Required Minimum Distribution: What This Means for Your Retirement Plan
You must make required minimum distributions from your traditional IRAs after you reach age 70-1/2. However, taking money from your 401(k) or employer-based retirement plan may be delayed until after you stop working. There are a lot of subtleties, so it pays to read the fine print.
For example, say you are turning 70-1/2, you have until April 1 of the next year to take the money out, but the second and subsequent withdrawals need to be done by December 31. Normally, the same distributions need to be withdrawn from your 401(k)s, but if you continue to work, you can delay that first payout until you retire and then annual distributions kick in.
So how are minimum distributions calculated? They're based on your traditional IRA balance at the end of the previous year and on your life expectancy as determined by the IRS. You may have several IRAs, and then the distribution is based on the balance of all your traditional IRAs — and you can withdraw the money from one or more accounts. And yes, you can take out more than the minimum required — assuming you've reached the minimum age, of course. But for 401(k)s, each one needs to be dealt with separately — the minimum distribution must be withdrawn from each, and that amount is calculated using the uniform life expectancy figures as well.
Suppose you inherit an IRA from a parent, for example. What then? You can take all the money, not just the annual minimum, but realize that this money is taxable income depending on the type of IRA and whether the contributions were pretax or post-tax. And consider that taking a taxable distribution all at once may push you into a higher tax bracket. But if you still choose to take all the money now, an inherited IRA will be opened in your name to ensure that tax information is correctly reported to the IRS, and then you can choose to take the money in a single lump sum.
If you inherited the retirement account from your spouse, you can transfer the assets into a retirement account of your own. Required minimum distribution rules regarding when and how you can take the money are the same as if the account had always been yours.
What about if you inherit an IRA from someone other than a spouse? You can transfer the money to an inherited IRA, which can continue to grow tax deferred, and you can generally start withdrawing it immediately without paying a penalty, even if you haven't reached retirement age. You're required to withdraw specified amounts — those same required minimum distributions. The rub is that inherited IRAs are not protected from creditors in bankruptcy under federal law.
If you inherit a Roth IRA, required minimum distribution rules didn't apply to the original Roth IRA owner, but the withdrawal rules do apply to beneficiaries in an inherited Roth IRA. Spouse beneficiaries can move the assets to their own Roth IRA instead of an inherited Roth IRA to avoid distributions.
Roth accounts in 401(k) plans are subject to minimum requirements, so you may want to roll your plan to a Roth IRA to avoid the distributions. Before doing so, be sure to consider the effect of this decision on the five-year holding period for qualified distributions if you have not met the five-year requirement in your employer plan.
Another choice is not to take the money. If you prefer to allow the assets to pass to alternate beneficiaries — perhaps to avoid tax implications — you can choose to "disclaim" the account. You need to act within nine months of the original owner's death and before you've taken possession of the assets.
If you don't take the required minimum distributions from these accounts, you will be subject to a severe financial penalty … so pay attention.