Age 69 1/2: The IRA Owner's Most Important Year?

IRA owners, mark this date on your calendar: the day you turn 69 1/2.

Wait a minute, who cares about turning 69 1/2? Everybody knows the big year is when you reach age 70 1/2, right?

Wrong. Age 69 1/2 is a big deal, a major year in the "life planning calendar." In the year you reach age 69 1/2:

• If you're still working, this is your final chance to make a traditional IRA regular contribution.
• It's also your final year to roll your traditional IRA into your workplace plan (if you are still working) to totally avoid taking any required minimum distributions from the IRA.
• Now's the time to consider other ways to reduce future RMDs, too, such as Roth conversions.

Final Traditional IRA Contribution If you are age 70 1/2 or older at the end of a calendar year, you are not allowed to contribute to a traditional IRA for that year. So the last year you can make a "regular" contribution to a traditional IRA is the year in which you turn 69 1/2.

Making that final contribution does not mean no contributions can be made ever again to your retirement plans. You can make rollover contributions to traditional IRAs (from workplace plans, for example) at any age. And if you're still working, you can continue to contribute to workplace retirement plans (including 401(k)s, pension and profit-sharing plans, Keogh plans, and even SEP-IRAs) regardless of age. You can even contribute to a Roth IRA after age 70 1/2 if you have compensation income and your total income is under the income ceiling for Roth contributions.

Traditional IRAs are the only tax-favored retirement plans that have an age restriction on contributions.

How Can You Reduce Future RMDs? Imagine you are approaching age 70 1/2. Looking ahead, you see that you will have to start taking required minimum distributions (RMDs) from your traditional IRA very soon. You don't want or need to take that money out, and you don't want to have to pay income tax on it. What are the legal ways to delay, reduce, or eliminate those RMDs?

There are a few avenues to consider, including rolling into a workplace qualified plan and converting to a Roth IRA.

Rolling Into a Workplace 'QRP' Traditional IRAs must start distributing RMDs at approximately age 70 1/2 regardless of whether the IRA owner is still working. "Qualified" retirement plans (such as pension and profit-sharing plans, Keogh plans, 403(b) plans, and 401(k) plans) have more flexibility. A QRP does not have to start distributions until the later of age 70 1/2 or the year the worker retires--provided the worker does not own more than 5% of the business that sponsors the plan.

For someone who is still working, rolling over IRA money into the workplace QRP is a tried-and-true, popular, safe, and legal way to delay RMDs if the following requirements are met:

• The QRP accepts IRA rollovers. Not all do--they are not required to allow this.
• The QRP uses the permitted later commencement of RMDs. Some plans start paying RMDs at age 70 1/2 regardless of whether the employee is still working.
• The worker owns less than 5% of the employer. There are back-testing dates and attribution rules involved in meeting this test, so if there is any doubt, consult an expert to make sure the worker is not considered a "5% owner."
• The worker is not "retired." If you work full time and have done so without interruption, this should not be a problem. If you have cut back on work, and/or stopped work and resumed work, again, consult an expert. There is no cut-and-dried test for what constitutes "retiring" for this purpose.

If you plan to continue working after age 70 1/2, and you are not a "5% owner" at the company you work for, consider rolling your traditional IRA funds into your workplace retirement plan no later than the year you reach age 69 1/2. Already over that age? More on that in a moment.

Convert to a Roth Roth IRAs do not have lifetime required minimum distributions. Age 70 1/2 is "just another year" for the Roth IRA owner. Thus a legal and safe way to eliminate (or reduce) RMDs on your traditional IRA is to convert it (or part of it) to a Roth IRA. Of course for most people, that move comes with a high income tax price tag, since the conversion amount is taxed as a distribution from the IRA. But this is definitely a move to consider, especially during any years after retirement but before age 70 1/2, when the individual may be in a lower-than-usual tax bracket. The idea is to convert now, at a relatively low tax cost, to reduce future taxable RMDs from the IRA when you may be in a higher bracket.

George Example: George retired at 65 from his law firm where he earned a high six-figure salary. He has a substantial IRA that will start paying him substantial RMDs when he hits age 70 1/2 in five years. In the meantime, his income is much lower than it used to be and lower than it will be once RMDs start. Now is the time to do annual piecemeal Roth conversions to use up those lower income tax brackets!

You can still do Roth conversions after age 69 1/2, but it probably won't be quite as cheap.

What If You Waited Past Age 69 1/2 to Do These Moves? If you wait until the year you reach age 70 1/2 (or later), you can still do both of these moves. You can roll money from your IRA into your workplace qualified plan, if you are still working. You can convert part of your IRA to a Roth for the same result. But the difference is this: Once you hit the age 70 1/2 year, you cannot do either of these moves without first taking the RMD for the year from your traditional IRA.

This confuses a lot of people. Most people know that, in the year you reach age 70 1/2, you have a choice: You can take the RMD for that year in that calendar year, or you can postpone it until as late as April 1 of the following year (the year you reach age 71 1/2).

Luke Example: Luke turns age 70, and also age 70 1/2, in 2015. He has only one traditional IRA, the account balance of which was $3 million as of Dec. 31, 2014. His RMD for 2015 for that IRA is 1/27.4th of the account balance ($3 million/27.4), or $109,489.35. Luke retired a few years ago, and last year his wife also retired, so their income is (so far) unusually low in 2015. He planned to postpone his 2015 RMD until April 1, 2016 (taking a double RMD in 2016, since the 2016 RMD can't be postponed), while doing a substantial Roth conversion in the low-income year, 2015. He is shocked to learn from his accountant that he cannot do the Roth conversion in 2015 unless and until he takes the 2015 RMD from the IRA first. So his 2015 income will have to include the $109,489.35 RMD, and the amount he can convert to a Roth while remaining within the lower bracket he was targeting will be equivalently less.

Why is this? Because there is a rule: You cannot roll over a required minimum distribution. A Roth conversion is considered (for this purpose) a "rollover." And there's another rule: The first distribution that comes out of a plan or IRA during the year is the RMD. Therefore, since a Roth conversion is considered a rollover, and the first money that comes out of the IRA is the RMD, you cannot do a Roth conversion from that IRA until after the RMD for the year has been distributed to you.

This means that yes, in theory, you can postpone the age 70 1/2-year RMD from your IRA until April 1 of the following year. But in reality you can only do that if you do not do any rollover or conversion from your IRA during the age 70 1/2 year. So the "real" rule is: In the age 70 1/2 year, the first required minimum distribution accrues, and the deadline for taking that distribution is April 1 of the following year, or, if earlier, the date you want to do a rollover or Roth conversion from the IRA!

That's why the age 69 1/2 year is so important. It's the last year you can do Roth conversions from your traditional IRA (or rollovers from the IRA into a workplace plan) without first having to take the RMD for the conversion (or rollover) year.

Resources: For complete explanation of these and all other aspects of the minimum distribution rules, see Chapter 1 of Natalie Choate's book Life and Death Planning for Retirement Benefits (7th ed. 2011). The book is available as a paperback with free web-posted updates (see www.ataxplan.com) or in an electronic edition (www.retirementbenefitsplanning.com)

This article originally appeared on MorningstarAdvisor.com. Click here to read more from Natalie.

Natalie Choate will be speaking at a location near you if you live in Grand Rapids, Mich. (April 29, 2015); San Francisco or Palo Alto (April 23, 2015) or San Diego (Oct. 24, 2015), Calif.; Milwaukee, Wis. (May 4, 2015); Orlando (May 15, 2015) or St. Petersburg (Oct. 15, 2015), Fla.; Cromwell, Conn. (May 13, 2015); Chicago (May 5, 2015); Doylestown (May 19, 2015) or Philadelphia (July 16, 2015), Pa.; Chattanooga (May 20, 2015) or Knoxville (Sept. 9, 2015), Tenn.; Lowell (May 12, 2015), Waltham (May 29, 2015), or Boston (July 17, 2015), Mass.; Rochester (June 10, 2015) or Albany (Oct. 20, 2015), N.Y.; Indianapolis (June 12, 2015); Kiawah Island, S.C. (July 30, 2015); Missoula, Mont. (Oct. 23, 2015); Atlanta (Oct. 22, 2015); or Honolulu (Oct. 26, 2015). See all of Natalie's upcoming speaking events at www.ataxplan.com/seminars/schedule.cfm.