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.

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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.

What are the rules for retirement plan distributions? When can I take distributions?

To take distributions from most 401(k), 403(b), 457(b) and profit- sharing plans, you generally must wait until you leave your job (separate from service) after age 55 or until you reach age 59 ½. You do not need a triggering event to take money from an IRA.

What is the penalty for early withdrawals?  

A 10% IRS penalty may apply to taking early distributions from most retirement plans. Note: 457(b) plans don't carry this penalty.

Retirement plan

 Early withdrawal penalties

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 IRA
  • 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).

401(k), 403(b), Profit Sharing
  • 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.

Designated Roth accounts
  • A 10% penalty may apply to the taxable portion of non-qualified distributions and conversion assets less than 5 years old 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
  • Designated Roth accounts in 457(b) plans are not subject to penalty.
1 For certain public safety workers in governmental plans, corrections officers and private sector firefighters, the penalty is waived if separation occurs in the year you turn 50 or older or if you have 25 years of service or more in the plan. 457(b) plans are not subject to the 10% penalty.

When do required minimum distribution (RMD) rules apply? 

IRA 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. If you have an employer plan and are not a 5% or greater owner, you may be able to delay RMDs until you retire.

The current RMD age is 73. In 2033, the RMD age is set to increase to 75 for individuals born in 1960 or later. 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 an excise tax penalty that may apply if you skip them or take less than the required amount.

Retirement account

RMD rules

IRA/SEP IRA/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 current RMD age is 73. In 2033, the RMD age is set to increase to 75 for individuals born in 1960 or later.

Roth IRA
  • Roth IRA owners are not subject to RMDs.

401(k), 403(b), Profit Sharing
  • If you are not a 5% or greater owner of the business and your plan permits, RMDs can be delayed until 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 current RMD age is 73. In 2033, the RMD age is set to increase to 75 for individuals born in 1960 or later.

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 current RMD age is 73. In 2033, the RMD age is set to increase to 75 for individuals born in 1960 or later.

Designated Roth accounts
  • Amounts designated as Roth inside a 401(k) plan account are not subject to RMDs.

 

How are retirement plan distributions taxed?

Distributions are generally taxable as income. However, you can take tax-free distributions from a Roth account if you've participated in the plan for at least five years and reached age 59 ½.

Retirement plan

Taxation of distributions

IRA/SEP IRA/SIMPLE 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 must be reported by the taxpayer proportionally.

Roth IRA
  • 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.

401(k), 403(b), Profit Sharing,457(b)
  • 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.

Designated Roth accounts
  • 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.

Guided help with retirement distribution planning

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.

RELATED INFORMATION

Prepare to collect your pension

Understanding retirement accounts

IRAs and retirement plans: Understand your options

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.

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This information is being provided only as a general source of information and is not a solicitation to buy or sell any securities, accounts or strategies mentioned.  The information is not intended to be used as the primary basis for investment decisions, nor should it be construed as a recommendation or advice designed to meet the particular needs of an individual investor. Please consult with your financial advisor regarding your specific financial situation.
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.
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