Successful retirement planning is a combination of short-term and long-term decisions and actions. In the short term, you need to decide how to invest your money and how much to contribute to your account each year.
Your long-term focus will touch upon a number of different factors, including how your account will impact your overall tax situation. As you begin to prepare your tax returns for the year, here are some of the top tax moves related to your self-directed IRA.
1. Identify Your RMD Obligations (if any).
Traditional IRAs, including self-directed IRAs that are set up as traditional accounts, are subject to the IRS rules on required minimum distributions. These rules are designed to prevent account holders from letting their funds continue to grow without the holder ever having to pay taxes on that money during their lifetime (remember that deposits to traditional accounts are often made with “pre-tax” income of the depositor).
These rules on required distributions apply to individuals above age 72, regardless of their other income. Therefore, in order to minimize your tax bill, you may wish to plan ahead for the upcoming year’s required minimum distribution and adjust your other income as appropriate. For example, you might wish to delay selling an asset or investment you hold in a taxable account if it would raise your taxable income too high, or perhaps even subject your Social Security benefit to a greater level of tax.
It’s important to note that Roth self-directed IRAs are not subject to the same rules on RMDs. Converting a traditional self-directed IRA to a Roth account – provided that you are able to bear the one-time tax hit with funds from outside the account – could give you a much greater level of flexibility (and tax savings) going forward.
2. Consider a Roth IRA Conversion.
Being able to avoid certain rules on required minimum distributions is only one reason that many individuals find a Roth self-directed IRA to be preferable to a traditional account. The Roth IRA structure also provides you with additional benefits when it comes to estate planning and other financial planning issues.
Therefore, it’s a good idea at the beginning of each year to explore whether converting your traditional self-directed IRA into a Roth account would be a good long-term financial move from a tax perspective.
3. Plan to Maximize the Value of Your Contributions.
If you have both a Roth self-directed IRA and a traditional self-directed IRA, you’ll need to decide how much to contribute to each account, subject to the annual contribution. Some individuals elect to make contributions to their Roth account only when they have a minimal tax deduction from a traditional account contribution, or perhaps aren’t eligible to contribute to the traditional account at all.
Understanding the various contribution options available to you, and weighing them against one another, is an important element to minimizing your tax bill in the coming year.