Many people are aware that once they turn 70½ they are required to start taking required minimum distributions (RMDs) from their retirement accounts on April 1st of the year after they turn 70½. However, if you are still working past 70½, you may qualify for a lesser known exception to the normal RMD rule. Under IRC Section 401(a)(9)(C)(i)(II), the required begin date (RBD) for required minimum distributions is delayed until April 1st of the year after the employee retires, not the year after they turn 70½. Thus, if you are still working beyond age 70½ and don’t own 5% or more of the company you work for, you can defer your employer plan asset RMDs beyond 70½! Note, the IRS is vague in their explanation of what qualifies as still employed. The general interpretation is that as long as you are employed you qualify. Let’s look at a case study example to see how this RMD deferral works in a couple different scenarios:
Example 1: Doug Smith is 68 years old and currently works for a major oil and gas company. He has started looking at his future retirement plans and is concerned about taking RMDs on top of his large salary if he continues to work past 70½. Doug loves his job and would like to work until he is at least 75. With his current employer, Doug has a 401(k) plan and a defined benefit pension that he is counting on to cover his income needs in retirement. Doug also has an outside 401(k) balance still held with a previous employer from earlier in his career.
In this scenario, if Doug wants to delay all RMDs until years after 70½, he needs to first find out if his current employer’s plan allows for the “still working” RMD exception. Not all plans allow for this exception, so Doug should reach out to his plan administrator for guidance on this. Next, Doug should also note that the “still working” exception only applies to his current employers plan. Thus, if he were to reach his RBD and still have his previous employer’s 401(k) plan elsewhere, like it is today, he would have to take RMDs on those assets. One potential solution here would be for Doug to see if his current employer’s plan would allow him to roll his previous employer’s 401(k) plan assets into his current employer’s plan. Once those assets were consolidated with his current employer’s assets he could potentially delay taking RMDs on all of his qualified plan assets until retirement. If Doug’s current plan will allow him to rollover his outside 401(k) assets, he should make sure to do this before turning 70½ or else the other plan may require him to take an RMD prior to rolling over the assets into his current plan.
Example 2: Doug is now 75 years old and ready to retire. His current employer allowed him to roll his outside 401(k) assets into his current plan before he turned 70½, and he has been able to delay taking any RMDs this far. Doug is ready to retire and is planning on leaving December 31st of this year. Since Doug has not had to take RMDs yet, he is concerned about the timing of the first RMD in what will be an already unusually high tax year for him. Doug has opened an IRA account and wants to roll his 401(k) and the lump sum of his pension over to the IRA account when he retires.
In this scenario, the RMD delay exception rule states that Doug will not have to take an RMD from his employer plan until April 1 of the year after he retires. Per the rule, if Doug retires December 31st of this year and he doesn’t work a single day next year, he will have to take an RMD for this year before April 1st of next year. He will also need to take next year’s RMD by December 31st of next year. If Doug were to wait one more day and retire on January 1st of next year, he could delay taking one additional RMD. Put another way, working one additional day allows Doug to delay taking a RMD for another year! Doug should also note that there is a special rule for IRA rollovers. RMD dollars are not eligible to be rolled into an IRA. The rules state that the first money out of a retirement plan in a year when a RMD is required must be RMD dollars. When Doug retires and rolls his employer plan assets into his IRA he will be required to take out RMDs from his 401(k) and pension lump sum amounts (calculated by the plan separately) before rolling them into his IRA. If done incorrectly and any of the calculated RMD amount is rolled into Doug’s IRA, any RMD amount plus earnings would be considered an excess IRA contribution and subject to IRS penalties.
Doug’s example above does not cover all of the moving parts associated with the “still working” exception rules. There are many other factors to consider when making retirement planning decisions like this, and Doug’s example simply highlights the importance of knowing the rules and working with a professional who is knowledgeable of your plan and benefits.
While Baird does not offer tax or legal advice, our Financial Advisors regularly work with clients' attorneys and tax professionals to help ensure that all phases of wealth management are addressed.