401(k) Alert: Don’t Forget the Rules on Required Minimum Distributions (RMDs) | Lord Abbett
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Retirement Perspectives

Many qualified plan participants may not be aware of, or fully understand, the 5% owner rule on required minimum distributions.

Required minimum distributions (RMDs) involve a long, and sometimes complicated, set of rules as well as exceptions. RMDs are annual mandatory distributions that participants must take upon reaching age 70½, thus beginning a transition from a vehicle used for retirement savings to a “forced” retirement income. In other words, a retirement saver must take an annual distribution whether or not he or she needs the income. Failure to take an RMD will result in a hefty 50% federal tax penalty on the amount of the distribution that was supposed to be taken, but wasn’t.

Annual minimum distributions apply to qualified plans, including 401(k), 403(b), and 457 plans, as well as IRAs (including SEP, SIMPLE, and SAR SEP, but not Roth IRAs). Notably, Roth 401(k) accounts are subject to lifetime RMDs. 

RMDs have a mandatory start date called the required beginning date (RBD); however, the RBD can differ for qualified plans versus IRAs (including SEP and SIMPLEs). For IRAs, the RBD and subsequent RMD rules are relatively straightforward: here an account holder is subject to RMDs in the year he or she reaches age 70½; however, the initial RMD can be deferred to April 1 of the following the year. All subsequent RMDs must be distributed by December 31 of the distribution year.  

For qualified plans such as a 401(k), the RBD potentially can be delayed beyond age 70½. In general, the RBD for qualified plans is the later of:

  • April 1 of the year following the year a plan participant turns 70½ for participants who own more than 5% of the business (referred to as “5% owners”) and participants who are not 5% owners but are retired or separated from service before or during the year in which they hit age 70½.

However, different rules apply to participants who are not 5% owners; here, for participants who continue to work beyond age 70½, their RBD is April 1 of the year following the year the non-5% owner retires.

EXAMPLE: George (who is not a 5% owner), 78, retires in December 2017 from Life’s a Dream Inc. His RBD is April 1, 2018. Although he can (but it’s not mandatory) take his 2017 RMD by December 31 or defer it until April 1, 2018. If he defers his 2017 RMD, he will be subject to two RMDs in 2018 (both 2017 and 2018).

“For purposes of qualified plan required minimum distributions (RMDs), the definition of a '5% owner' is an individual who owns more than 5% of the company sponsoring a qualified retirement plan. The required beginning date (RBD) for 5% owners to begin taking RMDs is April 1 of the year after they reach age 70½, regardless of whether they are still working.” – Internal Revenue Service

As mentioned, the determination of who satisfies the 5% owner test is crucial, as it determines his or her RBD—which then begs the question: what is the timing to determine whether or not a participant is a “5% owner” for the purposes of RMDs? A 5% owner is an employee with a 5% stake in the plan year ending in the calendar year in which the employer reaches age 70½.  

In other words, if a participant was a 5% owner when he or she reached age 70½, then he/she would always be a 5% owner—even if at a later date they sell such an interest reducing their ownership. Conversely, if an individual becomes a 5% owner after their RBD they are considered a non-5% owner for RBD purposes.

EXAMPLE: Jennifer was a 5% owner in 2017 via family attribution rules, due to her husband’s 100% ownership of the company. She reached 70½ in 2017, the same year he sold his entire interest in the business. Jennifer, for RMD purposes, is still considered a 5% owner; therefore, she must begin taking RMDs by April 1, 2018. 

An individual who qualifies as a 5% owner is determined by the ownership interest with respect to the plan year ending in the year the individual reaches age 70½. In addition, family attribution rules apply.  In other words, ownership in the company can be attributed to other family members, such as a spouse, parents, children, or grandchildren. 

While each plan documents the definition of an RBD, a plan is not required to adopt a broad definition.  Instead, a plan could require all participants to take their RMD at 70½ regardless of work ownership and work status.


To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

A 403(b) plan is a retirement savings plan that allows employees of public schools, nonprofit, and 501(c)(3) tax-exempt organizations to invest on a pretax and or Roth aftertax basis. Contributions to a 403(b) plan are conveniently deducted directly from your paycheck. In addition, your employer may elect to make a contribution on your behalf.

457(b) is a nonqualified, deferred-compensation plan established by state and local governments, tax-exempt governments, and tax-exempt employers. Eligible employees are allowed to make salary deferral contributions to the 457 plan. Earnings grow on a tax-deferred basis and contributions are not taxed until the assets are distributed from the plan.

A Coverdell Education Savings Account (ESA), formerly known as an Education IRA, is an attractive tax-advantaged college saving vehicle that allows an investor to save and pay for higher education for the account beneficiary (typically a child).

529 plan is a tax-advantaged investment vehicle in the United States designed to encourage saving for the future higher education expenses of a designated beneficiary.


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