For those clients who decide to stay on the job instead of retiring may reap more benefits beyond the obvious paychecks.
The reason is a provision of the tax code that is often overlooked that could make a major difference in a client’s prospects for saving enough for retirement.
Under IRS rules, if a client continues to work at the same employer that offered his 401(k) or 403(B) plan, even on a part-time basis, he does not have to take withdrawals at 70, or any time, until he retires or changes jobs.
This could prompt more people to keep working. Ordinarily, when a client retires, the IRS mandates that she start taking required minimum distributions of 7.5% from any tax-deferred retirement plan. That money would be treated as income and taxed.
But things are different if a client instead continues working at the same company that is sponsoring her retirement plan.
In that case, even if the client is working less than full-time, IRS rules allow for a delay in taking mandatory withdrawals—a waiver that lasts until the person leaves the job. While the IRS has not established any minimum number of hours per week needed to qualify for this waiver, it is mandated that the worker be an employee, not a contract worker. The rules also do not allow such deferrals of RMDs in the case of people who own 5% or more of a plan-sponsoring employer.
If an elderly person continued working past 70 and deferred withdrawals from his employer’s retirement plan, he typically would still have to make withdrawals from—and pay income taxes on—any other 401(k) plans or IRA accounts held.
But the IRS also allows plan holders to roll those older accounts into the current employer’s retirement plan. Once it’s rolled over, it’s considered part of the current plan’s funds, with no mandatory withdrawals required. (This, of course, is all dependent upon the current plan sponsor’s allowing such rollovers and delayed withdrawals.) The one exception is an IRA composed of money that the client directly contributed to. That money cannot be deferred, and if a 401(k) was rolled into such a pre-existing IRA, only the funds that had been rolled over could be deferred.
Meanwhile, that older worker still on the job also can continue to make regular payments into the still growing fund, and capitalize on the employer’s matching contributions, if available.
“If you simply want to stay in your job and save more money, and your retirement plan allows you to delay taking RMDs, I think it’s a great idea,” says Bo Bohanan, director of retirement plan consulting at Raymond James Financial in St. Petersburg, Fla. “But be sure you understand your plan’s rules.” Should it turn out your plan doesn’t allow deferrals, he warns that failure to take RMDs each year after age 70 can mean a whopping 50% penalty by the IRS.
Bohanan adds that deferral of RMDs is no free lunch. The longer a client defers taking distributions from a retirement fund, the bigger those taxable distributions will have to be once they begin.
The IRS’ Uniform Life Table sets out how many years you have for withdrawing and paying taxes on the total retirement fund balance. At age 71, it would be 26.5 years; at 75, it’s 22.9 years, at 80 it’s 18.7 years, and at 85 it’s 14.8 years.
If you continued working and deferring withdrawals until age 90, the IRS would give you just 11.4 years to make those RMDs. (Any undistributed tax-deferred retirement money left in a fund when someone dies goes into that person’s estate and is taxed as income for the heirs.)
“This strategy can be as much about tax planning as it is about saving more for retirement,” says Bill
McClain, a defined contribution consultant at Mercer. “If you can defer taking distributions and paying taxes on that money while you’re still earning a high salary, it can mean paying a lot less in taxes. But it’s also a good option to know about if you need to save more for retirement.”
“We see a lot of this kind of deferral of distribution being done among university teachers,” says David Ray, head of institutional retirement plan sales at TIAA-CREF. “In fact we have a name for it: the reluctant retiree.”
Ray says that among university professors, it is common to find people staying on the job well past 70. “And generally, they will defer their withdrawals and continue contributing to their 403(b) plans and getting matching money from their employers,” he adds.
Ray continues, “I can’t really think of any downsides to adopting this deferral strategy. In fact, it’s a key untapped opportunity for workers who have no intention of retiring as well as those who just think they need to earn more money for their eventual retirement.”
Pat Keating, president and CEO of Keating & Associates in Manhattan, Kan., says, “It’s important that everyone in the retirement business understand that people can, if their plan allows it, continue to delay distributions and to keep putting in more money in their account, including any employer match.”
There are advantages beyond financial issues for clients to consider. Turns out there are health benefits to working longer.
A recent study by the American Psychological Association found that people who work past retirement age suffer fewer major diseases and less physical decline than those who just stop working.
Then again, no amount of extra income will be worth it if your client is in a hellish work environment, or has to struggle physically to continue on the job. In that case, it might be better for the client to just forget about deferring RMDs and, if continuing to work is necessary, find something else to do.