Working Beyond Age 70.5 – A Bonanza for Retirement Plan Owners

By Kevin J. Sigler, PhD, CFP

Retirement Plan owners who have used a tax-deferred retirement accounts such as traditional IRAs, 401(k), 403(b) or 457 plans must begin taking minimum distributions soon after reaching age 70.5. Normally, the plan owner commences minimum distributions by December 31st of the year in which he turns age 70.5 years.  However, the first distribution may be delayed until April 1st of the next year.  The second required minimum distribution (RMD) must be taken by December 31st of that year, however. Each of these distributions is taxed as ordinary income in the year it is received.  If the RMDs are not taken when required the money not taken is subject to a 50 percent penalty. 

One way to avoid the RMDs beginning at age 70.5 is by continue working. Owners of 401(k) and other work related retirement plans can delay required minimum distributions beginning at age 70.5 if they continue working according to the IRS.   Plans that qualify for this treatment are 401(k), 403(b), 457 plans, and tax-sheltered annuities. Retirement plan owners with part time employment may postpone withdrawals.   This treatment does not apply, however, to traditional IRAs as well as Roth IRAs that have no required minimum distributions for owners.

This article illustrates the differences in retirement plan balances if an employee continues working and delays RMDs after age 70.5. 

RMDs

To calculate the Required Minimum Distribution (RMD) the account balance of the retirement account from the end of the previous year is divided by the distribution period factor for your age shown in the Uniform Lifetime Table (Table 1).  This number is the amount that must be withdrawn during the current year to avoid the 50 percent penalty on any amount not withdrawn that should have been.

For example, if the account balance at the end of 2006 is $1,000,000 and the owner turns age 70 in 2007, the RMD for 2007 is $36,497 ($1,000,000 ÷ 27.4).  There is one exception.  If the plan owner’s spouse is (1) the sole beneficiary of the account and (2) more than ten years younger than the owner, the Joint Life Expectancy Table is used instead of the Uniform Lifetime Table.  This will result in a lower RMD than one calculated using the Uniform Lifetime Table.   The next year the balance from the end of 2007 is divided by the factor for age 71 from the Uniform Table, 26.5.  RMDs continue for the owner until death.

Delaying RMDs

Required Minimum Distributions may be delayed for taxpayers who continue working past age 70.5 until April 1 of the year after the year they retire.  Therefore, a 75-year-old who retires in 2007 would have to take his or her first distribution by April 1, 2008. The second RMD would be December 31, 2008.

A retirement plan owner may not postpone required minimum distributions in certain instances.  If he owns more than 5 percent of the company for which he is working, the retirement plan owner is required to begin RMDs by April 1st the year following turning age 70.5.  Also if an employer requires beginning RMDs at age 70.5, then the employee cannot avoid the distributions even if he continues working for the firm.

In addition, the retirement plan must be one administered by the current employer to delay RMDs past age 70.5.  A 401(k) account from a past employer does not receive this treatment according to the IRS.  Again, RMDs from these plans must be made by April 1st after the year the employee turns age 70.5 regardless if the plan owners continues working for another firm or not.

Example

In this example it is assumed a retirement plan owner has $1 million in IRAs on December 31st the year prior to turning age 70.5.  In one scenario he retires and begins drawing RMDs the year he reaches age 70.5.  In the other scenario the plan holder has his plan with his employer and continues working through age 75 and contributes $15,000 per year into the plan. In both scenarios the portfolio has a 6 percent return per year.  According to Table 2 if the plan holder continues working past age 70 through 75 he will have over 35 percent more in the portfolio.  Retiring at age 70.5 the portfolio is worth $1,126,733 but the portfolio is worth $1,523,149 if the plan owners continues working through age 75 and contributes $15000 per year.  Of course the retirement plan owner can only delay RMDs on those funds in plans with the present employer.  If the plan holder has retirement plans from other employers he will have to take RMDs even if he continues to work.  If he owns more than 5 percent of the company he must take RMDs regardless of working status, and he will also take RMDs if the company requires him to make RMDs at 70.5 years. 

Conclusion

Continuing working for the same employer beyond age 70.5 can reap large benefits for retirement plan owners.  RMDs can be postponed for those employees until April 1st following the year they retire.  In the example presented above the plan holder increased his portfolio value by 35 percent by working through age 75.  

Kevin Sigler is a professor of finance at the University of North Carolina Wilmington in the Department of Economics and Finance in the Cameron School of Business.  He received a Ph.D. in finance from the University of Nebraska. siglerk@uncw.edu