Once you reach the age of 70½ you are required in most cases to begin withdrawing money from your retirement accounts. These required minimum distributions (RMDs) are taxable as ordinary income and are the government’s way of getting back the tax savings you realized over your working years via making pre-tax contributions to your retirement accounts and the tax-deferred earnings on the investments in the account.
Retirement accounts that are impacted by the RMD requirement include 401(k)s, 403(b)s, 457s, the government’s TSPs and traditional IRA accounts. Roth 401(k) and IRA accounts, as well as any contributions to a retirement account made on an after-tax basis, are not subject to taxable RMDs.
Many retirees and others need the income anyway, so avoiding the RMD is not a big deal. Others, however, don’t need the money and would prefer not to pay the tax on these distributions. For those who are working, there can be a way to avoid some or all of their RMD obligations.
The Rules for Your Defined Contribution Plan if You Are Still Working
If you are still working when you reach age 70½, you may not be required to begin taking RMDs from your employer’s defined contribution plan. This can include plans such as:
- Profit sharing
In order to delay your RMD if you're still working, you cannot own 5% or more of the company, and your employer must make the election to allow for this exception if it is not automatic. Additionally, you must be considered employed throughout the entire year. (This definition has never really been defined in terms of hours worked, etc.)
Note that this exception from taking RMDs does not apply to your IRA accounts or to any retirement plan dollars left in the plan of a former employer. It applies to only your current employer’s plan.
Unlike with an IRA account, you are allowed to continue to make contributions to your 401(k) past age 70½ if you are still employed.
What Happens When You Retire?
If you are able to defer your RMDs on the 401(k) from your current employer after age 70½, you will need to plan on taking RMDs from this account once you stop working. The same rules will apply to this money as to IRAs and retirement accounts that may still be with a former employer.
If you decide to roll this money over to an IRA, then you would take the RMDs as part of the distribution from that IRA.
Note: If you stop working during the year, the 401(k) might become eligible for an RMD based upon the balance in the account as of the prior December 31.
For example, if you are 73 and stop working on Nov. 1, 2016, your 401(k) account might be subject to an RMD based upon your age and the total balance in the account as of Dec. 31, 2015. This can get complex, and you might be wise to consult with a tax or financial planning advisor who is knowledgeable in this area. Not taking an RMD can get costly in terms of penalties.
Money held in the Roth option of your company’s 401(k) are not subject to taxable RMDs, but you must take distributions from a Roth 401(k) once you retire. It is generally best to roll this money to a Roth IRA once you retire or otherwise leave this employer.
One tactic to consider, especially if you know you will continue to work after age 70½, is a reverse rollover. This entails taking money that has been rolled over to an IRA and rolling it into your current employer’s plan. A couple of things to note here:
- The IRA money must have been contributed on a pre-tax basis, whether directly to the IRA or funds rolled over from a retirement plan of a former employer.
- Your current employer’s plan must accept rollovers. Currently some 70% of employer plans do accept them.
The benefit of doing this is that this tactic allows you to defer taking your RMD on these funds until after you retire from your current employer.
Before going this route, consider how the investments offered in your employer’s plan stack up. Are there solid, low-cost investment options? While the tax savings from deferring your RMD may be significant, you do need to take the quality of your employer’s plan into account as well.
Understand What You Are Doing
While reverse rollovers are becoming a bit more common, they are not what most would consider mainstream. If you feel you need advice, make sure you find an accountant or financial advisor who is familiar with them, as not all are. The last thing you want to do is inadvertently turn this into a taxable transaction.
Along the same lines, be sure everyone involved knows what they are doing. Some custodians may not fully understand this transaction. Likewise, make sure your employer will accept the rollover and understands logistically how best to do this. Ideally, this can be done as a trustee-to-trustee transaction, which is the cleanest. It could be, however, that this becomes a distribution from the IRA custodian, in which case the 60-day rollover rules will apply.
For those who reach age 70½, taking required minimum distributions is a fact of life. RMDs are mandatory from most retirement accounts, including traditional IRAs and 401(k)s.
For those who are 70½ and still working, there is an exception regarding their 401(k) account and other employer-sponsored defined contribution retirement accounts. Additionally, with some planning, other retirement account assets can be rolled into their current employer’s plan to take advantage of this opportunity to defer your RMDs.