11

I read on the IRS Roth Comparison Chart (mirror):

Required Distributions (for Pre-Tax 401(k) or Designated Roth 401(k)): Distributions must begin no later than age 70½, unless still working and not a 5% owner.

Why does one have to withdraw money from a 401(k) when older than 70.5? I.e., what could explain this IRS rule regarding this so-called Required Minimum Distribution (RMD)?

25

The tax code is a hodgepodge of rules that are often tough to explain.

The reality is that it's our Congress that writes the tax code, and they often have conflicting goals among themselves.

In theory, someone said "How about we force withdrawals at some point. After all, these are retirement accounts, not 'give your kid a huge inheritance account'." And the discussion continued from there. The age 70-1/2 was arbitrary. 70 happens to be the age for maximum Social Security benefits. But the average retirement age is 63. To make things more confusing, one can easily start taking IRA or 401(k) withdrawals at age 59-1/2, but for 401(k) as early as 55 if you separate from the job at 55 or later. One can also take withdrawals earlier from an IRA with tax, but no penalty using Sec 72(t) rules (such as 72(t)(2)(A)(iv) on Substantially Equal Periodic Payments).

To add to the confusion, Roth IRA? No RMDs (Required Minimum Distribution). Roth 401(k), RMDs once separated from service. Since the money has already been taxed, it's the tax on the growth the government loses. My advice to the reader would be to move the Roth 401(k) to a Roth IRA before 70-1/2. My advice to congress would be to change the code to have the same rules for both accounts.

Whether one agrees that a certain rule is 'fair' to them or others is up to them. I think we can agree that the rules are remarkably complex, from origin to execution. And a moving target. You can see just from the history of this site how older questions are often revisited as code changes occur.

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    What is an RMD? – TylerH Oct 28 '17 at 21:19
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    Required Minimum Distribution. I am sorry. Really, I should know better, acronyms should be defined at some point. – JoeTaxpayer Oct 28 '17 at 21:40
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    No worries; thanks for the clarification. It is a personal finance site, so some knowledge of acronyms is to be expected. I knew IRA, but couldn't place RMD after thinking for a few moments. I probably would have understood it if OP mentioned "Retired Minimum Distribution" instead of just "Retired Distribution"! – TylerH Oct 28 '17 at 22:29
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    "70 happens to be full retirement age for Social Security benefits" - well, Full Retirement Age used to be 65 but is now 66-67 depending on when you were born. You can defer starting your benefits as long as you like, but at age 70 you stop getting delayed retirement credits (of around 8% per year). – Joe Strazzere Nov 1 '17 at 23:58
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    Joe, I edited. You are correct. There's the full retirement age, and the delayed age, 70 for max benefits. Let me know if the edit makes my intent clear. – JoeTaxpayer Nov 2 '17 at 9:49
9

the government wants to tax your money before you die. If you die your 401(k) becomes part of your estate and will not be taxed to as great an extent.

  • Thanks, makes sense. Roth 401(k) are also affected by the same rule though. – Franck Dernoncourt Oct 28 '17 at 5:57
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    While that's valid for Traditional IRA money (which hasn't been taxed yet), Roth money has already been taxed. Thus, your answer does no answer why Roth 401(k) money -- which has already been taxed -- is mandated to be withdrawn. – RonJohn Oct 28 '17 at 6:00
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    "the government wants to tax your money before you die" is as good as it gets. The second sentence isn't quite true. When I die, and my kid inherits my 401(k) she will have RMDs and tax due on the full withdrawal, on top of her regular income. i.e. all taxed at her highest marginal rate, and perhaps pushing to next. For me, it starts at 0, and on average my rate in retirement is barely 11%. – JoeTaxpayer Oct 28 '17 at 8:45
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    "for Pre-Tax 401(k)" <<< this is the traditional, pretax, non-Roth, original, 401(k). Roth is 'post tax' money. – JoeTaxpayer Oct 28 '17 at 8:58
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    @RonJohn: But the answer still applies to the Roth 401(k), it's just that the government wants to tax your money AGAIN :-) – jamesqf Oct 29 '17 at 2:55
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In addition to the reasons discussed in JoeTaxpayer's answer, consider that a 401(k) plan is run by an employer (though the details might be delegated to a plan administrator) and it is a headache to have to deal with ex-employees (including retirees) with whom one might have no further relationship once the employment has ceased. Pension plans in addition to 401(k) plans are a rarity these days. Hence, no RMDs need be taken while still employed past age 70.5, but after that, let's keep in touch at least once a year so that we can send you some of the money we are holding for you.

  • Of course, this is why rolling your old 401(k) plans into an IRA is the best thing to do... :) – RonJohn Oct 28 '17 at 17:34
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    @RonJohn - Not always! Not when my 401(k) has access to VIIIX, an S&P index with .02% annual fee. Not when I might have IRAs with high pretax deposits, and converting to Roth would be cheap if that 401 stays put. – JoeTaxpayer Oct 28 '17 at 19:59
  • @JoeTaxpayer "I might have IRAs with high pretax deposits" wouldn't you roll it into a different (or even new) IRA? – RonJohn Oct 28 '17 at 23:49
  • No, it's an example of when a Roth conversion would be appropriate. If most money is pretax, conversion is cheap. Once 401(k) is mingled, it's too late. – JoeTaxpayer Oct 29 '17 at 0:01
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    @RonJohn: Does there need to be? You made a faulty suggestion in response to JoeTaxpayer's comment. If it was alright for you to address a scenario not included in the question or answer, why isn't it ok for me to address the same scenario? – Ben Voigt Oct 30 '17 at 5:04

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