By Sarah Brenner, JD
I have been reading you for more than 20 years – thank you for all your contributions to our industry.
I have a client (about to be over 70 ½) whose new employer told him that he should roll all of his old employer plans and IRAs over to the new employer’s 403b plan (in which he is participating), for the purpose of avoiding having to take RMDs when he turns 70 ½. Is this indeed a loophole that employees who work past 70.5 can use to avoid RMDs? Basically, bunching everything up into the current employer’s plan, to shelter those funds from RMD calcs?
If so, with so many people working past 70.5, this seems like it could be a lucrative loophole for many.
Yes. This strategy would work, provided a couple of requirements are met. First, the plan must offer the still-working exception and the client must qualify for it. Additionally, the plan must be willing to accept a rollover of the IRA funds. Finally, any RMD required from the IRA or the old plan for the year must be taken prior to the rollover.
While this may seem like a loophole, there is a catch that should not be overlooked. While the client may be able to delay RMDs this way, he cannot escape them forever. Eventually Uncle Sam will want his share. The client will need to start taking RMDs from the plan for the year he retires and if he has taken no RMDs up until this point, his balance will be bigger and so will his RMDs, which could mean a bigger future tax hit.
There seems to be a lot of conflicting information online regarding using Roth 401k distributions to pay for college expenses. I have even asked 3 different CPA’s and got 3 different answers.
So, if I am < 59.5 yrs old and take a distribution from my employer Roth 401k plan will it be subject to any tax and the 10% penalty if I use the funds to pay for college expenses?
You are right that this an area where there is a lot of confusion! Here is the good news, your contributions to your Roth 401(k) are available tax and penalty free to pay for higher education. However, earnings are a different story. If you are under age 59 ½ and you take a distribution from your Roth 401(k) to pay for higher education expenses, the earnings portion will be taxable and subject to the 10% early distribution penalty. The earnings would be taxable because paying higher education expenses does not result in a qualified tax-free distribution from a Roth 401(k). The earnings would also be subject to the 10% early distribution penalty because no exception for higher education exists for distributions from plans. This exception is available for IRAs only.
It is important also to keep in mind that your distribution would be prorated between contributions and earnings because the favorable ordering rules for Roth IRA distributions, which allow tax-free contribution to come out first, do not apply to Roth 401(k)s.