Tax deadlines for retirees: do this before the year ends

Tax planning can be arduous, but so is getting everything situated in the weeks leading up to Tax Day. There are also a few important deadlines retirees need to keep in mind to save money or avoid big penalties. 

One of the most popular strategies is the Roth conversion. Traditional retirement accounts, such as the traditional IRA or 401(k), are invested with pretax money, which means savers are taxed at the time of withdrawal. Roth accounts are contributed with after-tax dollars, so anyone who follows the rules will reap the benefits of tax-free distributions later in life. 

There’s no right answer for which account is best, but general guidelines suggest people in lower tax brackets contribute to a Roth, especially if they expect to be in a higher tax bracket at retirement, and those who are in their peak earning years should go with a traditional, if they expect their income to be lower at the time they take a withdrawal. 

A Roth conversion allows individuals to move money they may not need right now from a traditional account to a Roth account, so they’ll pay the taxes in the year they make the conversion. This strategy is best for taxpayers who may have seen a reduction in taxable income, as they could be in a lower tax bracket than usual and pay less in taxes on the conversion. 

See: Is now a good time to do a Roth IRA conversion?

Estimating tax brackets is a great way to save money, advisers said. One item on the “to do” list should be to compare their projected tax bracket with their current and potential future tax brackets, said Vaughn Kellerman, associate wealth adviser at HCM, a firm that provides retirement planning advice. 

“This allows for the optimization of the lowest tax bracket available regarding ordinary income sources,” he said. “For example, if it is determined that the retiree will be in a lower tax bracket this year versus next year, and they know they are planning for an additional large expense next year such as a new car, it would benefit them to take that money out of a retirement account before the end of the year.” 

Having an idea of what your income and expenses are for the current and future year is also just good general financial planning practice. With that information, retirees can decide if they should take Social Security early, or if they can afford to delay it, as well as feel more secure in their finances when the economic environment around them could be a bit scary, as it has been for many Americans this year. 

The deadline for required minimum distributions is Dec. 31 every year (except for people taking their very first RMD, who can delay until April 1 of the year following their 72nd birthday). The IRS calculates required minimum distributions using the individual’s age, account balance and a life expectancy chart, and those distributions are mandatory even if the retiree doesn’t need the money. 

The penalty for ignoring an RMD is 50% of what was supposed to be withdrawn – for example, someone whose RMD was $1,000 would face a $500 penalty on top of their RMD. Someone who takes a partial distribution would still pay the fine, so in the previous example, if the taxpayer took only $500 of the $1,000 he was supposed to take, he’d face a $250 penalty. 

Want more actionable tips for your retirement savings journey? Read MarketWatch’s ‘Retirement Hacks’ column

Tax-loss harvesting is another strategy advisers suggest, though it’s used in nonretirement investment accounts (there are restrictions in tax-deferred accounts, according to Charles Schwab). With tax-loss harvesting, assets currently suffering a loss are sold and replaced with similar options – consider working with a financial planner, qualified tax professional or someone at the investment firm housing your money before attempting it.  

Another important tax task at the end of the year: making sure you’ve reasonably estimated capital gains, losses and income, said Dennis Nolte, a financial adviser with Seacoast Investment Services. This is especially true for people who are not withholding taxes from pensions, Social Security and IRA distributions.

“Quarterly estimated taxes for the following year are always a concern for these folks,” he said. 

And then there’s organizing documents to avoid headaches around tax season. Retirees who itemize should keep a comprehensive collection of critical documents and receipts, such as medical expenses, so that they’re not fishing for those figures and any proof come April.