By Andy Ives, CFP®, AIF®
Employer-sponsored retirement plans, like 401(k) and 403(b) plans, have some definitive benefits vs. IRA accounts. For example, company plans provide an unlimited amount of protection from bankruptcy, while IRA contributions and earnings maintain a current bankruptcy protection cap of $1,362,800. In addition, employer-sponsor plans can allow loans – IRAs cannot – and retirees of certain plans (state and local public safety employees) can gain penalty-free access to plan dollars as early as age 50. Barring an exception, IRA owners must wait until age 59 ½ before they can access their funds penalty free.
Another feature that employer-sponsored retirement plans offer that IRAs do not is the ability to delay required minimum distributions (RMDs). At age 70 ½, both plan participants and traditional IRA account owners must begin taking RMDs. However, employer-sponsored plans may offer a “still working” exception that is not available with an IRA account. While the “still working” exception is not a mandatory plan feature, if adopted by a plan it could allow participants to delay paying taxes on a significant amount of earned income.
How does the “still working” exception work? For those who have a 401(k) or other eligible employee retirement plan, the required beginning date for RMDs is the same April 1st date as for IRA owners, unless they are still working for the company where they have the plan. If they don’t own more than 5% of the company in that year (and the plan allows), they can delay their required beginning date to April 1st of the year following the year they finally retire. (Note that the “still working” exception does not apply to SEP IRAs or SIMPLE IRA plans.)
For example, Milton is a scientist at a large corporation and is passionate about his work. At age 70 ½ he shows no signs of slowing down. In fact, he is currently building a team to start a decade-long research project. Scientist Milton participates in the company 401(k) but has no desire to begin taking RMDs. Milton’s 401(k) offers the “still working” exception. If Milton retires after the research project is complete – when he is 80 years old – he can delay RMDs from the 401(k) until April 1 of the year after he finally stops working for the company.
What if, part way through the research project when Milton is 75, he rolls over half of his 401(k) plan assets to his IRA? Since Milton is still working for the company, he will not have an RMD for the year on his 401(k). However, since the “still-working” exception does not apply to IRA accounts, in future years Milton will have an RMD for his IRA account, which now includes those dollars previously in his 401(k).
What if, at age 77, Milton feels the need to reduce his involvement with the research project? After all, he added some brilliant scientists to his team, and it is high time Milton did some traveling with his wife. Milton decides to officially work part-time. Does he still get to delay his RMDs from the plan? Yes! If an employee is considered “part-time” and is still employed on December 31, the “still-working” exception continues.
The research project is complete, Scientist Milton has seen the world with his wife, and he is 80 years old. Retirement is on his doorstep. Milton gathers the research team, says “thank you” for all their hard work, and walks into the sunset…but Milton is no dummy. This retirement party is held on January 1. Why is that important? If Milton had retired in the previous year – even if he retired at 5:00 PM on December 31, he would have an RMD for that calendar year. By waiting until the new year started, Milton locked in the previous year for his final “still working” exception. Yes, he will have to take his first RMD from the 401(k) plan for this new year, but he has until April 1 of next year to withdraw it.
Smooth move, Scientist Milton. Enjoy your retirement.