Retirement Accounts: Keep Contributing After Age 70 1/2?

Assume you have reached age 70 1/2 and are starting to receive required minimum distributions (RMDs) from an IRA or other retirement plans. Even though you are required to take money out, you may wonder, "Can I still reduce current income taxes by contributing at the same time?"

Although it seems strange to take money (the RMD) out of the plan with one hand and put funds back in with the other hand, this technique does work well for some people.

Here's what you can and cannot do.

First, You Cannot Convert Your RMDs to a Roth IRA Inevitably some investors will say: "I know I have to take RMDs from my IRA. Since I don't need the money for spending right now, and since I have to pay tax on it anyway, I might as well convert the RMDs to a Roth IRA. Whenever I take out an RMD, I'll just deposit it in a Roth IRA, and that way I'll be making some kind of silk purse out of the sow's ear."

Although it seems logical--"I know I can convert my traditional IRA to a Roth anytime if I'm willing to pay tax on the converted funds; so since I have to pay tax on the RMD I might as well convert at least that much to a Roth"--it does not work. Here's why:

There are only two types of contributions that can legally be made to an individual retirement account, whether traditional or Roth: "Rollover" contributions and "regular" contributions. A qualified rollover contribution is one that meets all the technical requirements of a rollover. Any contribution that does not meet those requirements is a "regular" contribution. Your required minimum distribution definitely cannot be a qualified rollover contribution and probably is not a valid regular contribution, either.

Example: Doug, age 73, has to take an RMD of $25,000 from his traditional IRA in 2016. He withdraws the $25,000, deposits it in his taxable bank account, then draws a check for $25,000 payable to his Roth IRA. He brings the check down to the Roth IRA provider's office. The Roth IRA provider is going to ask him, "Is this a regular contribution or a rollover contribution?" Remember, it has to be one or the other!

It's not a rollover contribution, because the distribution that came out of the traditional IRA is not a qualified rollover distribution. Most distributions from IRAs can be rolled over, but there are exceptions. The biggest exception is for required minimum distributions. An RMD is never a qualified rollover distribution.

Since Doug's distribution cannot possibly be a valid rollover contribution to the Roth IRA, it must be a "regular" contribution. But there's a problem with that, too. For one thing, the limit on regular contributions is $6,500 per year for people age 50 or older. Doug's $25,000 is way over that limit.

To the extent of $6,500, it could be a valid "regular" contribution--but only if two more requirements are met:

First, Doug must have at least that much compensation income in 2016. You cannot support a regular contribution to any type of IRA unless you have compensation income for that year at least equal to the contribution amount. If Doug is totally retired and has no compensation income, his regular Roth IRA contribution limit for 2016 is zero.

The second requirement is that, in order to be eligible to make a regular contribution to a Roth IRA, adjusted gross income for the year must be below $194,000 (if married filing jointly; $132,000 if single) for 2016. In addition, there are phase-outs for individuals (or couples) who make $117,000 (or $184,000) or more. If Doug is still working (so he does have taxable compensation income), he can contribute $6,500 of his $25,000 RMD to a Roth IRA if, and only if, his adjusted gross income for the year is below the applicable ceiling.

So Doug's "plan" to convert his RMDs to a Roth IRA is all wet. He certainly cannot contribute anywhere near $25,000. The annual contribution limit is $6,500--and he can only contribute that much if he is still working and earning compensation (enough to support an IRA contribution), but he does not have too much income for the year (so he stays below the adjusted gross income limit)!

Traditional IRA Contributions You cannot make a "regular" contribution to a traditional IRA for the year you reach age 70 1/2 or any later year. Traditional IRAs are the only type of retirement plan that have an age limit on contributions. You can still make rollover contributions to these accounts, and if you are still working you can generally have contributions made to a "SEP-IRA" (see below). But you cannot make the annual-type contribution of $5,500 or $6,500 to a traditional IRA that younger people are allowed to make from their compensation income.

Workplace Retirement Plans For an individual who is over age 70 1/2 and still working and earning compensation, the best bet for reducing the impact of RMDs is often to make ongoing contributions to a workplace retirement plan. If the employer offers a 401(k) plan, SEP-IRA, or other retirement plan, these offer a valid way to "shelter" current income after 70 1/2, just as they did before that age.

A SEP-IRA is treated as an IRA for purposes of the minimum distribution rules (so you do have to take annual distributions starting at age 70 1/2, even if still working). However, employer contributions to a SEP-IRA are not subject to the post-age-70 1/2 contributions ban normally applicable to traditional IRAs. By contributing the maximum (25% of taxable compensation or $53,000, whichever is less) an investor may be putting into the workplace plan (and deducting or excluding from income) more than he or she is being forced to take out in RMDs.

Where to read more: For rule that a contribution to a Roth IRA must be either a qualified rollover contribution or a regular contribution, see Treas. Reg. § 1.408A-3, A-1. For rule that a required minimum distribution cannot be a qualified rollover distribution, see IRC § 402(c)(4)(B), § 403(b)(8)(A)(I), and § 408(d)(3)(E). For rules that a regular IRA contribution cannot exceed the amount of taxable compensation income for the year or the applicable dollar limit, and that a regular contribution cannot be made to a Roth IRA if annual income exceeds the applicable dollar amount, see IRC § 219(b)(1) and (g)(3) and § 408A(c)(3)(A), and Treas. Reg. § 1.408A-3, A-3. For the 2016 applicable dollar amount (limit on income affecting eligibility to contribute to a Roth) and applicable dollar limit on "regular" (annual-type) contributions to an IRA, see IRS Publication 560 (2015) and IRS Publication 590-A (2015). For the age limit on contributing to a traditional IRA, see § 219(d). For the rule that a SEP-IRA is treated as an IRA for purposes of the minimum distribution rules, see Treas. Reg. § 1.408-8, A-2. See IRS Publication 560 (2015) (p. 6) for the rules that the applicable dollar limit and age restriction affecting annual contributions to a traditional IRA do not apply to SEP-IRA contributions.