How to Manage RMD Rollovers

We have all heard the expression “there’s an exception to every rule”. This expression can be found in all facets of life, including when we are planning for our retirement years. Exceptions to every rule can be found, and in the U.S. tax code, there are exceptions that can help shape one’s financial future. Understanding the rules and the exceptions to each of them is best left to a tax professional; for retirement planning purposes, a tax professional can help you preserve the retirement funds you’ve worked so hard to save.

In this guide, we will discuss the concept of Required Minimum Distributions, or RMDs, and how an exception to the U.S. tax code allows for certain handling of the distributions, helping you to save money on tax exposures. Let’s get started.

Required Minimum Distributions (RMDs): What Are They?

Under U.S. tax and retirement savings laws, Required Minimum Distributions (RMDs) are the minimum amounts one must withdraw from qualifying retirement accounts when the account holder reaches a certain age. For retirees who reach the age of 70 ½ years, regulations require RMDs for the following types of retirement accounts:

  • Simplified Employee Pension (SEP) IRAs
  • Traditional IRAs
  • SIMPLE IRAs
  • 401(k) Retirement Plans

RMDs can create tax implications for the recipient, potentially pushing him or her into a new (higher) tax bracket and affecting the eligibility of the recipient to receive certain government-sponsored benefits, such as Social Security and Medicare premiums.

Exceptions to the RMD Rules

There are certain rules governing the distribution and eligibility of taxpayers when it comes to RMDs. And, of course, there are exceptions to those rules. One of the critical exceptions is something referred to by financial professionals as the “still working” rule. If someone is past the age of 70 ½ years – the age at which RMDs must be taken – and still working, that person does not have to take the RMD from their current employer’s retirement plan. It is important to note that this exception does not apply for plans sponsored by a previous employer, nor does it apply if a person owns 5% or more of the company sponsoring the retirement plan. If a person 70 ½ years old is still working and has retirement plans from previous employers, RMDs must be taken from those older plans.

Prior to 1996, the “still working” rule was not an accepted exception in the U.S. tax code. In that year, the Small Business Job Protection Act (SBJPA) was passed, and went into effect on January 1, 1997. Before passage of the SBJPA, anyone over 70 ½ years, working or not, had to take their RMDs. While the Act benefitted taxpayers, it opened the door to many questions on the part of retirement plan sponsors – the employers offering and administering these plans. Some of the questions included:

  • Do employers have to adopt this exception?
  • If we do adopt the exception, how are RMDs from 1996 or 1997 handled?
  • Are RMDs issued in this time period treated differently than before the change?

To help clarify its position about the “still working” exception, the Internal Revenue Service (IRS) issued a guideline for employers entitled Notice 1997-75. Within the pages of the Notice, the exception was spelled out for employers’ benefit. Here are some of the factors employers could use to discern whether or not they were adhering to the tax code properly:

Employers are able to keep the pre-SBJPA distribution rules if desired. In other words, employers do not have to allow for the RMD exception, even if the affected employees continue to work past the age of 70 ½.

If an employer chooses to forgo the “still working” rule, the RMD is still not required under the U.S. tax code. Normally, there is a 50% excise tax on RMDs not taken by the deadline or not taken in sufficient monetary amounts to satisfy the regulation. Because the RMD is not required in the Notice language above, the 50% excise tax would only begin to apply once the employee retires.

The amount of RMDs is eligible for a rollover. According to the tax code and the Notice, a distribution under the rules exception qualifies as an eligible rollover distribution unless it is excepted for any other reason. For example, a taxpayer that is working for an employer that has not chosen to adopt the “still working” exception can continue to roll over any distributions made under the retirement plan until he or she finally retires.

Delays and Deferments

For those older employees that continue to work long after traditional retirement age, there are additional aspects to consider when it comes to required minimum distributions. Employees who still contribute to employer-sponsored 401(k) or 403(b) plans and are older than 70 ½ years of age may wish to defer or delay taking any RMDs. Older employees may want to wait to take RMDs – delaying distributions — until they actually retire rather than at the age set by IRS regulations, and some plans allow this. Each employer plan is different, so it is suggested that you speak with your plan’s administrator to see if delay or deferment is available if you find yourself in this situation.

Deferment may also be an option. if you reach the age of 70 ½ in any given year, it is possible to defer one’s first required minimum distribution until April 1 of the following year. There are positives and negatives to deferring that first RMD; on one hand, a taxpayer may see benefits from allowing his or her retirement savings a few more months of tax-deferred growth, helping to improve the overall value of those savings.

On the other hand, if the taxpayer wait until April 1 of the year following turning age 70 ½ to take that first RMD, he or she will have to take TWO RMDs in that year, which can potentially push the taxpayer into a higher tax bracket. This double RMD can also interfere with Medicare premiums or cause Social Security benefits to be taxed as income as well, especially if it is at or near thresholds for taxation.

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As with any complex tax strategy, it can be of great benefit to seek the assistance of a qualified tax planning professional. The U.S. tax code is very complicated, exceptions to rules notwithstanding. With a tax planner at your side, those planning for retirement can preserve more of the value of their retirement assets while avoiding penalties and excessive tax exposure.

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