Revisiting the ‘Still-Working” Exception to RMDs

Take-Away: The ‘still-working’ exception to taking required minimum distributions (RMDs) is a great strategy to consider, but it is also important to keep some of its limitations and the hidden tax costs that will probably result from the delay in taking an RMD.

Background: The ‘still-working’ exception allows a qualified plan retirement account owner to delay taking required minimum distributions (RMDs) after attaining age 72. The IRS has not indicated what amount of time constitutes ‘still working.’ There is no requirement that the plan participant work 40 hours in a week for the RMD exception to apply . Presumably a part-time position will be considered ‘working’ for purposes of the RMD exception. There are, however, some constraints and limitations to be aware of if a participant exploits the ‘still-working’ exception, so that any RMD is not ‘missed.’

Still-Working Limitations: The ‘still-working’ exception does not apply-

1. Only Qualified Plans: To all retirement accounts. The exception applies only to employer sponsored qualified plans. Consequently, the ‘still-working’ exception does not apply to IRAs or to SEP and SIMPLE IRAs. RMDs must still be taken from an IRA that is  maintained by the ‘still-working’ employee- participant.
2. Only for the Plan Sponsor Allows the Exception: To all qualified plans. A qualified plan sponsor must formally allow the ‘still-working’ exception to apply to its qualified plan in question.
3. Only for the Plan Sponsor That Hires the Employee: To other qualified  plans in which the employee participates and maintains an account. The exception is only available for the qualified plan of the company for which the individual currently works. If the working individual maintains retirement funds in another company’s qualified plan, the exception will not apply to those other qualified plans.
4. 5% Owners Ineligible: To an employee-participant who owns more than 5% of the plan sponsor for which the employee is ‘still working.’ Moreover, the family attribution of ownership rules apply to this 5% ownership determination. Accordingly, any ownership in the plan sponsor by the employee-participant’s spouse, child, or grandchild will be included when making the determination whether the employee-participant is more than a 5% owner of the business sponsor.
5. Separation from Service: To the year when the employee finally separates from service. Accordingly, if the employee-participant finally retires on December 31, that retired employee’s RBD will be April 1 of the year after their separation from service.

Example: Todd, age 76, formally retires on December 31, 2022. Todd must take his first RMD from his qualified plan account on April 1, 2023. Todd cannot postpone his first RMD until December 31, 2023.

Income Tax Considerations: While delaying an RMD by exploiting the ‘still-working’ exception may sound like a good idea, there will probably  be tax complications that should also be factored into the decision to delay taking RMDs. By taking RMDs later in time, that means that the employee-participant will end up taking larger RMDs due to his/her higher life expectancy factor. Larger RMDs will mean more income taxes, possibly pushing the individual into  higher marginal federal income tax brackets. In addition, the individual’s Social Security income could be taxed due to that higher reported taxable income. Along with that higher taxable income will come the possibility of losing out on other tax deductions, credits, exemptions, and phase-outs. Finally, with the higher reported taxable income will come the likelihood of paying higher Medicare premium taxes.

Conclusion: Delaying taxable required minimum distributions usually sounds like a good idea. However, there are tax considerations to factor into the decision to exploit the ‘still working’ exception to taking an RMD. Delaying an RMD is not always a ‘no-brainer’ decision.