Guide to retirement distribution planning: rules, strategies and taxation

When it’s time to withdraw money from your employer plans and IRAs, understanding the distribution rules and learning about retirement distribution planning strategies can help you make informed choices.

To cover essential and lifestyle expenses in your retirement, you'll likely begin drawing some income from your retirement accounts.

However, before you begin withdrawing funds, it's important to do some planning to understand the rules governing retirement plan distributions.

In this guide to retirement distribution planning, you'll learn about:

Understanding retirement distribution guidelines

When can you withdraw distributions? To take distributions from most 401(k), 403(b), 457(b) and profit- sharing plans, you generally must leave your job (separate from service) or reach age 59 ½.
When will you face a penalty for withdrawing distributions?

A 10% IRS penalty may apply to taking early distributions from most retirement plans.

Note: 457(b) plans don't carry this penalty.
How are distributions taxed? Distributions are generally taxable as income. However, you can take tax-free distributions from a Roth IRA if you've participated in the plan for at least five years and reached age 59 ½.
What is the age you’re legally required to withdraw distributions?

Most plans require that you start taking required minimum distributions (RMDs) by April 1 of the year following the calendar year you reach your RMD age, regardless of whether you remain employed.

The RMD age is 73 for individuals who turn 72 after 2022. Individuals who turned 72 prior to 2023 are already subject to RMDs. In 2033, the RMD age will increase to 75.

These distributions are based on your life expectancy and your account balance at the end of the previous year. RMDs are usually taxable, and there is generally a 25% penalty on the amount not taken if you skip them or take less than the required amount.

 

Guide to IRA rules for retirement plan distributions

 

How are distributions taxed?
IRA/SEP IRA
  • Distributions of pre-tax contributions and earnings are taxed as income.
  • Distributions of after-tax contributions are not subject to income tax.
Note: If both pre- and after-tax contributions have been made, distributions are taken from both proportionally.
SIMPLE IRA
  • Distributions are taxed as income.
Roth 401(k), Roth 403(b)
  • Distributions of contributions and conversion assets are always income tax free.
  • Qualified distributions of earnings are tax free.
  • Non-qualified distributions of earnings are taxed as income.
  • Contributions are distributed first, followed by conversion assets and earnings.

 

What is the penalty for early withdrawals? 
IRA/SEP IRA
  • A 10% penalty may apply to taxable distributions made prior to age 59 ½ (exceptions apply).
SIMPLE IRA
  • A 25% penalty may apply to taxable distributions prior to age 59 ½ if distributions are taken within two years from the date you first participated in the SIMPLE IRA (exceptions apply).
  • A 10% penalty may apply to taxable distributions prior to age 59 ½ if you have participated in the SIMPLE IRA for more than two years (exceptions apply).
Roth 401(k), Roth 403(b)
  • A 10% penalty may apply to distributions of conversion assets made within five years of conversion and prior to age 59 ½ (exceptions apply).
  • A 10% penalty may apply to taxable distributions of earnings prior to age 59 ½ (exceptions apply).

 

Do required minimum distribution (RMD) rules apply? 
IRA/SEP IRA
  • RMDs must begin by April 1 of the year following the calendar year you reach your designated RMD age,  regardless of whether you remain employed.
  • The RMD age is 73 for individuals who turn 72 after 2022. Individuals who turned 72 prior to 2023 are already subject to RMDs. In 2033, the RMD age will increase to 75.
SIMPLE IRA
  • RMDs must begin by April 1 of the year following the calendar year you reach your designated RMD age, regardless of whether you remain employed.
  • The RMD age is 73 for individuals who turn 72 after 2022. Individuals who turned 72 prior to 2023 are already subject to RMDs. In 2033, the RMD age will increase to 75.
Roth 401(k), Roth 403(b)
  • Yes, RMDs currently apply. However, this will soon change. Beginning in 2024, these two plans will be aligned with Roth rules and will not be subject to RMDs even if they were taken previously.

 

Rules for employer-sponsored retirement plan distributions

How are distributions taxed?
401(k), 403(b), Profit Sharing, Defined Benefit
  • Distributions of pre-tax contributions and earnings are taxed as income in the year distributed.
  • Distributions of after-tax contributions are not subject to income tax.
457(b)
  • Distributions are taxed as income in the year distributed.
Roth 401(k), Roth 403(b)
  • Distributions of contributions are tax-free.
  • Qualified distributions of earnings are tax-free.
  • Non-qualified distributions of earnings are reportable as income.
  • Contributions and earnings are distributed proportionately.

 

What is the penalty for early withdrawals?
401(k), 403(b), Profit Sharing, Defined Benefit
  • A 10% penalty may apply to the taxable portion if you are not yet age 59 ½ (exceptions apply) or if you have terminated from employment prior to the year you turned 55.1
457(b)
  • No penalty.
Roth 401(k), Roth 403(b)
  • A 10% penalty may apply to the taxable portion of non-qualified distributions if you are not yet age 59 ½ (exceptions apply) or if you have terminated from employment prior to the year you turned 55.

 

Is there a required minimum distribution (RMD)?
401(k), 403(b), Profit Sharing, Defined Benefit
  • If you are not a 5% or greater owner of the business, RMDs must begin by the later of April 1 of the calendar year following the year you reach your designated RMD age or the year you retire.
  • You must begin RMDs by April 1 of the year following the year you reach your designated RMD age if you are a 5% or greater owner of the business.
  • The RMD age is 73 for individuals who turn 72 after 2022. Individuals who turned 72 prior to 2023 are already subject to RMDs. In 2033, the RMD age will increase to 75.
457(b)
  • RMDs must begin by the later of April 1 of the calendar year following the year you reach your designated RMD age, or the year you retire.
  • The RMD age is 73 for individuals who turn 72 after 2022. Individuals who turned 72 prior to 2023 are already subject to RMDs. In 2033, the RMD age will increase to 75.
Roth 401(k), Roth 403(b)
  • Yes, required minimum distribution rules currently apply to these accounts, however this will soon change. Beginning in 2024, these two retirement plan distributions will be aligned with Roth rules and will not be subject to RMDs even if they were taken previously.
1For public safety workers in governmental plans, the 10% penalty is waived if separation from service occurs in the year they turned 50 or older.

 

Guided help with retirement plan distributions

Deciding how and when to take distributions from your retirement plans is an important decision for many retirees. An Ameriprise financial advisor can help you evaluate your options and decide on an approach that appropriately serves your particular needs.

 

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Different plans have a variety of features, benefits and tax advantages to help you save for your retirement.

Talk to your Ameriprise financial advisor about your retirement goals and milestones.

Or, request an appointment online to speak with an advisor.

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If you know someone who could benefit from a conversation, please refer me.

Background and qualification information is available at FINRA's BrokerCheck website.

Be sure you understand the potential benefits and risks of an IRA rollover or transfer before implementing. As with any decision that has tax implications, you should consult with your tax adviser prior to implementing an IRA rollover or transfer.

 

A Roth IRA is tax free as long as you leave the money in the account for at least 5 years and are 59 1/2 or older when you take distributions or meet another qualifying event, such as death, disability or purchase of a first home up to $10,000.

 

Ameriprise Financial, Inc., and its affiliates do not offer tax or legal advice. Consumers should consult with their tax advisor or attorney regarding their specific situation.

 

Investment products are not insured by the FDIC, NCUA or any federal agency, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.

 

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