Do you have employees who will soon reach retirement age? If so, are they aware of the required minimum distribution (RMD) obligations beginning at age 70½ for both their individual IRAs and their 401(k) plans? It’s important that they know what to expect when they reach that age, for financial and tax-planning purposes.
IRAs and 401(k)s
To avoid a whopping penalty, current employees must take RMDs from their IRAs on reaching age 70½. However, the first payment can be delayed until April 1 of the year following the year in which the employee turns 70½. But they don’t have to begin taking distributions from their 401(k)s if they’re still working.
Although the regulations don’t state how many hours employees need to be working to postpone 401(k) RMDs, they must be doing legitimate work and receiving wages reported on a W-2 form. There’s an important exception, however: Workers who own at least 5% of the company must begin taking RMDs from the 401(k) beginning at 70½, regardless of their work status.
If an employee has multiple IRAs, it doesn’t matter which one he or she takes RMDs from so long as the total amount reflects their aggregate IRA assets. In contrast, RMDs based on 401(k) plan assets must be taken specifically from the 401(k) plan account.
Sooner rather than later
The IRS prefers taxing income sooner rather than later. (Roth IRAs aren’t subject to RMD requirements because the money in them has already been taxed.) The IRS determines how RMD amounts change each year as the retiree ages, using a formula and life expectancy tables.
For example, at age 72, the IRS “distribution period” is 26.5, meaning that the IRS assumes that participants will live another 26½ years. Thus, participants must withdraw the percentage of the IRA or 401(k) account that is 1 divided by 26.5 (3.77%).
If a participant lives to age 90, the distribution period would be 11.4, resulting in an 8.77% RMD. Although the percentage amount increases over time, the IRS rules don’t force retirees to zero out their accounts. Still, based on the IRS formula, they’re not likely to have a lot of funds remaining in those accounts when they die.
Other pertinent facts
Here are some additional RMD facts that you can share with employees approaching retirement:
Beneficiary spouses. Account holders who have a beneficiary spouse at least 10 years younger are subject to a different RMD formula that allows them to take out smaller amounts to preserve retirement assets for the younger spouse.
Tax penalty. The tax penalty for withdrawing less than the RMD amount is 50% of the portion that should have been withdrawn. Participants must pay the penalty first and then bring a refund case for the penalty.
Form of distribution. RMDs can be in cash or be taken in stock shares whose value is the same as the RMD amount. Although this can be administratively burdensome, participants can defer incurring brokerage commissions on securities they don’t want to sell. And, their tax basis in the stock (for future capital gains liability calculation purposes) resets to the value of the securities when they’re distributed.
Remember, informed participants are happy participants. It’s never too early to educate your soon-to-be retirees about their RMD obligations. Involve your benefits advisor to ensure you’re providing the most current information.
BPM is one of the largest California-based accounting and consulting firms, ranking in the top 50 in the country. It has served the San Francisco Bay Area's emerging and mid-cap businesses, as well as high-net-worth individuals, since 1986. Our Employee Benefits team consists of professionals with extensive knowledge of ERISA guidelines and deep expertise performing employee benefit plan audits. We can help you craft a smooth-running plan that serves your employees while mitigating associated risk. For more information or for a free expert consultation, contact Jenise Gaskin at (925) 296-1016, Michelle Ausburn at (707) 524-6588, or visit us at www.bpmcpa.com/ebp.