Should You Delay Your 401(k) Payout?

If you keep working, you can keep stashing your cash.

Dec. 30, 2008 — -- As one of the worst years in the nation's financial history nears an end, many Americans are trying to figure out ways to cope.

Those facing the most urgent issues are individuals at or near retirement age. Many have questions. Here are two:

Question: I've been trying to find out at what age do you have to cash in your 401(k)? I'm hearing age 70 ½, but I cannot find this answer anywhere. I'm still working at age 69 (age 70 in March 2009) and I am still contributing to a 401(k) through my employer. I plan on working as long as I can because I do not have enough money in my 401(k) to retire yet (especially after taking a big loss recently).

--J.M., Sierra Vista, Ariz.

Answer: You may be able to delay taking required distributions if you continue to work into your 70s as planned, but there some things you need to know first.

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In most cases, IRS regulations require retirement savers to begin drawing from their 401(k) accounts, traditional IRAs and other retirement savings plans after reaching age 70, though Roth IRAs are excluded from this requirement.

The reason for the required distributions after age 70 is that after years of extending tax breaks on your retirement savings, Uncle Sam finally wants his share. Otherwise, the wealthy could use traditional IRAs, 401(k) or other retirement savings plans as permanent tax shelters, forever avoiding taxation on income earned over a lifetime.

After age 70 ½, retirement account owners must at least withdraw a minimum amount annually based on an IRS formula. Those withdrawals are then subject to taxation.

The deadline for the first required distribution is April 1 of the calendar year after the year in which you turn 70 ½. For instance, if you turned 70 ½ on June 1, 2008, the deadline for your first required distribution is April 1, 2009.

Fail to take the required distribution by the right date, and the IRS will impose a hefty 50 percent penalty on the amount that was supposed to be withdrawn.

The exception that may apply in your case allows taxpayers who continue to work past age 70 ½ and contribute to their employer's 401(k) plans to hold off on required minimum distributions from the plan, provided the plan allows it. That means if you're still working at 72, 73 or even 74, there may be no mandatory withdrawal.

There are several things to keep in mind before you assume you're free and clear from the minimum distribution requirements.

First, check with your employer or its 401(k) provider to see if your plan allows participants to delay minimum distributions. Individual plans can require participants to begin taking withdrawals after age 70 even if they remain employed with the company.

Second, if you own 5 percent or more of the company that sponsors the 401(k) plan, then no delay is allowed. In such a case, the owner must begin to make withdrawals by the regular deadline.

If you find you are eligible to delay your distributions, then the deadline for your first required minimum withdrawal will be April 1 of the year after you retire from the employer that maintains the 401(k) plan.

One other thing to keep in mind is that this exception from the age 70 distribution rule applies only to a retirement plan sponsored by an employer you currently work for. If you hold money in a traditional IRA or a retirement savings plan maintained by a former employer, then the minimum required distribution rules apply to those accounts.

Provided you meet the above conditions, continuing to work into your 70s and contribute to a 401(k) or other employer-sponsored retirement savings plan will go a long way toward making up for the past year's investment losses.

One strategy you and others might consider would be to work part time in a job that offers a 401(k) and allows delayed withdrawals for those over 70. This way you continue to enjoy the advantages of tax-deferred investing, but you work at a schedule that's to your liking.

It's not a realistic strategy for everyone, but if it works for you, it can provide a terrific financial advantage.

For more information, check out the Tax on Excess Accumulation section of IRS Publication 575: "Pension and Annuity Income."

Question: I rolled over my 401(k) when I left the work force eight years ago, into a 10-year, fixed annuity. When I turn 65, I will be able to start drawing on that annuity. Can an annuity be cashed out at that time or is it better to draw on it? Knowing what is happening now, I think I made a good choice.

--S.C., Paris, Tenn.

Answer: You may be able to cash out the entire balance upon reaching age 65, depending on how the annuity contract is written. However, that's not something I would recommend generally. The reason is that you would then be taxed on the full amount, assuming you funded the annuity entirely with 401(k) funds.

If the annuity balance is a substantial sum, then withdrawing it all at once could push you into a higher tax bracket, forcing you to pay more taxes than necessary.

Unless you need the entire amount right away, it would be better to draw from the annuity over time so as to limit the tax hit.

For more information on taxation of annuities, you also should check out IRS Publication 575.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

David McPherson is founder and principal of Four Ponds Financial Planning in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at