Rolling Over Required Minimum Distributions? Sounds Crazy, But There’s Always an Exception

One of the most important things you learn in law school is how the law is structured. You are better able to analyze the rule (and predict outcomes) when you understand how it is was created and how is has been treated ever since. Every law starts with a broad concept. After that exceptions are created through regulations, agency rulings, case law, and even statutory amendments. I like to think of it as a funnel, with the broad concept at the top.

The “still working” exception wasn’t always a part of the Tax Code. It was added by the Small Business Job Protection Act of 1996 (“SBJPA”). Before that, RMDs always began at age 70 ½. The law became effective on January 1, 1997 and while beneficial to taxpayers, it created several problems for plans sponsors. Do we have to adopt this change? If we want this change, what do we do about RMDs issued in 1996 or 1997? And lastly, how should these RMDs be treated?

To answer these questions, the IRS issued Notice 1997-75. You can read the Notice here https://www.irs.gov/pub/irs-drop/not97-75.pdf. When it comes to the “still working” exception, the IRS explained that plans can keep the pre-SBJPA rules, meaning RMDs begin at age 70 ½ regardless of working status. However, even if a plan decides to do this, the IRS explained that the distribution isn’t required under the Tax Code. That means the 50% excise tax cannot apply until the employee retires. It also means the amount is eligible for rollover! In fact, the IRS says that “such a distribution is an eligible rollover distribution unless it is excepted for some other reason.” As a result, a taxpayer that is still working for an employer with a retirement plan that has not adopted the “still working” exception can rollover those RMDs up until retirement.

While most plans apply the “still working” exception, this is an important piece of information for people in plans that have not adopted the rule. Instead of taking those distributions into income, you can roll those assets over to an IRA and delay RMDs on that amount for at least one year. The reason you can only delay RMDs for one year is because the “still working” exception only applies to company plans, not IRAs.

So, for example, Jeff is 71 years old in 2018 and is working for a company that sponsors a retirement plan that has not adopted the “still working” exception. His plan issues Jeff his 2018 RMD before December 31, 2018. Understanding the IRS guidance in Notice 1997-75, Jeff rolls that distribution over to his traditional IRA. He still receives a 2018 RMD from that traditional IRA in 2018, since the still working exception doesn’t apply. However, that RMD is based on his IRA account balance on December 31, 2017, which didn’t include the 2018 contribution from the employer plan. However, when Jeff takes an RMD from his traditional IRA in 2019, the rolled over RMD will be taken into account because it will be part of the December 31, 2018 IRA balance.

While Jeff would ultimately be better off if his plan adopts the “still working” exception, he benefits from understanding this exception to the exception by rolling over that distribution. Sure, the employer plan RMD is included in the traditional IRA RMD for the following year. However, the amount he takes into income (and pays taxes on) is much less.