Regardless of the topic, we could all use an occasional refresher. Retirement account rules are incredibly complicated, and we all have our blind spots. Even seasoned financial advisors with extensive client lists can overlook certain details. I had a conversation recently with a respected professional who was operating on a misconception regarding the still-working exception. Fortunately, we were able to identify the oversight and make the necessary corrections. But the conversation confirmed, once again, that understanding the rules is paramount to success.
For those who have 401(k) or other employee retirement plan funds, the required beginning date (RBD) for starting required minimum distributions (RMDs) is the same April 1 as for IRA owners, unless they are still working for the company where they have the plan. If they do not own more than 5% of the company in the year they reach their RMD age and the plan allows, workers can delay their RBD to April 1 of the year following the year they finally retire. This is called the “still-working exception” to the RBD, but it only applies to RMDs from employer plans. It does NOT apply to IRAs or IRA-based work plans like SEPs and SIMPLEs. It also does not apply to employer plans if the individual is not currently working for that company.
The first misconception about the still-working exception is about the date when a person retires. A worker must be employed for the entire year for the exception to apply for that year.
Example: Mary, age 75, has an IRA and a 401(k) plan and is still working for the company that sponsors the 401(k). She never owned more than 5% of that company. Mary can delay distributions from her 401(k) until April 1 of the year following the year she retires. (The exception does not apply to her IRA.) Mary leaves her job after working her last day on December 31, 2025. She thinks that since she worked the “full year,” she has “retired” in 2026 and therefore can avoid taking the 2025 RMD from her 401(k). Such is not the case. It appears that retiring on December 31 is not good enough when it comes to the still-working exception and delaying RMDs. The RMD will be due for that same year for anyone whose last day of work is December 31. In the case of the still-working exception, it behooves a worker to hang on for one more day and “retire” on January 1.
Another misconception about the still-working exception is how an RMD can apply “retroactively.” If a person is leveraging the still-working exception and, therefore, has no RMD to worry about, that worker can roll over his entire 401(k) to an IRA (assuming the plan allows for in-service distributions). However, if the worker is laid off later that same year, or if he abruptly retires for whatever reason, then the RMD applies for that year. If he already did a full rollover of the plan assets to an IRA that same year, then this springing “retroactive” plan RMD is now an excess contribution in the IRA. This is not the end of the world as there is a relatively easy fix: remove the excess contribution (the plan RMD) from the IRA, plus any earnings attributable to those dollars. There is no penalty if the error is corrected by October 15 of the year after the year of the excess (although the earnings will be taxable).
Be careful with the still-working exception. The governing rules can be sneaky.
If you have technical questions you would like to have answered, be sure to submit them to mailbag@irahelp.com, to be answered on an upcoming Slott Report Mailbag, published every Thursday.
Specializing in private wealth management, we provide education, guidance, and strategies to help you achieve a tax-efficient retirement income.
Specializing in private wealth management, we provide education, guidance, and strategies to help you achieve a tax-efficient retirement income.
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