401(k) retirement plans and traditional individual retirement accounts (IRAs) offer attractive tax breaks that serve to encourage people to save and invest for retirement during their working years. In addition to offering pretax or potentially tax-deductible contributions, these retirement savings vehicles allow your investment earnings to grow tax deferred.
The Bill Eventually Comes Due
However, the tax deferral benefits of these retirement accounts do not last forever. Traditional IRA owners and 401(k) plan participants are taxed — at ordinary income tax rates — on distributions taken from their accounts. Moreover, the IRS requires that you begin taking distributions from your account once you reach what is called your “required beginning date” (RBD). That’s the case even if you have sufficient retirement income from other sources and do not want to touch the money in your retirement account.
The Ground Rules
The rules that determine your RBD greatly depend on the type of account you have.
You’ll have to begin taking required minimum distributions (RMDs) from your traditional IRA no later than April 1 of the year following the calendar year in which you reach age 73. If you take your first RMD on April 1, you will be required to make another withdrawal by December 31 of the same year. The bottom line is that you will have to take two RMDs in that first year, and subsequent RMDs every year by December 31.
The RMD rules for 401(k) plans are basically the same. However, participants who are not considered to be 5% owners of the company and are still employed by the employer maintaining the 401(k) plan when they reach age 73 generally are not required to begin taking RMDs until April 1 of the year following the calendar year in which they retire. Note also that RMD payments are not rollover eligible. Your plan administrator can provide further details regarding your plan’s specific requirements and whether you are considered a 5% owner.
How Much to Take Out
The amount you will have to withdraw to satisfy the RMD rules will vary from year to year. Generally, the amount is calculated by dividing your account balance at the end of the prior year by an age-based factor taken from the “Uniform Lifetime Table,” which is available on the IRS’s website. However, a different table must be used under certain circumstances.
You have to be careful since you can be penalized for taking out too little. The penalty is 25% on the amount not withdrawn as required. There’s no penalty for taking out more than the required annual amount. Just be aware that any additional withdrawals are also taxed as ordinary income. Moreover, these additional withdrawals are not counted toward RMDs for future years.
When Multiple Retirement Accounts Are Involved
If you own several IRAs, tax law allows you to, if you choose, withdraw the total RMD from one IRA. The rules are different, however, for individuals with multiple 401(k) plan accounts. If you have several 401(k)s, you are not permitted to stack the RMDs within one 401(k) plan as you can with IRAs. Moreover, the RBD for taking distributions from your 401(k) plan accounts can vary depending on employment status.
The rules regarding RMDs can be complicated, and it could be beneficial to seek input from your financial or tax professional. Give us a call at 800-658-9474 with your questions.