By the time many clients reach age 70 ½, they are ready to enjoy retirement and are well aware of the obligation to begin taking required minimum distributions (RMDs) from various retirement accounts.
Although this may generally be the case, there are a variety of reasons why a client may wish to continue contributing to retirement accounts past the age when RMDs begin — perhaps the client is still working and trying either to reduce taxable income or make up for missed contributions during earlier working years.
Whatever the reason, clients must understand that they cannot always continue contributing to their accounts after they reach age 70 ½. Different rules govern each type of account, so the client must carefully examine his or her portfolio of retirement accounts to determine where a post-70 ½ contribution may be permissible — as well as the RMD impact of the contribution.
The IRA Post-70 ½ Contribution Rules
The rules for post-70 ½ IRA contributions depend upon whether the account is a traditional IRA, Roth IRA or SEP IRA. Direct contributions to a traditional IRA are not permitted after the client reaches age 70 ½, although the client may roll funds from another type of retirement account into his or her traditional IRA.
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Conversely, the client may contribute directly to a Roth IRA after he or she has reached age 70 ½ (up to the annual $6,500 limit, which includes a $1,000 catch up amount). Direct Roth IRA contributions, however, are subject to income limitations that apply to reduce the contribution limits for taxpayers who earn more than $184,000 (married taxpayers) or $117,000 (single taxpayers) in 2016.
Further, the client must have annual compensation that is at least equal to the direct contribution (meaning that the taxpayer must still be working in some capacity to contribute directly, as the compensation must be earned income, rather than investment income or Social Security benefits).
Rollovers to Roth IRAs are permitted, but clients must remember that a traditional IRA RMD cannot be characterized as a rollover transaction. Therefore, if the client wishes to contribute his or her RMD to a Roth account, the client is limited to depositing $6,500 (or 100% of compensation) of the RMD into the Roth for the year, assuming that the income thresholds are not exceeded.
SEP IRA contributions are also permitted after the client reaches age 70 ½. These contributions are limited to 25% of the client’s compensation, or $53,000 (in 2016), whichever is less. RMD rules do apply once the taxpayer reaches 70 ½, so the client may be both making contributions and taking RMDs from the account.
Annuities As an RMD Answer
While many advisors have counseled against purchasing an annuity with IRA funds in the past, in today’s post-recession world, there are several reasons why a client may be interested in the annuity-within-an-IRA strategy. However, as with any retirement income planning strategy, the pitfalls associated with a poorly executed annuity purchase strategy can cause unnecessary expenses and disappointment down the road.