When it comes time for required minimum distributions (RMDs) from your retirement savings accounts, it’s important to consider how those withdrawals may boost your taxable income in retirement. People who are still working in their 70s may be especially worried about increased taxes — but there may be a workaround.
If you are still working, you may not have to take RMDs from your 401(k) plan yet. But the same rule doesn’t apply to individual retirement accounts (IRAs). Here’s what you need to know.
What is the RMD exception if you’re still working?
RMDs are required withdrawals from traditional retirement plans that generally start when someone turns 73 (or 75 if you were born in 1960 or later). Typically the older you get, the higher the percentage you will have to withdraw from your traditional retirement plans. Roth plans are generally not subject to RMDs.
This context sets the stage for understanding how RMDs change if you still work. A salary will boost your taxable income, but you can delay an RMD from your current employer’s plan until after you retire. Not all workplace retirement plans allow for the exception, so it’s a good idea to check if it applies to your company.
You typically need to work with your plan administrator to take advantage of the RMD exception, and you cannot own more than 5% of the business that is sponsoring this plan. Delaying RMDs means you can avoid taxable withdrawals on money that you don’t need yet.
The exception applies to 401(k)s, but not IRAs
The exception only applies to eligible retirement plans sponsored by your current employer. 401(k), 403(b) and similar workplace plans are eligible. However, IRAs, SEP IRAs and SIMPLE IRAs are not eligible.
The 401(k) exemption also only applies to your current employer. If you have an old 401(k) from a company that you no longer work with, you may have to make RMDs for that account unless you roll it over into your current employer’s plan. It’s a good idea to verify with your current employer that the plan accepts rollovers and if it will shield you from RMDs before rolling over old accounts. Taking that extra step can help you avoid tax penalties.
How to use the rule without creating a tax headache
The first step is to check if your current 401(k) lets you delay RMD withdrawals if you are still working. If the exception is in place, you can consider rolling over funds from inactive 401(k) plans. Some workers will also have to verify that they do not own 5% or more of the company.
Even if you qualify for the RMD exception, it may make sense to make withdrawals from your retirement plan, depending on your overall finances and tax situation. Delaying a 401(k) RMD gives the money more time to grow, and that can trigger larger RMDs when you retire.
It’s important to stay on top of RMD eligibility and tax treatment since the IRS has a steep penalty for missing RMDs.
