RMDs from a 401(k) When You Are Still Working

Understand how employment status can affect your required distributions

Key Takeaways

Still-Working Exception: If you are still employed by the company sponsoring your 401(k) and you do not own more than 5% of it, you can often delay taking RMDs until after retirement.
Plan Specifics and Limitations: This exception applies only to your current employer’s 401(k); previous employer accounts and IRAs remain subject to the standard RMD rules.
Complex Ownership Rules: The “5-percent owner” test and family attribution rules can complicate eligibility, making it crucial to verify your plan’s rules and consult a financial professional.

Introduction

Required Minimum Distributions (RMDs) are mandatory withdrawals that must be taken from qualified retirement plans and IRAs once you reach a certain age. Typically, these distributions are designed to ensure that tax‐deferred savings eventually become taxable. In recent years, changes in the law and nuanced rules regarding employment status have given rise to the “still-working exception” for 401(k) plans. This provision allows some plan participants who continue working past the traditional retirement age to delay taking their RMDs from their current employer’s 401(k) plan. However, understanding when and how this exception applies requires a careful look at both IRS rules and the specific stipulations in your plan documents.

This comprehensive guide explains the standard RMD rules, outlines the eligibility criteria for deferring distributions if you are still employed, explores the complexities of the “still-working exception,” and discusses planning strategies and potential tax implications. Whether you are actively working well into your 70s or weighing the benefits of continued employment versus retirement, this discussion will help illuminate your options.

Understanding Required Minimum Distributions (RMDs)

What Are RMDs?

RMDs are predetermined minimum withdrawals that individuals must take annually from their tax-advantaged retirement accounts after reaching a specified age. Historically, the age at which RMDs begin was 70½, though recent legislative changes have raised the threshold. For many, the new starting age is 73 (and may rise to 75 for future cohorts), but the exact age is determined by your birth date and the corresponding regulatory updates.

The principal objectives of RMDs are to:

Ensure that deferred taxes on contributions and earnings are eventually collected.
Prevent the indefinite accumulation of tax-deferred savings.
Reduce the potential for legacy tax avoidance by requiring periodic withdrawals.

How RMDs Are Calculated

The amount required as an RMD for each year is calculated based on your account balance as of the end of the previous calendar year divided by an IRS-provided life expectancy factor. This calculation must be applied separately to each qualified plan account. Critical to planning is the fact that while you can aggregate RMDs from multiple IRAs, 401(k) plans from different employers are generally subject to individual calculations and distributions.

The Still-Working Exception Explained

Overview of the Exception

The “still-working exception” is a provision within the RMD rules that allows certain employees to delay taking RMDs from their current employer-sponsored 401(k) plan. Essentially, if you are still employed by the sponsoring company and you have not retired from that employer, you can postpone your first RMD—even if you have reached the age when RMDs are generally required.

However, eligibility is subject to several important conditions:

You must be actively employed by the company sponsoring the 401(k) plan.
You must not be considered a “5-percent owner” of the company. Importantly, this criterion involves complex rules, including family attribution rules that may aggregate indirect ownership interests.
This exception applies exclusively to the current employer’s plan. If you hold other retirement accounts or 401(k) plans from previous employers, standard RMD requirements apply to those funds.

Eligibility Conditions and Timing

To qualify for the still-working exception, you have to fulfill the following:

Employment Status: You must be considered “still working” by your employer. The IRS does not mandate a minimum number of hours; even minimal continued employment is typically sufficient, as long as your employer still regards you as actively employed.
Retirement Age and Test Date: An employee must be employed for the entire plan year, which includes not retiring at any time during the year – even on December 31. Retirement on the last day of a year effectively disqualifies you from the exception for that year.
Ownership Limitations: You must not own more than 5% of the company. The ownership test includes direct and indirect interests, meaning that even if your individual stake is below 5%, the combined ownership through family members or related entities could exceed the threshold.

Many find that the exact moment of “retirement” for the purpose of RMDs is not as straightforward as it might seem. Even if you put in a full workday on December 31, if that day is your last day of employment, for that tax year you are regarded as retired. It is advisable, if possible, to work at least a day in the following calendar year to maintain eligibility for the delay.

Accounts and the Exception – What’s Included and What’s Not

It is critical to understand that the still-working exception does not apply universally to all retirement account types:

Current Employer 401(k): If your current employer’s plan permits it and you meet the criteria, you may delay RMDs.
Previous Employer 401(k)s: These accounts are not eligible for the exception. Even if you are still working at another job, you must take RMDs from these earlier accounts according to the normal schedule.
IRAs and Other Plans: Traditional IRAs and other tax-deferred retirement accounts do not benefit from the still-working exception. RMDs must be taken when you reach the applicable age, regardless of whether you are still employed.

Complexities Surrounding the 5% Ownership Rule

Understanding the 5% Ownership Test

One of the most challenging aspects of the still-working exception is the determination of whether an individual qualifies as a “5-percent owner.” IRS rules define ownership not only based on direct holdings but also include constructive or indirect ownership. This means that if family members or entities linked to you hold shares, these can be aggregated with your own holdings to potentially exceed the 5% threshold.

Key points include:

If you own exactly 5% of the company, you are not disqualified by default; however, if you own more than 5%, you lose eligibility for delaying your RMDs under the still-working exception.
The ownership test is a one-time evaluation taken in the plan year that you turn the applicable age (typically 70½ or the updated age of 73). Once determined, your status does not change in subsequent years even if your ownership stake subsequently decreases.
Family attribution rules require that shares owned by your spouse, children, grandchildren, or parents are counted toward your total ownership. Even if you personally own a low percentage, these related interests can push you above the threshold.

Implications for Tax Planning and Distribution Strategy

Understanding and managing the 5% ownership rule is vital for effective RMD planning. Many individuals are prompted to consider strategic moves, such as:

Rolling Over Other Accounts: If your current employer’s 401(k) allows roll-ins, you might consider consolidating funds from previous employer accounts or IRAs. By doing so, you can maximize the delay of RMDs to when you finally separate from service.
Divestiture Planning: For business owners reliant on the still-working exception, planning a sale or divestiture of a portion of the business prior to the key measurement date could allow you to qualify. However, this must be balanced with the strategic value of retaining a business interest.
Changing Employment Status: Remaining engaged in a part-time or consulting role after reaching the age threshold might enable you to maintain eligibility for the still-working exception, providing additional flexibility in managing distributions.

These strategies are complex and require careful consideration of your long-term financial goals and tax situation. Consulting with a tax professional or financial advisor is highly recommended to tailor your plan to your specific circumstances.

A Detailed Comparison of Retirement Account RMD Rules

Summary Table: RMD Eligibility Based on Employment and Account Type

Criteria	Current Employer 401(k)	Previous Employer 401(k)	IRA (Traditional)
Standard RMD Age	Typically delayed if still working and eligible	RMDs required at standard age	RMDs required at standard age
Still-Working Exception Eligibility	Applies if employed for entire plan year and not >5% owner	Does not apply	Does not apply
Ownership Restrictions	Must not exceed more than 5% ownership (including family attribution)	N/A	N/A
Roll-In Possibility	May be able to accept roll-ins from other accounts, subject to plan rules	N/A	Rollover available but RMDs still apply once in IRA

This table encapsulates the differences in RMD application based on your employment status and account type. It highlights the flexibility available for your current employer’s 401(k) plan compared to the inflexible nature of previous employer plans and IRAs when it comes to meeting the RMD requirements.

Practical Considerations and Strategies

Understanding Your Plan Documents

Not every employer-sponsored plan automatically incorporates the still-working exception. Some plans may require that distributions begin at the standard RMD age regardless of employment status. It is essential to review your plan documents or summary plan description to determine if the still-working exception is available.

If your plan does allow for the exception, ensure that you maintain continuous employment throughout the calendar year. Even a single day of retirement during the year can disqualify you from the benefit for that year. For example, if you retire on December 31, that day’s retirement status means you will be subject to RMDs for that year rather than being able to delay until the following year.

Tax Considerations

Delaying RMDs by taking advantage of the still-working exception can create a strategic tax advantage in the short term by allowing your retirement assets to continue growing tax-deferred. However, when RMDs eventually begin, taking a large distribution—or even multiple distributions in the same tax year—could push you into a higher tax bracket.

It is therefore important to plan ahead. Financial advisors often recommend coordinating RMDs among different account types in order to balance taxable income. Remember that if you choose to roll over funds from an IRA or another 401(k) into your current employer’s plan (provided your plan accepts roll-ins), you might be able to delay RMDs on those funds as well. However, keep in mind that once money is rolled into an employer plan, the still-working exception may apply only if the funds are part of that plan as of the start of the year in which you turned the relevant age.

Evaluating Work Decisions and Retirement Timing

The decision to continue working past the traditional retirement age involves more than just the potential for delaying RMDs. Many individuals plan to keep working to maintain social engagement, purpose, and additional income. In this light, the still-working exception is just one piece of a larger financial strategy.

When weighing the benefits of continued employment against the tax implications of RMDs, consider the following:

Income Needs: If you do not rely on your 401(k) funds for living expenses, delaying distributions can allow you to grow your balance tax-deferred for longer.
Long-Term Growth Potential: Keeping funds invested in a tax-deferred environment may benefit those who have a long-term investment horizon.
Future Tax Rates: Consider potential changes in your tax situation. Delaying RMDs now may lead to larger distributions later, which must be planned for in order to avoid unexpectedly high taxable income.

Strategic Moves for Business Owners and 5% Owners

For business owners or highly compensated employees, the intricacies of the still-working exception compound due to the 5-percent ownership test. If you hold an ownership stake—directly or through related parties—that exceeds the allowable threshold, you are not eligible to delay RMDs under this exception. Some strategies to address this include:

Reassessing Ownership Structure: Consider whether adjustments to your ownership structure, such as selling or transferring shares prior to the measurement date (typically the end of the year in which you turn the qualifying age), can help you qualify.
Timing of Business Transactions: In some instances, business owners who plan to retire or restructure their companies can time transactions to optimize eligibility. For example, creating a new business after reaching the milestone age may allow you to establish a new qualified plan that does not retroactively consider prior ownership percentages.
Consulting a Professional: Due to the complexity of the rules, working with a tax advisor or financial planner who has expertise in retirement plan strategies is crucial. They can help determine how best to coordinate your retirement account management with your broader financial goals.

In summary, for many individuals, the advantage of delaying RMDs through the still-working exception can be significant. However, it requires a clear understanding of the various rules—especially regarding employment status and ownership thresholds—and careful planning to align the strategy with your overall retirement goals.

Planning for the Future and Making Informed Decisions

Next Steps in Your Retirement Strategy

When considering the complexities of RMDs and the still-working exception, the following steps can help you make informed decisions:

Review Your Plan Documents: Analyze your current employer’s 401(k) plan documents to verify if the still-working exception is available and understand any specific limitations including rollover provisions.
Assess Ownership Levels: Carefully evaluate any direct and indirect ownership interests you hold. If you are near or above the 5-percent threshold, deliberate planning regarding share transfers or divestitures may be necessary.
Coordinate Multiple Retirement Accounts: Consider your broader retirement portfolio. Since the still-working exception applies only to your current employer’s plan, ensure that RMDs from IRAs and previous employer plans are accounted for in your tax planning.
Consult Financial Professionals: Given the intricacies of tax law and the potential for significant tax implications, professional advice is essential. A knowledgeable advisor can help you integrate these rules into a comprehensive retirement strategy.

Ultimately, whether you decide to remain employed past the traditional retirement age or transition to part-time work, understanding how the still-working exception interacts with your retirement accounts is paramount for long-term financial success.

Final Thoughts on Managing RMDs While Still Working

The still-working exception offers valuable flexibility for those who do not need to tap into their retirement savings immediately. By deferring RMDs from your current employer’s 401(k), you can allow your investments to continue growing tax-deferred. However, it is essential to note that this benefit is limited to the specific account with your current employer, and other accounts remain subject to standard RMD rules.

With the evolving landscape of retirement planning and frequent legislative updates, staying informed and proactive about your retirement strategy is more important than ever. Ensure you review relevant plan details annually, adjust your strategies as necessary, and stay in close communication with your financial advisors to optimize your retirement outcomes.

Conclusion

Navigating RMDs while still working presents both opportunities and complexities. The still-working exception allows eligible participants to delay distributions from their current employer’s 401(k) plan, facilitating continued tax-deferred growth. Key criteria such as maintaining active employment throughout the year, not exceeding the 5-percent ownership threshold, and understanding the distinctions between different retirement accounts are crucial for leveraging this exception effectively. By carefully reviewing your plan’s rules, coordinating across your various retirement accounts, and consulting with financial professionals, you can tailor a strategy that aligns with your long-term financial goals.

References

How does rolling over a 401(k) into an IRA affect RMD timing?

What strategies can minimize taxes associated with required minimum distributions?

What are the complexities of the 5-percent ownership test for the still-working exception?