401k Required Minimum Distribution (RMD)

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August 1, 2017
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August 9, 2017

Do you have to take a required minimum distribution (RMD) from your 401k like you do from your Traditional IRA?

It depends.

Like a Traditional IRA, required minimum distributions must be taken from a 401k account by April 1st of the year following the year you turn age 70 ½. Unlike a Traditional IRA, RMDs from your current employer’s 401k can be delayed until April 1st of the year following your departure from the organization if you are older than 70 ½ and still working.

This difference between the nature of RMDs from a Traditional IRA and a 401k is yet another reason to consider all the relevant factors involved prior to rolling over your current employer’s 401k account balance into a Traditional IRA while you’re still employed.

The ability to delay these RMDs can be a big deal for some people. Imagine someone who rolled all or some portion of their current employer’s 401k into a Traditional IRA but continued to work past age 70 ½. They would be required to take distributions from their IRA regardless of their need for income.

Not only does this mean that they will have to deplete account balances earmarked for when they are no longer working, but these unwanted distributions are also adding to their employment and, presumably, Social Security income, creating an elevated tax burden. Conversely, if they would have left their assets inside their current employer’s 401k plan, they could have waited to take those distributions until they retired and their total income no longer included employment income.

The 5% Owner Exception to Delaying 401k RMDs

One big exception to your ability to defer required minimum distributions from your current employer’s 401k beyond age 70 ½ is if you also happen to be a 5% or more owner of the company. If you are a 5% or more owner of the company, you’re still required to start taking RMDs from your 401k by April 1st of the year after you turn 70 ½, even if you’re still working.

Most people believe that this doesn’t apply to them, and it might not, but it should be said that this exclusion also applies to the Individual 401k (also known as a Solo 401k or Solo k). Since Individual 401ks apply to one owner employee or, at most, the owner and their spouse, it is quite likely that they own more than 5% of the company that established the 401k plan, and need to start taking RMDs even if they continue to work beyond 70 ½.

How Are 401k RMDs Calculated?

Similar to a Traditional IRA, 401k RMDs are calculated by dividing the previous year’s December 31st adjusted account value by what can be thought of as your government appointed life expectancy, which can be found – in helpful worksheet form – on the IRS website.

Depending on your 401k plan, you should have access to someone at your plan administrator that can perform this calculation for you. There is no harm in being aware of how that calculation is performed, however, just in case.

What Happens if I Miss a 401k RMD?

If you are over age 70 ½ and a more than 5% owner of the company sponsoring your 401k or no longer work for the company sponsoring your 401k, and believe that you have missed a required minimum distribution, you need to act fast.

First, you need to determine if you have actually missed a required distribution. Remember, you do not have to take a required minimum distribution until April 1st following the year in which you reach age 70 ½ – six calendar months after you turn age 70. Usually, the best course of action is to simply call the number on your 401k account statement and ask a service representative.

If you determine that you have missed a required minimum distribution, it is critical that you begin taking the steps to get caught up. This is not something that you want to ignore. In every year that required minimum distributions are not taken, a 50% penalty will be applied to the amount that you were supposed to have distributed but did not. Of course, you will also still have to take the distribution that you were supposed to have taken, and pay taxes on the amount of that distribution at your ordinary income tax rate.

The stakes are obviously high here, so RMDs should not be taken lightly. However, if you are behind on your RMDs, it is worthwhile to not only work with your 401k plan administrator to set up distributions, but also to contact the IRS and fill them in. Under some circumstances, the IRS has been known to waive some or all of the penalties associated with delinquent RMDs, although they do not have to.

The penalty for missing your RMDs is huge, so it is better to stay on top of them than to plan on asking for forgiveness, as the assumption should be that exceptions will not be granted.

The Curious Case of Roth 401k Required Minimum Distributions

Yes, that’s right, Roth 401k required minimum distributions. It’s fairly common knowledge that RMDs do not have to be taken from Roth IRAs. This is not the case for after-tax Roth contributions to your 401k.

If you are over age 70 ½ and no longer work for your 401k plan sponsor, you will need to take required minimum distributions from the Roth portion of your 401k in the same manner as the pre-tax portion of your assets in the plan. However, if your Roth 401k assets are rolled into a Roth IRA at some point, required minimum distributions will no longer apply.

Always Consult Your Tax and Financial Professionals

The eventuality of 401k required minimum distributions might be a fact of life if you have a 401k. Because of the steep penalty that can apply if these distributions are mishandled, it is advisable to make sure that you are well aware of your obligation, and to always consult your tax and financial professionals.

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