By: Ric Edelman
Question: My wife has an IRA and a 401(k) account from her prior employer. When she reaches RMD age, can we calculate the required minimum withdrawals from both and simply take the grand total out of one account — for example, the IRA?
Ric: No, you can’t — and that error is one way people incur a 50% penalty from the IRS.
The fact that your wife has money in both an IRA and a 401(k) is common. We typically find that people have five retirement accounts by the time they stop working. Those may be IRAs, 401(k) accounts from multiple prior employers, perhaps a 403(b), and others.
Let’s say you had five IRAs of different values. You could add up the total RMDs and withdraw the entire amount from just one of the IRAs — much like you asked. That works fine if all the money is in IRAs. But if one of those accounts is a 401(k), you must take from the 401(k) its pro rata portion.
Taking the 401(k) portion from one of the IRAs triggers the penalty. Even though you took the proper total amount from all the accounts, the IRS will say you didn’t take it from the proper place. Thus, a simple paperwork error costs you a 50% penalty on the amount you were supposed to take from the 401(k) — and that’s on top of the taxes.
Your wife must take the withdrawals separately from each of her two accounts. If she should roll her dormant 401(k) into an IRA (she will first need to take the current year’s minimum distribution from the 401(k)) — as we often recommend, because an IRA usually provides more investment options and solves this paperwork problem — then she could take the total withdrawal from just one of the IRAs in subsequent years.
Meanwhile, there’s another trap you must avoid. Many people know that IRS Publication 590 contains a table showing the amount that must be withdrawn each year — but the amount is based on the account value as of the prior Dec. 31, not on the value at the time the funds are withdrawn.
Account values ordinarily rise, so it’s usually not a problem if you use, say, a May date instead of the previous December’s date, because the account value in May is probably higher. But remember what happened in 2008. That year, the stock market was down sharply; if you took the withdrawal late in the year, your account value likely was far less than it was the previous Dec. 31 and you could have ended up withdrawing too little. The difference would have been subject to the penalty.
These rules are needlessly burdensome. They penalize people who, often because of cognitive decline in their 70s and beyond, handle the complex paperwork incorrectly and end up owing double or triple the amount they should have to pay.
I’ve had conversations with Congressional staff members on Capitol Hill on this subject. Perhaps those discussions will lead to some positive changes.
Neither Edelman Financial Engines, a division of Financial Engines Advisors L.L.C., nor its affiliates offer tax or legal advice. Interested parties are strongly encouraged to seek advice from qualified tax and/or legal experts regarding the best options for your particular circumstances.