401k RMD Rules: A Comprehensive Guide

401k RMD Rules

 

You’re probably familiar with the term “required minimum distributions” (or RMDs for short).  They’re the systematic withdrawals that the IRS makes you take out of an IRA after you turn 70 1/2.  But what about for 401k and other qualified retirement plans?  What are the 401k RMD rules?

While they largely resemble IRA RMD rules, 401k plans have a few subtle but important differences.  And since many people these days are staying at their jobs beyond 70 1/2, it’s a situation that more and more people find themselves in.

To help you navigate the waters, here’s a comprehensive guide to 401k RMD rules, which also applies to 403b, 457, and other qualified plans.

Do 401k plans even have RMDs?

Indeed they do.  The IRS imposes required minimum distributions on your 401k balances beginning April 1st following the year you turn 70 1/2.  Keep in mind that each subsequent RMD must be taken by December 31st each year.  This means that if you wait until April 1st to take your first RMD, you’ll have to take another later in the same year.  From then on, you’ll need to take them by December 31st each year.

Roth 401k RMDs

You might recall that while traditional IRAs force you to take RMDs starting at age 70 1/2, Roth IRAs do not.

And even though Roth 401ks share the same tax advantages as Roth IRAs, you are required to take RMDs from a Roth 401k plan.

This might seem confusing, but fortunately it’s easy to avoid the situation.  Once you leave your employer, just roll your Roth 401k balances into a Roth IRA, and voila!  No more RMDs.

 

How much are my RMDs?

Either you or your tax professional will need to calculate your RMDs each year.  To do so:

  • Start by looking up your account balance on December 31st of the previous year
  • Determine which of the 3 tables from IRS Publication 590-B applies to you
    • Use table 1 if you’re the beneficiary of an IRA
    • Use table 2 if you’re married AND your spouse is more than 10 years younger than you AND is the sole beneficiary of the account
    • Use table 3 in all other circumstances
  • Look up the distribution period using your age on the appropriate table
  • Divide your account balance by your distribution period

Here’s an example:

You’ve just turned 70 1/2, and have some assets in a 401k plan sponsored by an old employer.  The balance of your account on December 31 of last year was $100,000.  Your wife is the sole beneficiary of your account, who is 65 years old.  Your 71st birthday will occur in February of next year.

  1. Since your wife is not more than 10 younger than you are, you’ll use table 3 from IRS publication 590-B.
  2. Using table 3, your life expectancy factor is 27.4 since this was the year you turned 70.
  3. Your first RMD will be $3649.64, which is found by dividing $100,000 by 27.4.
  4. You’ll be required to take your first required minimum distribution and withdraw $3649.64 by April 1 of next year.  You’ll then be required to take your second RMD by December 31st of next year, based on your account balance on December 31 of this year

 

What if I continue working beyond 70 1/2?

If you continue working, you can delay RMDs until April 1st of the year following your retirement.

However, this exception doesn’t apply if you own 5% or more of the company sponsoring the 401k plan.

Also, it only pertains to your current employer.  Any assets in a 401k from a previous job are still subject to RMDs.  Only the balances in the 401k sponsored by your existing employer are eligible for delay.

 

Are there are any other differences between 401k RMD rules and IRA RMD rules?

IRAs don’t let you delay taking RMDs if you’re still working.

They do allow account aggregation though.  If you have multiple IRAs, you’ll need to calculate the RMD for each account every year.  Once you add up the total amount of RMDs across all your accounts, the IRS let’s you withdraw the total aggregated amount from any single or multiple IRAs.

401k plans do not share the same luxury.  If you have assets in several different 401k plans, you’ll need to take RMDs from each plan individually.

 

What about my beneficiaries?

Beneficiaries of a 401k or other qualified plan have a few choices to make.

If your spouse is your sole beneficiary, he or she can transfer the assets into their own traditional IRA and claim them as their own.  The assets will then continue to grow tax deferred and they can name their own beneficiaries.  They’ll then be subject to RMDs once your spouse turns 70 1/2.

Alternatively, your spouse could also take a lump sum distribution.  It wouldn’t be subject to the 10% early withdrawal penalty, but would be counted as taxable income.

If your beneficiary isn’t your spouse, the landscape is slightly different.  Your friend or family member can transfer your 401k funds into “inherited IRA” free of penalty.  It will be subject to RMDs though:

If you’re younger than 70 1/2 on the date of death:

  • They must take RMDs by December 31st of the year following your death, OR
  • They can delay RMDs up until December 31st of the fifth year after your death, at which point all the assets must be distributed

If you’re older than 70 1/2 upon the date of death:

  • Your beneficiary must begin taking RMDs no later than December 31st following the year of your death

Alternatively, if a non-spouse inherits your 401k assets, they can also have the assets distributed in a lump sum that’s free of the early withdrawal penalty.  It would be taxable though, and subject to a mandatory 20% withholding.

What are the penalties if I don’t take required minimum distributions?

The penalties are steep if you forget to take an RMD or miscalculate the amount.  The IRS will calculate the amount you should have withdrawn, and impose a 50% penalty on any unpaid portion.  Needless to say, avoid this if you can.

 

In Practice

It’s fairly uncommon to be in a situation where you take required minimum distributions from a 401k plan.  Most people elect to roll their 401k balances into an IRA after they depart from an employer, since it’s usually more cost effective and there are far more investment options.

If you’re in a situation where you’ll need to take RMDs from a 401k plan, make sure you understand the rules.  That 50% penalty is not something to mess around with!

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