Most people who have an IRA are patient, as they should be. They have a 401k for when they grow older and, preferably, won't start withdrawing until the really have to, which is when they reach the age of 70 1/2. So what are the 5 things you should know about 401k withdrawal rules? If you have a 401k, it is important to be prepared. You must also stick to the rules, because failure do so could become very expensive.
Understanding the 5 Things You Should Know About 401k Withdrawal Rules:
Below are the top 5 things you should know about 401k withdrawal rules. Make sure you also have regular conversations with your plan administrator and tax advisor, so you know that you are sticking to all the rules.
1. You must start taking the required minimum distributions (RMDs) once you turn 70 1/2, or at least by April 1 of the following year. After that initial withdrawal, you must take your next RMD by December 31 of that same year. So, if you were to turn 70 1/2 in March of 2017, you could defer your first RMD to April 1, 2018, and your second to December 31, 2018. This means that, if you do defer to April 1, you may have to take two payments in a single year.
2. Working out your 401k withdrawals is a matter of life or death, sort of… In order to find out how high your RMD will be in a certain year, you have to divide whatever is left in your account after the day of your last payment by the life expectancy for someone of your demographic background. That may seem pretty arbitrary, but the IRS does publish a full table on its website that allows you to work out exactly what your life expectancy is.
3. Your RMD may be, and likely will be, classed as taxable income. This should have been explained to you when you first opened the account. However, a quick reminder is that, in case of a 401k, you did not pay any taxes on the money that you contributed into your 401k. However, when you withdraw from this money, you will have to start paying taxes. If you have a Roth 401k, you may have qualified distributions that won't be taxed. However, the IRS says that you should speak to your administrator and tax advisor.
4. If you do not take your annual RMD, it will cost you a great deal of money. In fact, the amount that isn't distributed will be taxed at 50%.
5. If you make an RMD mistake, you can fix it. You can have the 50% tax waived by filling in Form 5329 and writing a letter explaining that a "reasonable error" was made, and that you have taken "reasonable steps" to fix it.
The above are the five key things to know about the rules for withdrawing from a 401k. These are complex, not in the least because of the tax issue. However, the IRS is there to help you if you have questions.