Do you have a significant portion of your retirement assets in a 401(k) plan or traditional IRA? If so, you’re not alone. Many Americans use these tax-deferred vehicles to accumulate retirement assets.
Traditional IRAs and 401(k) plans provide tax benefits in several ways. First, your contributions may reduce your taxable income. Traditional IRA contributions may be tax-deductible, and 401(k) contributions are taken from pretax earnings. As long as the funds stay inside the account, you don’t pay taxes on your growth.
However, you can’t defer your taxes forever. Distributions from these accounts are usually taxable. The IRS requires you to take distributions from a traditional IRA or 401(k) by age 70½. The amount of these required minimum distributions (RMDs) is based on your account balance and your age. The withdrawal usually increases as you get older.
While RMDs are a common element for both 401(k) plans and traditional IRAs, there are subtle differences between the two accounts. Understanding those differences can help you better plan your income. Below are a few of the biggest RMD differences between traditional IRAs and 401(k) plans:
Calculations for Separate Accounts
It’s possible that you could have several IRAs and 401(k)s. It’s not unusual for people to have multiple 401(k) plans from former employers or to open different IRA accounts at various points in their lives. Your RMD calculation for multiple accounts differs based on whether the accounts are IRAs or 401(k)s.
If you have multiple IRAs, you can simply total your balance for all the accounts and then take the required amount from any account. As long as you withdraw the minimum, it doesn’t matter which account the funds come from. With multiple 401(k) plans, you must calculate and take a separate RMD from each account.
Working Past 70½
Perhaps you want to stay in your job past age 70½. What does that mean for your RMD calculation? It doesn’t impact your traditional IRA RMDs at all. You must take RMDs from your traditional IRA at age 70½ regardless of whether you are still working.
If you work past age 70½, however, you don’t have to take RMDs from that employer’s plan at that age. Your RMDs would start after you leave the employer. Keep in mind, though, that you would have to take RMDs at 70½ from any balances in former employer plans.
Roth IRA and Roth 401(k) Distributions
Roth IRAs are popular because they offer tax-free retirement income after age 59½. They also don’t have RMDs at age 70½, so you are never forced to take distributions from your Roth IRA.
It’s possible that you may have some funds in a Roth 401(k). These plans have grown in popularity in recent years. They are taxed much like a Roth IRA. You make contributions with after-tax dollars, defer taxes on growth while the funds are in the account and then take tax-free distributions after age 59½.
However, a key difference between Roth IRAs and Roth 401(k) plans is that you must take RMDs from a Roth 401(k). These distributions aren’t taxable, but they are required. If you fail to take them, you could face a penalty. If you don’t wish to take distributions from your Roth 401(k), you could consider rolling the balance into a Roth IRA.
Tax-Free Charitable Distributions
Want to give to charity and minimize your tax burden? Consider donating your traditional IRA RMDs to your favorite cause. The IRS allows you to transfer your RMDs from a traditional IRA directly to a charitable organization. If you do so, the distribution is tax-free. This option isn’t available for 401(k) balances. However, you could roll your 401(k) funds into an IRA and then complete the tax-free transfers.
Ready to plan your RMD strategy? Let’s talk about it. Contact us today at Carstens Financial Group. We can help you analyze your needs and implement a plan. Let’s connect soon and start the conversation.
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