For every 401(k) participant, there comes a day of reckoning - the day he or she must begin making required minimum distributions and start paying taxes on the nest egg accumulated with the help of tax-deferred saving. In this article, we'll show you how working a little longer can help stave off high tax payments for retirement.

Normally, investors who have used a tax-deferred retirement savings vehicle such as a Traditional IRA, 401(k), 403(b) or 457 plan must begin taking these minimum distributions soon after reaching age 70.5. Each of these distributions is taxed as ordinary income, nibbling away at the retirement nest egg.

For those looking to continue the benefits of tax-deferred saving, there is a simple way to delay required minimum distributions from a retirement plan. Just keep working.

IRS regulations allow participants in a 401(k) and other workplace retirement plans to delay their minimum distributions well beyond 70.5 as long as they continue to work. (This option does not apply to traditional IRAs; for Roth IRAs there are no required minimum distributions.)

The Benefits of Working Longer
Of course, to many workers, the prospect of working into their 70s is not appealing. But for seniors who are in good health and enjoy their jobs, the benefits may be worth it.

Two distinct groups can benefit from such a plan. There are those who need to boost meager retirement savings, and then there are those who did a fine job saving for retirement and wish to preserve some assets for their heirs. (For further reading on your kids and retirement, see The Generation Gap and Boomerangs: Why Some Kids Never Leave The Nest.)

Under either scenario, working past age 70.5 will allow the employee to postpone required minimum distributions if they participate in an employee retirement savings plan. The types of plans that qualify for this treatment include 401(k), 403(b) and 457 plans, and tax-sheltered annuities. Even a part-time job that offers such a plan will postpone the day of tax reckoning for the given plan.

The Basics of Required Minimum Distributions
Under IRS regulations, the owners of Traditional IRAs and participants in employee retirement plans must begin making minimum withdrawals by April 1 of the year after they turn 70.5. For instance, somebody who turns 70.5 on May 30, 2009, would have until April 1, 2010, to receive the first required minimum distribution.

Then there would be additional minimum distributions required for each succeeding calendar year. In the first year, the taxpayer would be required to receive two minimum distributions if he or she waited until the first three months of the calendar year (January 1 to April 1) after turning 70.5.

In the scenario above, the first distribution would cover 2009; the second distribution would cover 2010.

The size of the required minimum distribution is governed by tables published by the IRS. Most taxpayers would use what is called the Uniform Lifetime Table, which provides a figure representing an anticipated distribution period. The account balance is divided by the distribution period figure to come up with the minimum amount that must be withdrawn by December 31 of the given year.

Uniform Lifetime Table
Age of Distribution Distribution Period
70 27.4
71 26.5
72 25.6
73 24.7
74 23.8
75 22.9
76 22.0
77 21.2
78 20.3
79 19.5
80 18.7
Source:  http://www.ira.com/faq/faq-54.htm
Figure 1

For instance, the distribution period for age 72 is 25.6. That means if a taxpayer's account balance is $500,000, the required minimum distribution is $19,531.

Note that the balance for a given year's distribution is the balance as of December 31 of the preceding year, while the age is as of the end of that calendar year. So for the 2010 distribution, the account balance is divided by the distribution period for the taxpayer's age as of December 31, 2010.

For a plan participant whose beneficiary is a spouse more than 10 years younger, there is a different table used to reflect the joint life expectancy of the couple. Generally, this table allows the participant and spouse to make smaller minimum withdrawals.

The penalty for failing to make the required minimum withdrawal is hefty. There is a 50% tax on the difference between the required amount and the amount actually received.

The Exceptions
The IRS allows taxpayers who continue working past age 70.5 to delay the start of required distributions until April 1 of the year after the year they retire.

Therefore, a 75-year-old who retires in 2010 would take his or her first distribution by April 1, 2011. The deadline for the second required distribution would be December 31, 2011.

There are several caveats to the postponed required minimum distribution. First, it is not available to a worker who is more than a 5% owner of the company. Second, some employers may require participants to begin taking distributions upon reaching age 70.5, even if they continue to work.

There is another important qualification that must be met to postpone required minimum distributions. The retirement plan in question must be one administered by the current employer. A 401(k) account from a past employer does not qualify for this treatment. Minimum withdrawals must be made from that plan.

Why might a worker want to work past age 70.5 and postpone the start of required minimum distributions? The power of tax-deferred compounding. The longer a sum of money can grow without taxes being subtracted, the larger the eventual balance. (For related reading, see Understanding The Time Value Of Money.)

Back to the Two Scenarios
As mentioned above, two groups in particular may want to consider this strategy.

First, there is the worker at or near retirement age who has not accumulated sufficient retirement savings. A few extra years in the workforce - even in a part-time job - can make a big difference.

Consider the case of a 70-year-old with just $100,000 set aside for retirement and no other income sources other than Social Security. Being sure the required minimum distribution is made is unlikely to be an issue for that taxpayer, but making those savings last for a lifetime will be.

If that 70-year-old works for four additional years and sets aside the current 401(k) maximum contribution of $22,000 ($16,500 regular maximum, plus a $5,500 50-and-over catch-up contribution), that $100,000 could grow to around $243,000, assuming an 8% annual return.

Then consider the case of a 70-year-old with $2 million set aside in a company retirement plan. Under the same savings scenario - $22,000 a year for four years, compounded at 8% annually - the $2 million could grow to $2.8 million. The added benefit to this taxpayer is that the nest egg's distribution period has been shortened by four years, meaning fewer tax payments and a larger balance left for heirs when the taxpayer dies. (For more information on building a nest egg, see Ten Tips For Achieving Financial Security andDetermining Your Post-Work Income.)

Conclusion
In any case, a plan participant must carefully consider beneficiary designations because there are tax implications upon death. Also, the worker should evaluate whether, upon retirement, the savings will be rolled over into an IRA or remain with the employer.

Under any scenario, of course, working into your 70s relies on good health and an enjoyable job, but for the young at heart, it might be just the right financial solution.