If you have assets in a qualified retirement plan, such as a
company-sponsored 401(k) plan or a traditional individual
retirement account (IRA), you'll want to be aware of several rules
that may apply to you when you take a distribution.
Required Minimum Distributions During Your Lifetime
Many people begin withdrawing funds from qualified retirement
accounts soon after they retire in order to provide annual
retirement income. These withdrawals are discretionary in terms of
timing and amount until the account holder reaches age 70½.
After that, failure to withdraw the required minimum amount
annually may result in substantial tax penalties. Thus, it may be
prudent to familiarize yourself with the minimum distribution
For traditional IRAs, individuals must generally begin taking
required minimum distributions no later than April 1 following the
year in which they turn 70½ and by December 31 every year
thereafter. The same generally holds true for 401(k)s and other
qualified retirement plans. (Note that some plans may require plan
participants to remove retirement assets at an earlier age.)
However, required minimum distributions from a 401(k) may be
delayed until retirement if the plan participant continues to be
employed by the plan sponsor beyond age 70½ and does not own
more than 5% of the company.
In accordance with IRS regulations, minimum distributions are
determined using one standard table based on the IRA owner's/plan
participant's age and his or her account balance. Thus, required
minimum distributions generally are no longer tied to a named
beneficiary. There is one exception, however. IRA owners/plan
participants who have a spousal beneficiary who is more than 10
years younger can base required minimum distributions on the joint
life expectancy of the IRA owner/plan participant and spousal
These minimum required distribution rules do not apply to Roth
IRAs. Thus, during your lifetime, you are not required to receive
distributions from your Roth IRA.
Additional Considerations for Employer-Sponsored Plans
The table below is general in nature and not a complete
discussion of the options, advantages, and disadvantages of various
distribution options. For example, there are different types of
annuities, each entailing unique features, risks, and expenses. Be
sure to talk to a tax or financial advisor about your particular
situation and the options that may be best for you.
Employer-Sponsored Retirement Plan Distribution
||A regular periodic payment, usually of a set
amount, over the lifetime of the designated recipient. (Not
available with some plans.)
||Assurance of lifetime income; option of spreading
over joint life expectancy of you and your spouse.2
||Not generally indexed for inflation.
||Installment payments over a specific period, often
5 to 15 years.
||Relatively large payments over a limited
||Taxes may be due at highest rate.
||Full payment of the monies in one taxable
||Direct control of assets; may be eligible for
10-year forward averaging.
||Current taxation at potentially highest rate.
||A transfer of funds to a traditional IRA (or Roth
IRA if attributable to Roth 401(k) contributions).
||Direct control of assets; continued tax deferral
||Additional rules and limitations.
In addition to required minimum distributions, removing money from
an employer-sponsored retirement plan involves some other issues
that need to be explored. Often, this may require the assistance of
a tax or financial professional, who can evaluate the options
available to you and analyze the tax consequences of various
Retirees usually have the option of removing their retirement
plan assets in one lump sum. Certain lump sums qualify for
preferential tax treatment. To qualify, the payment of funds must
meet requirements defined by the IRS:
- The entire amount of your balance in employer-sponsored
retirement plans must be paid in a single tax year.
- The amount must be paid after you turn 59½ or separate
- You must have participated in the plan for five tax years.
A lump-sum distribution may qualify for preferential tax
treatment if you were born before January 2, 1936. For instance, if
you were born before January 2, 1936, you may qualify for 10-year
forward income averaging on your lump-sum distribution, based on
1986 tax rates. With this option, the tax is calculated assuming
the account balance is paid out in equal amounts over 10 years and
taxed at the single taxpayer's rate. In addition, you may qualify
for special 20% capital gains treatment on the pre-1974 portion of
your lump sum.
If you qualify for forward income averaging, you may want to
figure your tax liability with and without averaging to see which
method will save you more. Keep in mind that the amounts received
as distributions are generally taxed as ordinary income.
To the extent 10-year forward income averaging is available, the
IRS also will give you a break (minimum distribution allowance) if
your lump sum is less than $70,000. In such cases, taxes will only
be due on a portion of the lump-sum distribution.
If you roll over all or part of an account into an IRA, you will
not be able to elect forward income averaging on the distribution.
Also, the rollover will not count as a distribution in meeting
required minimum distribution amounts.
If you choose to receive periodic payments that will extend past
the year your turn age 70½, the amount must be at least as
much as your required minimum distribution, to avoid penalties.
Uniform Lifetime Table for Required Minimum Distributions
This table shows required minimum distribution periods for
tax-deferred accounts for unmarried owners, married owners whose
spouses are not more than 10 years younger than the account owner,
and married owners whose spouses are not the sole beneficiaries of
Source: IRS Publication 590.
If your plan's beneficiary is not your spouse, keep in mind that
the IRS will limit the recognized age gap between you and a younger
nonspousal beneficiary to 10 years for the purposes of calculating
required minimum distributions during your lifetime.
There are several considerations to make regarding your
retirement plan distributions, and the changing laws and numerous
exceptions do not make the decision any easier. It is important to
consult competent financial advisors to determine which option is
best for your personal situation.