This week, Gail explains the IRS regulations on 401(k) distributions, clarifies a Roth IRA contribution law and has urges you to check your state's tax policy.

Gail,

I have an employee who will soon be 70-1/2 years old. The IRS says you must start taking distributions from your 401(k) when you reach this age but my company policy says you can’t start taking distributions if you are still working. Seems like the IRS rule would take precedence. What’s your advice? Also, is he free to take money out if he wants to, since he’s over 70-1/2?

Kelly

 

Dear Kelly,

There are two issues here, so let’s deal with them separately.

The first question is: When MUST someone start taking withdrawals from their retirement plan? Here, your interpretation of IRS regulations is incorrect. However, the rules have changed, so your confusion is understandable.

Up until a year an a half ago, the regulations said an employee must start withdrawing a minimum amount of money (determined by a formula) from his company retirement by the later of:

• April 1 in the year after he reached age 70-1/2,

OR

• the year he retired - unless he owned at least 5% of the company.

In other words, someone who continued to work for a firm - even though he was in his 70s - could leave the money in his 401(k). This meant he could delay his "required beginning date" until he retired. The exception is if the employee owned 5% of the company. In that case, he had no choice; withdrawals had to start by age 70-1/2, whether he kept working or not.

However, in January 2001, the IRS issued new proposed regulations covering required distributions. The new regulations give companies a choice: Continue to operate under the old regulations and allow non-owner employees to keep their money in the plan for as long as they’re working at the company, or, simplify things by amending your plan to require that ALL plan participants use the same "required beginning date" and start withdrawals by April 1st in the year after they turn 70-1/2.

As you can see, while the government allows flexibility here, a company can choose to take a more restrictive approach. In your case, it would appear your plan is operating under the earlier, more lenient rules. That is perfectly legal. There’s a saying in the retirement industry: the rules of the plan rule. Provided it is within the law, a company retirement plan can adopt any number of rule variations. That’s why all retirement plans are not alike. For your reference, see Proposed Treasury Regulation Section 1.401(a)(9)-2,A-2(e).

The second part of your question concerns whether your company can prevent someone from accessing their retirement money.

By law, a company is not allowed to give you access to your 401(k) account prior to age 59-1/2.* A plan might permit you to tap into your account after this age, but it doesn’t have to. However, it must allow you to start withdrawing money once you reach your "required beginning date" under the plan (see above).

Hope this clears things up.

Gail

* There are some exceptions, such as if you terminate employment, or die, or become disabled. Another exception the so-called "hardship withdrawal," which can occur at any age. Events that qualify for hardship withdrawals are generally spelled out in the retirement document. Ask your plan administrator for a copy of the "summary plan description." As its name implies, this lays out the information and rules most pertinent to an employee, as opposed to the mountains of legal language that cover technical aspects of the retirement plan.

 

Gail,

In a past column you wrote that, "If you are married but file separately, neither spouse can contribute to a Roth IRA." Say what?

John

 

Dear John,

For all practical purposes this is correct. A couple that is married, but files separate tax returns ("Married, filing separately") is not eligible to make any contribution to a Roth IRA once their adjusted gross income (AGI) exceeds $10,000. (I don’t make up these rules, I just try to clarify them.)

Even if you take the more traditional route and submit your tax return as "married, filing jointly," there is still an income phase-out for what the government considers "high income" households. While a lot of the rules governing IRAs changed for the better this year, unfortunately, this rule did not. In order for a couple (filing jointly) to make the maximum contribution of $3,000 apiece to Roth IRAs, their modified adjusted gross income (MAGI) cannot exceed $150,000. A joint income of $150,000 to $160,000 allows each person to contribution a portion of the full amount.

In order for a single individual to max out a Roth IRA, her MAGI must not exceed $95,000. Eligibility is phased out completely at $110,000.

Keep in mind, anyone over age 50 can contribute an extra $500 to their IRA this year. This so-called "catch-up"amount is not reduced under the income phase-out.

Sorry I don't have better news!

Gail

 

Dear Gail:

First, I would like to say that I really enjoy your articles. They are extremely informative and educational.

Speaking of education, my question is: Are distributions from education IRAs taxed by the state of Iowa? I know that they are tax-free from Uncle Sam.

Thank you for your time and assistance.

Bryan

 

Dear Bryan,

This one is easy! Iowa’s tax system follows the lead of the federal government. When I called the Iowa tax information line I was told "if something is not subject to tax on the federal return, then we don’t tax it, either."

This means the same policy would extend to college 529 plans, which allow you to stash away a lot more than an Education IRA (now called a "Coverdell Education savings account"). Regardless of whether you use Iowa’s 529 plan, or that of another state, which might offer more investment choices or better features, qualified withdrawals for higher education would not be subject to either federal or Iowa state income tax.

While a number of states have patterned their tax regulations after the federal system, this is far from universal. It’s always smart to check.

Gail

 

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The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.