More than ever, workers are continuing to work into their 70s and beyond. The general rules governing retirement accounts require nearly every individual account owner to begin taking Required Minimum Distributions (RMDs) by April 1 of the year following the year in which the owner turns 70½. There exists a notable exception for employer-sponsored 401(k) accounts owned by employees who continue working past age 70½.
If the plan allows, an owner who leaves funds in the 401(k) can avoid RMDs if s/he remains employed with the employer who sponsors the plan. Moreover, the owner can also continue to make contributions to the 401(k)!
This exception has some significant requirements, though. The current employer must sponsor the 401(k); an owner cannot change employers and defer RMDs beyond age 70½. In other words, if a former employer sponsors the relevant 401(k), the owner must take RMDs even if continuing to work for another employer that also sponsors a 401(k). If the owner has more than one 401(k) and the plans allow for rollovers, however, it may be possible to roll all 401(k) funds into the 401(k) of a current employer and delay RMDs on all of the funds if the still working exception applies. Combining accounts will also simplify RMD planning once the owner stops working, because the RMD on each account would have to be determined separately.
The plan, too, must permit the exception. Because not all 401(k) plans permit the exception, even though permitted by law, an account owner must ensure that his/her plan actually does allow the funds to remain in the plan to avoid a steep 50 percent penalty that apply to missed RMDs.
The exception does not apply if the plan is an IRA (whether a traditional, SEP or SIMPLE IRA). As an aside, remember that RMDs do not apply to Roth IRAs during the original account owner's lifetime.
Despite these carefully prescribed and limited conditions, the last condition, that the owner continues to work for the employer, is without a concrete definition, and therefore, may permit flexibility. Because the IRS does not provide a provides a concrete definition of what it means to continue working past age 70½, it may be possible for an owner to continue working on a reduced-hours or consulting basis and still defer his or her RMDs past the traditional required beginning date.Of course, if special arrangements are crafted by an employer and employee, it is advisable to consult an attorney to document the special relationship in order to ensure that it won't be deemed a sham or fraudulent arrangement by the IRS.
While an account owner may generally avoid taking RMDs from his or her 401(k) as long as s/he continues working past age 70½, many small business owners are not permitted to take advantage of this exception, because the exception does not apply to participants who are five percent owners of the business sponsoring the retirement plan. Plan participants who own a portion of the business sponsoring the 401(k) must also be aware of the constructive ownership rules that apply when determining whether s/he is a five percent owner; interests held by certain members of the owner's family (e.g., spouse, children, parents, etc.) and by certain entities which the owner controls will be added to the ownership interest of the participant/business owner in determining whether the 5 percent threshold has been crossed.
The above article is based upon an article published by ThinkAdvisor, which in turn was drawn from Tax Facts Online, and originally published by The National Underwriter Company, a Division of ALM Media, LLC, as well as a sister division of ThinkAdvisor.
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