posted by: Radnor Financial Advisors
It has been said that Ben Franklin coined the famous saying “nothing is certain except death and taxes”. For individuals who are over 70 ½ and still working however, Ben Franklin may have spoken too soon (about taxes)! With improving health, longer lifespans, and a greater need (or ability) to work longer in order to assure financial stability for themselves and their families, individuals are staying in the workplace longer than ever. Fortunately, current IRS rules allow individuals with 401k plans the ability to strategically plan for this scenario.
The IRS permits individuals who are over age 70 ½ and working to continue to contribute to employer sponsored retirement accounts. What many plan participants may not know is that plan participants over age 70 ½ may also be able to defer taking required minimum distributions (RMDs), which typically begin in retirement accounts either by year-end of the year an individual turns 70 ½ or by April 1st of the year following the client’s 70 ½ birthday (in which case they would also need to take a second RMD prior to year-end of that year). This ability to defer RMDs is commonly referred to as the “still working” provision.
In order to qualify for the “still working” provision, several factors must be met. First, the 401k plan for the company must permit this – although most do allow for it, there is no requirement plans do so. Second, the individual does in fact need to still be working for the company. Interestingly, the IRS currently does not have any threshold or guidance for what qualifies as “still working”. As such, it may not be prudent for a plan participant to push their luck and justify working for one hour during a calendar year as support they qualify for the “still working” provision. Another guideline for the rule is plan participants must own less than 5% of the company they are working for. The 5% ownership criteria doesn’t just count the plan participant’s own stake in the company, it also factors the ownership percentages of certain other family members, such as a spouse or children. An interesting item to note with the 5% rule is that individuals who become 5% or more owners after having reached the age 70 ½ milestone and use the “still working” deferral strategy are grandfathered in and allowed to continue to do so.
Assuming the plan participant meets the above conditions, a plan participant may continue to defer RMDs as long as they are working. This rule can be very attractive for individuals who anticipate working for several years longer, as they avoid taking RMDs and dealing with the potential tax ramifications.
The “still working” provision can have other strategic benefits that may be worth further consideration. For instance, plan participants with other 401k plans may be able to roll the other 401k plans from previous employers into their current plan, thus deferring potential distributions for the other 401k plans as well.
Additionally, if participants are contributing to a Roth 401k, the same “still working” treatment applies as with traditional 401k accounts. Once they retire or stop working, the “Roth after-tax portion” of the account can be rolled into a Roth IRA prior to year-end, thus allowing that portion of the Roth 401k account to avoid needing an RMD. Any pre-tax (employer or employee) contributions would still be subject to the RMD rules (and an RMD would be required to be enacted prior to any pre-tax contribution rollover). Failure to roll the “after-tax” portion of the Roth 401k into a Roth IRA after separating from the company would result in the participant needing to take a RMD on the entire amount of the Roth 401k account. Although only any pre-tax portion of the distribution would be considered taxable, the distribution would also generally be enacted on a pro-rata basis with regard to pre and after-tax monies based on the ratio of pre and after tax proportions within the account. So in addition to taking a larger than necessary distribution, the participant would also permanently lose the ability for that portion of their after-tax contributions to continue to grow tax free in a Roth IRA. However, rolling the “after-tax” portion of the participant plan account out of the plan and into a Roth IRA account prior to year-end would allow the participant to avoid taking an unnecessary distribution on that portion of the account while also allowing them to continue to enjoy the tax-deferred growth benefits of a Roth IRA.
In summary, no one enjoys paying taxes, and this has not changed in at least 250 years since Ben Franklin commented on paying taxes as a certainty in life. However, the “still working” provision seems to be something anyone who is still working in their 70s should be aware of and should consider utilizing if it is attractive for them to defer tax paying as long as possible.Important Disclosure Information