How to put off mandatory distributions
There is no escaping death, but it turns out that when it comes to employer-sponsored 401(k) and 403(b) tax-deferred retirement plans, clients can escape taxes, at least for as long as they keep working at the same job that sponsors their retirement plan.
The Internal Revenue Service sets no minimum number of hours that a person needs to be employed for this deferral of the minimum distribution requirement to apply. Even a few hours a week does the trick, as long as the employee continues to be on the payroll, isn’t working as an independent contractor and doesn’t own 5% or more of the plan sponsor.
There is a catch, of course.
Clients don’t escape the rule that says that after reaching 70 1/2 one must start taking minimum distributions from the 401(k) or 403(b) plan, just delaying the date at which they must start taking distributions. And when they do start taking distributions, they will be higher, based on the IRS’ rather optimistic actuarial estimate of their remaining lifespan.
For example, if a client starts taking distributions at 70 1/2, their life expectancy is considered to be 26 1/2 years, so the annual minimum distribution is the balance of the fund divided by that number. Clients who keep working until 80 and then start taking distributions, and the divisor of the balance is a life expectancy of 18.7 years.
At 90, the magic divisor is 11.4 years. If a client dies before leaving the job and starting to take distributions, his or her heirs inherit the balance of plan funds but have to pay taxes on them, though they can take the money in phased annual distributions to minimize the tax hit.
David Ray, head of institutional retirement plan sales at TIAA-CREF in Lewisville, Texas, which manages 403(b) plans for many universities and schools, say that university professors, who often are able and want to keep teaching and doing their research well into their 80s and even beyond, will take this option of deferring distributions.
“We call it the reluctant retiree syndrome,” he says.
Ray notes that an advantage of staying on the job and deferring distributions is that the employee continues to contribute to his or her fund and to receive matching employee contributions.
“I can’t really think of any downsides to adopting this strategy,” he says.
Pat Keating, founder and president of Manhattan, Kan.-based Raymond James-affiliated wealth management firm Keating & Associates, has a number of clients who work for companies and a number who are on university faculties, who are working past 70, sometimes on a part-time basis, and deferring their distributions.
“I think it’s a great idea for people who don’t need the money,” he says.
But Keating adds, “since people will likely need to take distributions eventually, we advise them to take some money out along they way, keeping these distributions just below the point where they would be pushed into a higher tax bracket.”