An apparently erroneous response in a recent financial advice column has inspired us to share some basic rules about Required Minimum Distributions (RMDs) from qualified retirement plans. RMDs are sometimes called “70½ distributions” because that is generally the age at which a participant must start taking withdrawals from his plan account.
A 74-year-old reader who is employed is wondering whether he or she should be getting distributions from his or her 401(k) plan. The worker is getting conflicting advice from those always-reliable sources of information: a “relative” and a “colleague.” The relative says the worker doesn’t have to withdraw money yet because he or she is, well, still working. The colleague says that “nowhere in the IRS guidelines does it state that” the over-70½ worker may hold off on RMDs. The reader looks to the financial columnist to break the tie. The columnist says, without hesitation, “You were required to start drawing on your 401(k) at 70½. There's no way you can leave it intact.”
Correct Response or No?
Is that so? Let’s go to the IRS guidelines – actually the Treasury Regulations. Regulation 1.401(a)(9)-2, Q&A 2, says the required beginning date for qualified plan distributions is April 1 after the later of (i) the year the employee attains age 70½, or (ii) the “calendar year in which the employee retires from employment with the employer maintaining the plan.”
This seems to say that the worker wouldn’t need to take distributions now despite being older than 70½ because the employee has not retired. This would make the columnist wrong. But wait. The letter from the reader did not indicate whether the 401(k) in question is from the job he or she is at now or a previous job. Perhaps this important piece of information was edited out. If the reader is talking about a 401(k) from a prior job, then yes, distributions should have already begun from that plan.
RMD Rules at a Glance
Here is when retirement distributions must start under various circumstances:
401(k)s and other qualified plans:
- Active employees: April 1 following calendar year of “retirement”
- Terminated/retired employees: April 1 following calendar year of attainment of age 70½
- More-than-5% owners: April 1 following calendar year of attainment of age 70½
- Traditional IRAs, SEPs, SIMPLE IRAs: April 1 following calendar year of attainment of age 70½ (no exception for being actively employed anywhere)
- Roth IRAs: RMD rules do not apply during the lifetime of the owner
Here are some comments about those rules:
- RMDs for currently active employees must begin when the employee retires. The word “retire” is not defined anywhere in the law or regulations. We interpret “retire” to mean when the employee completely stops working for the company, not when there is a reduction in hours or the employee leaves and comes back on a part-time basis. That’s not retirement!
- A person’s status as a more-than-5% owner is determined in the calendar year he attains age 70½. Any changes to a person’s ownership after that are irrelevant. So you could have someone older than 70½ who owns more than 5% of the employer but is not required to take distributions because the percentage he owned at age 70½ was 5% or less.
- Distributions must start for the calendar year you turn 70½ or retire. As noted above, the first distribution may be postponed until April 1 of the following year. If you do wait until the following year, there will be another distribution due December 31 of that same year, so there would have to be two distributions that year. The worker would need to consider whether taking two distributions in one year is best for his tax situation or if he should go ahead and take the first distribution in the year age 70½ is attained or retirement occurs.
- If an RMD is missed, severe penalties may apply.
- The distribution rules for defined benefit plans are different in some ways than those of defined contribution-type plans such as 401(k)s and IRAs. The principles relating to the April 1 start date, 5% ownership, active employment, etc. are the same, however.