When you invest in a tax-deferred retirement account, such as an employer-sponsored 401(k) plan, you get a tax deduction on your contributions. The deduction defers income taxes on the money you put into the 401(k). The Internal Revenue Service wants to make sure the deferred taxes eventually are collected, however, and it has imposed rules requiring retirees to take mandatory annual distributions from their 401(k) plans.
You must start taking mandatory minimum distributions from your 401(k) in the year you turn 70 1/2 or the year you retire, if you retire after age 70 1/2. You must take your first required distribution by April 1 of the year following the year you retired or turned 70 1/2. For example, if you retired or turned 70 1/2 in 2012, you would have to start taking distributions from your 401(k) by April 1, 2013. You must take another minimum distribution by Dec. 31, 2013 and pay income tax on both distributions. After 2013, you must take your required minimum distribution by Dec. 31 of each calendar year.
The minimum amount you must withdraw each year is calculated by dividing your 401(k) account balance by your longevity. According to IRS 2011 longevity tables, if a single person who works until age 70 1/2 with $300,000 and 5 percent earnings, the IRS figures he has a 17-year remaining life expectancy, so his first required minimum distribution would be $18,529. The required minimum will vary each subsequent year to reflect earnings and the fact that calculated life expectancy is reduced by 9 months. You can have your 401(k) administrator calculate your minimum each year.
IRS rules impose a harsh penalty for failing to withdraw your required minimum distribution. It will impose a penalty tax equal to 50 percent of the required minimum distribution that wasn’t withdrawn. If your failure to take the required minimum distribution was because of an error or circumstances beyond your control, you can petition for waiver of the penalty tax by filing Form 5329 along with a letter of explanation and a plan to correct the situation. If you have multiple 401(k) accounts, you must figure the minimum withdrawal separately for each account and take the required sum from each separate account.
Taking the Minimum
You can take your required minimum distribution in monthly or quarterly installments during the year, so long as the installments add up to the required amount at the end of the year. If you take out more than the required minimum in any one year, the amount in excess of the mandatory minimum can’t be counted toward the next year’s minimum distribution.
IRAs Are Different
If you roll your 401(k) money into an IRA, you will have to start taking required minimum distributions at age 70 1/2 even if you are still working. The "still working" exemption only applies to 401(k)s and other employer-sponsored retirement plans.
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