401(K) and IRA accounts have different Required Minimum Distribution (RMD) rules and navigating them can be challenging. Understanding these nuances is crucial for retirees to manage their finances effectively and comply with tax regulations.
Consider a hypothetical scenario involving a 78-year-old single female who is currently working and has a 401(k) worth $200,000 as of December 31, 2023. Additionally, this individual has two IRA accounts: a regular IRA with a balance of $100,000 and a Roth IRA, also with a balance of $100,000, both established 10 years ago.
401(k) RMD Rules:
A key difference in RMD rules lies in the treatment of 401(k) plans. The law exempts individuals from taking RMDs from their current employer’s 401(k) plan, regardless of age, unless they own 5% or more of the company. This exemption is significant for those who continue to work beyond the typical retirement age. For our 78-year-old individual, if they are still employed and do not have a 5% or greater ownership stake in the company, they are not required to take RMDs from their 401(k). The first RMD for their 401(k) would be required by April 1 of the year following the year they stop working. Therefore, if this individual stopped working anytime in 2024, their first RMD would need to be taken by April 1, 2025.
IRA RMD Rules:
In contrast, IRAs have different RMD requirements. Regardless of employment status, individuals are required to start taking RMDs from regular IRAs. Most RMDs for regular IRAs are calculated based on the account balance as of December 31 of the previous year. For someone who turned 73 after 2020, the first RMD must be taken by April 1 of the year following the year they turn 73. They must also take a second RMD by December 31 of that same year, with future distributions due by December 31 of each subsequent year. Starting in 2024, no RMDs are required from designated Roth IRA accounts.
In our example, the 78-year-old individual must take RMDs from their regular IRA account, as the exemption for current employment does not apply to IRAs. The RMDs for the regular IRA account would be based on the respective account balances as of December 31 of the previous year. No RMD is required for the Roth IRA.
The calculation of RMDs is based on the IRS Uniform Lifetime Table, which provides a factor based on the individual’s age. The account balance is divided by this factor to determine the RMD amount. In this example, we estimate that the RMD for the $100,000 regular IRA would be approximately $4,166.67.
Understanding the different RMD rules for 401(k)s and IRAs is essential for effective retirement planning. Given the complexity of these rules and the potential for significant tax implications, consulting with an independent Fee-Only financial adviser can be highly beneficial. A knowledgeable independent adviser can provide personalized guidance on RMD calculations, tax strategies, and overall financial planning to ensure compliance and optimize retirement income.
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