Here’s a twist: In recent months, I’ve received more questions from advisors about delaying required minimum distributions than I have about taking them.

Whether for economic reasons or by choice, more people than ever are staying on the job past age 70½. And those workers may be able to delay taking RMDs from company plans until they retire, using what are known as the “still working” rules.

For most people who have 401(k)s or other employee retirement plans, the required beginning date — that is, the date by which they must take their first RMD — is the same April 1 date as for IRA owners. But there’s an exception. If they are still working for the company where they have the plan, they don’t own more than 5% of the company, and the plan allows them, they can delay their required beginning date to April 1 of the year following the year they finally retire. This is sometimes called the “still working” exception to the required beginning date.

That delay of RMDs will reduce clients’ tax bill while they are still in a higher bracket. But judging from the questions I receive, advisors need more information on the nuances of this rule. Like everything else in the tax code, once you look under the hood, you realize there’s more you need to know to give the proper advice. So here are some key points advisors should keep in mind:

Implementation of videoconferencing is intended to serve taxpayers virtually via computers or mobile devices, explains Donna Hansberry, chief of IRS appeals.
Bloomberg News

The still-working exception does not apply to IRAs. It also doesn’t apply to employer plans if an employee isn’t currently working for that company.

Example: Nathan has an IRA, a 403(b) plan from a previous employer, and a 401(k) sponsored by the company for which he still works. Nathan, who has no ownership stake in his current employer, can delay distributions from his 401(k) until April 1 of the year following the year he retires, regardless of his age.

The still-working exception, however, does not apply to Nathan’s IRA. Nor does it apply, in this case, to his 403(b). It is possible for a 403(b) plan to qualify for a still-working exception, but only if a person is still working for the employer sponsoring it (a school, for example). So Nathan must still take his first RMDs from his IRA and his 403(b) by April 1 of the year following the calendar year in which he turns 70½.

“Still working” is a gray area. The IRS has no official position on what exactly constitutes staying on the job. Presumably, an individual could work one hour a year and still be considered employed for this exception to the RMD rules to work. While that situation is highly unlikely, there is no requirement that an individual work 40 hours a week for the exception to apply.

Owners don’t get a break. The still-working exception also does not apply to a person who owns more than 5% of the company as of the end of the plan year in the year when the individual turns 70½. This is a one-time determination. If the worker owns more than 5% of the company the year he or she turns 70½, he or she will never be able to use the still-working exception. Conversely, if the individual becomes more than a 5% owner at the age of 72, he or she will continue to be able to use the still-working exception.

In addition, family aggregation rules apply in determining the percentage of ownership.

Example: Ezra owns 35% of Disco Mining. The company’s 401(k) plan has a still-working exception as part of the plan. Ezra is 70½ this year, but because his ownership stake exceeds 5%, he will not be able to use the still-working exception. Later, after Ezra turns 74, he sells all his shares of the business to his children. Ezra can’t start using the still-working exception, however, because his ownership status was determined the year he turned 70½ and cannot be changed later on.

Well, a few years afterward, Ezra has a falling-out with his children. He quits Disco Mining and becomes the 100% owner of rival Ruby Quarry, which has a still-working exception provision in its 401(k) plan. Ezra will not have to take RMDs from Ruby Quarry’s 401(k) plan, because he was not an owner of the company in the year he turned 70½. He can also move his assets from Disco Mining’s 401(k) plan to the 401(k) plan of Ruby Quarry and use the still-working exception for the combined plan assets. He will have to take his annual RMD from the Disco Mining plan, however, before moves the remaining assets to Ruby Quarry.

Ownership is a family affair: In determining who is more than a 5% owner, the analysis starts with an individual’s personal ownership in the business but doesn’t end there. The Tax Code’s family attribution rules apply. Any ownership in the business by a spouse, child, or grandchild will be included as well when making the call as to whether a client owns more than 5% of a company.

Example: In 2017 Mike Brady owns 2% of Sunshine Day Records. His wife, Carol, also owns 2% of the company. His six children each have an ownership interest of 1%. The company’s 401(k) plan has a still-working exception as part of the plan. Although Mike is 70½ this year, he will not be able to use the still-working exception, because any ownership interests in the company belonging to his wife or children will be attributed to him. When the percentages are added up, the Brady family owns 10% of Sunshine Day Records, meaning that Mike owns more than 5% of the company.

Carol will be 70½ next year. If the Brady family maintains its current ownership interests in Sunshine Day Records, she will be in the same boat as her husband and be unable to use the still-working exception to delay RMDs.

Separation speeds things up. When an employer plan has a still-working exception, then the first RMD must be made for the year of separation from service – even if the last day of work is December 31 of that year. That payment can be deferred until April 1 of the following year. A second RMD (the one for the second year), however, must be taken by the end of that year as well. Normally this bunching of two RMDs in one year would not be a good idea for the employee from a tax standpoint, but in this case, once an employee retires, advisors should look at the income in both years to see if it might be beneficial to bunch the income from the first two RMDs into the following year where the former employee might be in a much lower income tax bracket.

Example: Pam is 75 and still working. She is planning on retiring on December 31, 2017. Pam, who will have an RMD from the employer plan for 2017, can defer that RMD until April 1, 2018. But then she’ll also have to take her 2018 RMD by December 31, 2018.
Be careful when mixing rollovers and RMDs!
The above RMDs rules are not overriden by any rollovers. For employees who separate from service after their 70½ year and want to move their plan funds to an IRA, any RMDs due from the plan must be paid out to the employee before funds can be moved to the IRA. There are several rules that come into play here:

  1. All distributions from an employer plan to an IRA or another plan are considered to be rollovers.
  2. RMDs cannot be rolled over.
  3. The first funds out of the plan are considered to be the RMD.

It does not matter that the employee could defer a distribution until the following April 1 or that they do not want to take their distribution until the end of the year. The RMD must be paid out first.

(Bloomberg News)
(Bloomberg News)

Example: The above-mentioned Pam retires on December 31, 2017. Taking no distributions from the plan in 2017, she prepares to move her plan funds to an IRA in January 2018. But first she’ll have to take RMDs for both 2017 and 2018

What if Pam moves her entire plan balance to an IRA without taking her RMDs? Unfortunately, she can’t just correct this mistake by simply removing the excess amount from her IRA. A net income calculation must be done for the entire IRA balance, and a portion of the income, or loss, in the account must be allocated to the excess amount. The custodian must be told that the distribution is a return of an excess amount, and the custodian must be told (if it did not do the calculation) what the net income amount is. The custodian will issue a 1099-R for the distribution that will be coded to show the return of the excess amount and the amount of the income (or loss) as separate figures. Pam has until October 15 of the year after the excess contribution occurred to correct the problem. If she misses that deadline, though, she’ll have to pay a 6% penalty on the excess contribution.

Example: Pam retires with a 401(k) balance of $300,000, and her RMD amounts for 2017 and 2018 total $27,000. The plan distributes all the money from her 401(k) to her $400,000 IRA. That brings the total balance of her IRA to $700,000, including an excess contribution in the amount of $27,000. Later on, by the time Pam realizes she must remove the excess contribution, her IRA has grown in value to $720,000, for a gain of $20,000. Because approximately $771 of the gain is attributable to the excess contribution, Pam must withdraw $27,771 ($27,000 excess amount + $771 gain) as a return of an excess contribution to fix the problem.

Take note: If Pam simply withdraws the $27,000 — considering it to be her RMD — she has not fixed the problem. She has merely taken a normal distribution of $27,000; it will be $27,000 that she did not need to take, since it will not satisfy her RMD from the plan. The excess contribution of $27,000 remains in her IRA. It will be subject to a penalty of 6% for every year that it stays in the IRA.

Roth 401(k)s fall under the same rules. Unlike Roth IRAs, Roth 401(k) plans are subject to RMD requirements. If the Roth 401(k) plan includes a still-working exception to the RMD rules, then an employee who is still working has no RMDs from the plan until separating from service.

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