A 401K Head-Scratcher For The Tax Gurus

Bozo | Dec 27, 2017 | 1,375 posts since 2011

Background: Most folks are familiar with RMDs. RMDs are required from IRAs, but not from 401Ks, so long as the 401K participant is still "employed" by the employer providing the 401K. OK, that's easy. Here's the head-scratcher.

Hypothetical: Jane is employed by XYZ company and has a 401K plan. Her vested balance is bigger than a bread-box, she's turned 70 1/2 this year, and she really doesn't want to start taking RMDs from her 401K anytime soon. Her tax advisor (and the HR folks) advise her she need not take RMDs from her 401K until the year she retires. Jane wants to throttle back, but not retire. XYZ is more than wiling to let Jane go seriously "part-time", say to 10 hours/week, and still consider her a part-time employee, and participate in the 401K.

The head-scratcher: Will the IRS still consider Jane an "employee" for purposes of the 401K and not be required to start RMDs? Clearly, were Jane to retire, her RMDs on the 401K would kick in immediately. But if Jane only "semi-retires" and is still an employee, can she continue to defer RMD withdrawals indefinitely? Everything I've read points to "yes". Stated another way, part-time employees are still "employees", and there appears to be no minimum hourly threshold.

Conundrum: Clearly, the IRS wants to get its deferred tax from IRAs and 401Ks. If 401K participants can stretch out the process by staying "employed" (even as part-timers), does not this strike one as odd?

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Answers

gbtexas | Dec 27, 2017 | 78 posts since 2013

Now this is an excellent question. And I do mean excellent. Before elaborating on it, let's look at the basic requirements for the exception to apply. First, Jane must be employed throughout the entire year and then she must participate in a plan that allows her to delay RMDs. Let's assume that she meets both requirements. Now, to my knowledge, nowhere in the 401k regs, is there anything mentioned whereby retirement is defined.

The question then is where should someone measure the number of hours worked needed to continue to meet the minimum level so Jane can avoid retirement? Is 10 hours a week sufficient? What about 5 hours a week? As far as I know, there's no guidance by the IRS on this matter. Again, as far as I'm aware. Consequently, if Jane meets the two requirements, she still unretired for RMD purposes.

So, does Jane's company plan enable her to continue participation in the 401k program? I don't know the answer, but 10 hours a week, or 25% of full time employment, may not be enough. If this is the case, she's retired for RMD purposes. The critical question then becomes whether the plan allows her to continue participating.

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Bozo | Dec 28, 2017 | 1,375 posts since 2011

Gbtexas, yes, the key is employer acquiescence, I suspect. If the employer is willing to keep you classified as an "employee" and allows continued participation in the 401K, the IRS really has no practical way to track hours worked, even assuming hours worked might be relevant. Last I checked, the W-2 one receives at EOY just reflects income, withholding, and perquisites (401K contribs, medical, dental, parking, etc.). In answer to your query, might five hours/week qualify? If the employer agrees, why not?

I think we both might agree this could lead to abuses. But, hey, last I checked, neither you nor I wrote the Regs.

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gbtexas | Dec 28, 2017 | 78 posts since 2013

One thing's pretty clear, Bozo, is that should they find abusiveness to be pretty prevalent, they'll eventually issue regs on this. As you're aware, special types of audits are designated at various times by the IRS. If and when they do one on this issue, it'll only be then that they're able to assess whether regs should be issued. My guess is it's not worth the time, effort or $ for them to undertake one right now. But, as more boomers retire and then become part time employees, this could eventually get on their radar.

In the meantime, our good friends have their hands full dealing with the new tax bill, especially the part relating to C corps. In view of their limited resourses, I'd suspect the general audit rate, already incredibly low, will get even lower, as should quality of service (already pitiful).

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