Are you one of the millions of Americans who uses a 401(k) or a traditional IRA to save for retirement? Do you have assets in both types of vehicles? You’re not alone. Both IRAs and 401(k) plans are popular choices for retirement savings, largely because of their favored tax treatment.
Both types of accounts are qualified. That means you don’t pay taxes on growth as long as the funds stay inside the account. Both also offer tax-favored contributions. Your 401(k) contributions are deducted from your paycheck pre-tax, effectively reducing your taxable income. You also may be able to deduct your traditional IRA contributions from your taxes, depending on your income.
However, distributions from these qualified accounts are usually counted as taxable income. While you can defer those taxes for some amount of time, you can’t put them off forever. Both accounts have required minimum distributions (RMDs), which are mandated starting at age 70 ½. Failure to take your RMD could result in penalties.
While both accounts have RMDs, the rules aren’t the same for IRAs and 401(k) plans. If you have assets in both types of accounts, it may be helpful to understand the distinctions. That way, you can plan your distributions and perhaps minimize your tax exposure. Below are some of the biggest differences:
It’s not uncommon for people to have multiple IRAs and 401(k)s. You may have 401(k) balances at several former employers, or you may have opened different IRAs at various points in your life. Your RMD calculation for multiple accounts differs based on whether the accounts are IRAs or 401(k)s.
If you have multiple IRAs, you can simply total your balance for all the accounts and then take the required amount from any account. As long as you withdraw the minimum, it doesn’t matter which account the funds come from. With multiple 401(k) plans, you must calculate and take a separate RMD from each account.
Work Past 70½
Do you want to continue working past age 70½. If so, what does that mean for your RMD calculation? It doesn’t change your RMDs from your traditional IRA in any way. You must take RMDs from your traditional IRA at age 70½ regardless of whether you are still working.
If you work past age 70½, however, you don’t have to take RMDs from that employer’s plan at that age. Your RMDs would start after you leave the employer. Keep in mind, though, that you would have to take RMDs at 70½ from any balances in former employer plans.
Roth IRA and Roth 401(k) Distributions
Roth IRAs are popular because they offer tax-free retirement income after age 59½. They also don’t have RMDs at age 70½, so you are never forced to take distributions from your Roth IRA.
It’s possible that you may have some funds in a Roth 401(k). These plans have grown in popularity in recent years. They are taxed much like a Roth IRA. You make contributions with after-tax dollars, defer taxes on growth while the funds are in the account and then take tax-free distributions after age 59½.
However, a key difference between Roth IRAs and Roth 401(k) plans is that you must take RMDs from a Roth 401(k). These distributions aren’t taxable, but they are required. If you fail to take them, you could face a penalty. If you don’t wish to take distributions from your Roth 401(k), you could consider rolling the balance into a Roth IRA.
Tax-Free Charitable Distributions
Want to give to charity and minimize your tax burden? Consider donating your traditional IRA RMDs to your favorite cause. The IRS allows you to transfer your RMDs from a traditional IRA directly to a charitable organization. If you do so, the distribution is tax-free. This option isn’t available for 401(k) balances. However, you could roll your 401(k) funds into an IRA and then complete the tax-free transfers.
Ready to plan your RMD strategy? Let’s talk about it. Contact us today at Peak Financial. We can help you analyze your needs and implement a plan. Let’s connect soon and start the conversation.
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