Required minimum distributions (RMDs) from IRA accounts get a lot of press coverage, but money in your 401(k) account is also subject to RMDs as well.
You see, the IRS requires you to start taking distributions from all of your retirement accounts once you reach age 70 ½. And if you don’t follow their rules to a T, the penalties can be costly.
So what do you need to know about RMDs when it comes to your 401(k)?
How Big Is Your RMD?
In general, the amount you must withdraw is determined by dividing the balance in your account at the end of the prior calendar year by a “distribution period” that the IRS has established.
This table presents some ages and the distribution periods associated with them.
So, for someone age 70 with a $500,000 account balance, their RMD would be $18,248 ($500,000 divided by 27.4). For a 90-year-old with the same balance, the RMD would be $43,860.
(Note: You’ll find the IRS’s complete table of distribution periods, plus the single life expectancy table in IRS Publication 590-B.)
Is Your RMD Taxable?
Unless you’re taking the distributions from a Roth account, the IRS will tax your RMD in addition to requiring it. The logic this is that you made the contributions on a pre-tax basis and, before you withdrew it, the money was allowed to grow on a tax-deferred basis. But now the government wants its money back, so to speak.
What Are the Rules for Traditional 401(ks)?
A traditional 401(k) is an account funded with pre-tax salary deferrals, rollovers from another account funded with pre-tax dollars, and/or your employer’s matching contributions.
Each traditional 401(k) account requires a separate RMD calculation and distribution. This differs from those who hold multiple IRA accounts where account holders can aggregate the accounts and take a single distribution for the total amount from one or any of their IRA accounts.
Could You Be Exempt From RMDs?
Those who are employed at age 70 ½ and own 5% or less of the company may be exempt from having to take an RMD on your 401(k) with your current employer. I say “may” because this exemption is not automatic; your employer needs to have made this election for their plan. If you are in this situation, it would behoove you to check with your benefits department prior to reaching age 70 ½. If they haven’t made this adjustment to their plan documents, you certainly should request that this change be made.
As mentioned previously, if you have other 401(k) accounts from previous employers, you will still need to take your RMDs from those accounts.
If you would like to extend this exemption to other retirement assets, you can look into doing a reverse rollover into your current 401(k) account. However, there are two requirements here: First, your current employer’s plan must accept rollovers into the plan. Second, the money rolled over must have originally been contributed on a pre-tax basis.
If you meet these requirements and wish to delay your RMDs, this could be an option. Of course, you will also want to be sure that the investments in your current plan are solid and low cost before committing more dollars there.
Can You Donate Your RMD?
IRA account holders have the option of diverting up to $100,000 of their RMDs to a qualified charitable organization. This is a great opportunity to save on their taxes. Unfortunately, this option is not available for RMDs from a 401(k) account.
What About Roth 401(k) RMDs?
Roth 401(k)s are a great option for those who want to contribute to a Roth IRA but who earn too much money to qualify. They are also a great option for those who want to contribute more to a Roth account than an IRA allows.
Like the Roth IRA, withdrawals from a Roth 401(k) account are tax-free as long as certain requirements are met.
RMDs are required from a Roth 401(k). While the amount withdrawn will not generally be taxed, you do lose the advantage of tax-free growth for the money invested in the account.
A good strategy to avoid Roth 401(k) RMDs is to roll your Roth 401(k) account to a Roth IRA once you leave your employer.
What About Other Workplace Retirement Accounts?
RMDs are required from other workplace retirement accounts such as 403(b)s or 457s. The requirements are similar to a 401(k), but there can be some differences. Be sure you understand what is required to avoid unneeded penalties or taxes.
What If You Don’t Take Your RMD?
The penalty for not taking your RMD is 50% of the amount not taken, plus the taxes that would normally be due. In some cases, you can appeal the penalty on a missed RMD and the IRS will decide whether to enforce it.
RMDs from a 401(k) can be complicated and costly… especially if you’re not prepared. Be sure that you understand what is required, and don’t be afraid to seek the help of a qualified tax or financial advisor if needed.