19 Oct 70 1/2, working and 401(k) distributions

Q. My husband is still working and contributes to a company 401(k). Should the value of his 401(k) be included in the calculations for the Required Minimum Distribution?
— Wife

A. Your question is common among people close to retirement age who want to continue working and don’t necessarily want to start depleting their retirement accounts just yet.

Let’s go over some of the rules for Required Minimum Distributions (RMDs).

RMDs only apply to qualified retirement accounts, said Michael Green, a certified financial planner with Wechter Feldman Wealth Management in Parsippany.

He said qualified accounts have special perks and grow tax-deferred until withdrawn.

“Why do we need to take Required Minimum Distributions? The concept behind RMDs is simple,” Green said. “Owning a qualified retirement account means that money is deposited or contributed to the account on a pre-tax basis — no taxes have been paid on it yet.”

Uncle Sam allows this tax-deferment in order to incentivize taxpayers to save money, Green said. But the catch is that when we finally open up our piggy bank in retirement, Uncle Sam will come knocking and ask for his share, Green said.

When the time comes to begin withdrawals, you have a couple of options: take your initial RMD in the year you turn 70 1/2 or wait until the year after you turn 70 1/2.

Depending on your situation, Green said, either strategy might suit your needs.

“It should be noted that if you delay your first RMD until the year after turning 70 1/2, you must take two RMDs in that year — this will increase your taxable income and may cause you to pay more taxes,” he said.

After the initial RMD, all future distributions — which are based on life expectancy and the balance as of the end of the previous year — must be taken by Dec. 31 each year, he said.

And there is a steep 50 percent penalty if you miss this deadline, Green said.

Remember, you are required to start taking distributions from qualified retirement accounts no later than April 1 of the year after turning 70 1/2, he said.

Keep in mind that RMD rules apply to employer sponsored plans, such as 401(k), 403(b) or 457 plans, as well as traditional IRAs and IRA-based plans like a SEP, SARSEP, or SIMPLE IRA, he said.

Roth IRAs do not have an RMD because contributions are made after-tax, and the earnings grow tax-free. Because we have already paid taxes on the contributions, the government does not require us to take distributions from a Roth IRA. The tax-free growth is a bonus, he said.

Now to your specific question.

Although it is mandatory that we make withdrawals from our IRAs, one of the perks of having an employer-sponsored plan like a 401(k) is the exception that applies when we continue to work beyond age 70 1/2.

“We are not required to begin taking withdrawals from our current 401(k) until April 1 of the year after we retire,” Green said. “It is important to note that employees who own more than 5 percent of the company sponsoring the plan cannot take advantage of this special rule, and must start distributions from their 401(k) accounts at age 70 ½, regardless of whether they continue to work.”

So if your husband is still working — and if he does not own more than 5 percent of the business — the value of his 401(k) does not need to be included in the calculation for his RMD, Green said.

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This post was originally published in October 2017.