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Avoid this retirement withdrawal strategy

What's the best way to take withdrawals from more than one account?

Q: My wife has an IRA and a 401(k) account from her prior employer. We are wondering if the following retirement withdrawal strategy would work for us 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?

No, you cannot choose a retirement withdrawal strategy that only debits one account, even if it meets the Required Minimum Distribution amount. This error is one way people incur a 50% penalty from the IRS.

Having 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.

And that’s why it’s so important to make sure you have a retirement withdrawal strategy in place before you reach the age (either 72 or 70 ½, depending on when you were born) at which need to start taking RMDs.

The rules are different for IRAs and 401k plans. If 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. But with 401(k) plans, you must take your RMD separately for each 401k you have. .

So, your wife’s retirement withdrawal strategy must include separate RMDs from each of her two accounts. 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 recognize 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 withdraw from the 401(k) – and that’s in addition to the taxes.

If she eventually decided to roll her dormant 401(k) into an IRA – she would first need to take the current year’s minimum distribution from the 401(k) – then she could take the total withdrawal from just one of the IRAs in subsequent years. But be aware there are strict rules about rollovers so to avoid facing any penalties, be sure to speak with the plan administrator or a financial advisor before taking choosing this option.

How much is the required distribution?

IRS Publication 590 contains a table showing the amount that must be withdrawn each year, but there’s another trap you must avoid. 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.

If you don’t calculate correctly, you could end up withdrawing too little, and the difference would be subject to the 50% penalty. But you can take out more than the required minimum without penalty.

Helping to explore tax-efficient retirement withdrawal strategies is just one of the ways we help our clients. Talk with an Edelman Financial Engines advisor to see how we can help you.

 

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.

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