have a Jan. 1, 2013, start date.

You'll hit the five-year mark in a little over four years -- on Jan. 1, 2018 -- by acting now.

When you convert, think big. Do a large conversion. Don't worry now about whether the numbers work.

You can recharacterize -- which is IRS jargon for reverse -- all or part of the conversion until Oct. 15, 2014. The amount you revise will go back into your traditional IRA.

You'll owe income tax on the amount you convert. So if you change your mind, any part of the conversion that you return to your traditional IRA in 2014 cuts the tax you'll owe on the 2013 conversion.

By the time you prepare your 2013 tax return next year, you'll know your exact taxable income. Then you or your tax pro can reduce the conversion so it fits into your tax bracket.

For the best after-tax result, do multiple Roth IRA conversions. Segregate the accounts by asset classes, market sectors or even individual securities.

This will give you planning flexibility next year when you recharacterize. You can hold on to your winners and undo laggards to save tax.

Here's an example. Say you like two mutual funds: ABC and XYZ.

You convert $100,000 of your traditional IRA to two $50,000 Roth IRAs. One holds ABC shares, the other holds XYZ shares.

Suppose next October, the price of ABC is up. That Roth IRA is now worth $70,000. But XYZ has dropped, so that Roth IRA is down to $25,000.

If you still like XYX long-term and want to hold it, you should recharacterize that Roth IRA back to a traditional IRA. Why pay tax on a $50,000 conversion to own a Roth IRA now worth $25,000?

You can do another conversion of XYZ late in 2014 and hold the company's shares in the new Roth IRA.

Meanwhile, you can retain the ABC Roth IRA. You'll pay tax on a $50,000 conversion and have a $70,000 Roth IRA.

Eventually, you can withdraw gains tax-free. That's the reason for the conversion. You can even sell the fallen-value XYZ shares and then recharacterize, as long as you left sale proceeds in the Roth.

Small Bites

If you don't want to pay tax on a full $50,000 conversion, you can recharacterize some of your ABC Roth IRA, too. You'll know exactly how much to convert to stay in your tax bracket.

If you had simply converted to one big Roth IRA, holding ABC and XYZ shares, you would have converted $100,000 but wound up with a $95,000 Roth IRA. Any recharacterization would mean giving up profits as well as losses.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Mutual Funds

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