One of the most rewarding aspects of my role is to help address questions from our clients. Recently, a client and avid reader of our In the Vanguard newsletter submitted a comment about required minimum distributions (RMDs) from retirement plans that merits further discussion.
When Frank P. from New York turned 70 ½ and withdrew his first RMD from his traditional IRA, he believed he’d taken the necessary steps to satisfy annual withdrawal requirements from his multiple accounts, which also included an employer-sponsored 401(k). However, Frank later learned the hard way that, when it comes to RMDs, IRAs and 401(k)s must be treated separately.
Frank raises a good point—and one that can easily be overlooked. When we discuss RMDs, it’s often in the context of traditional IRAs. By the time retirees enter the distribution phase, most have rolled their assets out of their employer-sponsored retirement plans and consolidated them into IRAs. Some roll over their accounts because they are not permitted to leave their assets in their employer plan, while others do so for simplicity in managing their assets in retirement. But some retirees do keep their assets in an employer-sponsored plan, and they should be aware that RMD rules differ.
These are the main points I discuss when clients such as Frank are managing RMDs from more than one source:
With IRAs, RMDs must be calculated separately for each account, but the amounts can then be added together and distributed by any one of the IRAs.
It doesn’t matter which IRA you take the distribution from, as long as you take the correct distribution overall.
In the case of an employer-sponsored plan such as a 401(k), the RMD must be calculated separately and distributed separately from each plan.
Not doing so will result in a steep penalty—the amount not withdrawn is taxed at a hefty 50%. (It’s worth noting that 403(b) accounts are treated similarly to IRAs in that the RMD must be calculated separately from each account but can be aggregated and taken from any of the 403(b) accounts.)
Employer-sponsored Roth accounts are subject to RMDs.
Participants in Roth 401(k) and other employer-sponsored retirement accounts must take RMDs once they reach 70 ½. This can be a key consideration when retirees are weighing the IRA rollover decision, because a Roth IRA affords more flexibility with regard to withdrawals. Keep in mind that the distribution from a Roth 401(k) remains income-tax-free.
If you’re still contributing to your employer-sponsored plan, you may be able to delay taking RMDs.
If you’re working and participating in your employer’s plan when you reach 70½, your plan might allow you to wait until you retire before having to take RMDs. Check with your plan administrator for guidance.
When you reach 70½, consider the trade-offs when deciding whether to defer the initial RMD.
In the year you turn 70½, you have the ability to delay the RMD until April 1 of the following year. Although this may seem appealing because you could potentially benefit from additional tax-deferred growth, doing so will result in two distributions in one year and could have negative tax consequences. For example, the amount could push you into a higher marginal tax bracket, temporarily impact your Medicare premiums because of the higher income, or potentially make your Social Security taxable if it’s near the taxable thresholds.
The IRS has a useful reference chart that outlines the differences in RMD rules for IRAs and employer-sponsored plans: https://www.irs.gov/retirement-plans/rmd-comparison-chart-iras-vs-defined-contribution-plans.
The bottom line is, if you’re approaching RMD age and have funds in employer-sponsored plans, confirm your options, assess the implications of staying in the plan versus rolling it into an IRA, and consult with a tax-planning professional before taking action.