By Andy Ives, CFP®, AIF®
IRA Analyst
401(k) custodians are usually pretty good about distributing required minimum distributions (RMDs) from the plans they oversee. This is especially important when a participant is rolling over his plan balance to an IRA. Why must plan custodians to be on their toes in situations like this? Because plan RMDs are not permitted to be rolled over to an IRA. Some people think they can roll their entire 401(k) to an IRA and simply take the plan RMD from the IRA later in the year. No deal. The plan RMD must be taken prior to any rollover. If the plan RMD is erroneously rolled over, it is now an excess contribution in the IRA, and that error must be corrected.
If a retired plan participant is rolling his entire 401(k) balance to an IRA, and if that participant has yet to take his RMD for the year, 401(k) custodians will typically send a check for the RMD, and another check for the plan balance to be rolled over. Even in situations where the original 401(k) owner died years before his required beginning date for starting RMDs (the RBD) and the account has sat dormant as an inherited plan account in the name of a surviving spouse, 401(k) plan custodians are also good at identifying when the RMDs on that account must start for the surviving spouse. (For those plan participants who die before their RBD, the surviving spouse beneficiary does not need to take RMDs on that inherited plan account until the deceased spouse would have reached RMD age – and that could be years down the road.)
But you know what they say about “the best laid plans.” Sometimes things don’t always go as they should. When it comes time to pay out a 401(k) RMD, there are times when the proper handling of that distribution goes off the rails.
The most common problem occurs when a plan participant is leveraging the “still-working exception” to delay his 401(k) plan RMDs until after he retires. The still-working exception allows a worker to delay his RBD until April 1 of the year after the year he separates from service. This means that a 75-year-old who is gainfully employed can avoid RMDs on his 401(k) until after he retires. (The still-working exception does not apply to IRAs, so this same energetic 75-year-old will still have to take an RMD from his IRA, but his 401(k) can remain untouched.)
The stumbling block occurs when a person using the still-working exception rolls over his entire 401(k) early in the year. There is no RMD to worry about, because he is still working. But what if he gets laid off or quits later that same year? Uh-oh. Since he is no longer still working for that company on the last day of that same year, he now DOES HAVE an RMD for that year. Since the entire plan balance was already rolled over earlier that year, that means the RMD was improperly rolled over. It is now an excess contribution in the IRA and must be addressed.
A recent 401(k) RMD situation presented an interesting confluence of events. A gentleman was eligible for the still-working exception, but he intended to retire later in 2025. He was only 72 years old, but was turning 73 in December. As a 72-year-old who was still working, all signs pointed to no plan RMD. He requested a rollover, and the plan sent his entire balance in a single check. Fortunately, this gentleman was wise enough to recognize that he did have an RMD for the year.
Working with his financial advisor, we intercepted the full rollover check before it was deposited into his IRA. The IRA custodian was able to separate out the plan RMD and deposit the net amount into the IRA. The gentleman will receive a 1099-R from the 401(k) showing a full distribution, and a Form 5498 from the IRA custodian showing the net amount rolled over (the full distribution less the RMD). Plan RMD: satisfied! Excess IRA contribution crisis averted.
If you have technical questions you would like to have answered, be sure to submit them to mailbag@irahelp.com, to be answered on an upcoming Slott Report Mailbag, published every Thursday.
https://irahelp.com/401k-rmd-rollover-problemsand-a-last-minute-save/