Distribution Rules, Alternatives And Taxation - Taxation of Distributions

Taxation of Distributions Tax Management Techniques
As a general rule, it is best to allow the plan assets to grow tax-deferred as long as possible. However, IRS regulations require that for most retirement plans, eventually distributions in minimum amounts must begin, in most cases, after the plan participant reaches the age of 70.5. An exception to the RMD rules are Roth IRAs, Roth 401(k)s and other types of Roths.

A suggested order of withdrawal in order to take maximum advantage of tax deferral:

  1. Taxable Accounts – Long-term capital gains in a taxable account are taxed at the lower capital gains rate, as opposed to the higher ordinary income rates.
  2. Tax-Deferred Accounts with RMD requirements.
  3. Roth Accounts – Since no RMDs are required, the owner of a Roth account should allow these assets to grow tax deferred as long as possible.

Exception to RMD Rules – Participants in qualified plans, 403(b) and 457 plans may delay distributions if they continue working past the age of 70.5 for the plan sponsor. This exception does not apply to more than a 5% owner of a company. Also, individual plan rules may require participants to begin distributions after reaching the age of 70.5 even if they continue to work. The exception does not apply to traditional IRAs or to plans sponsored by past employers.

Net Unrealized Appreciation
This is the difference in value between the average cost basis of shares and the current market value of the shares held in a tax-deferred account. The net unrealized appreciation (NUA) is important if you are distributing highly appreciated company stock from your tax-deferred employee-sponsored retirement plan, such as a 401(k). Upon the distribution, the NUA is not subject to ordinary income tax. For this reason, it may be better to transfer the company stock to a regular brokerage account instead of rolling the stock over to a tax-deferred IRA: that is, if rolled over to an IRA, the company stock's NUA would eventually be taxed at your ordinary income tax rate (when you take the distribution of the stocks).

However, the other assets in the 401(k) - such as mutual funds - do not receive the NUA tax break. So, plan participants would still likely want to roll these plan assets into an IRA and continue deferring taxes on past and future growth. Also, when an individual takes advantage of the NUA tax break for your company stock (by not rolling it over into an IRA), they will not have to worry about taking RMDs on those assets since they are not part of an IRA.

Related Articles
  1. Stock Analysis

    The Biggest Risks of Investing in Netflix Stock

    Examine the current state of Netflix Inc., and learn about three of the major fundamental risks that the company is currently facing.
  2. Mutual Funds & ETFs

    3 Fixed Income ETFs in the Mining Sector

    Learn about the top three metals and mining exchange-traded funds (ETFs), and explore analyses of their characteristics and how investors can benefit from these ETFs.
  3. Professionals

    Career Advice: Financial Planner Vs. Wealth Manager

    Understand the differences between a career in financial planning and wealth management, and identify which is better for you based on your goals and talents.
  4. Mutual Funds & ETFs

    Top 3 Muni California Mutual Funds

    Discover analyses of the top three California municipal bond mutual funds, and learn about their characteristics, historical performance and suitability.
  5. Mutual Funds & ETFs

    Mutual Funds Are Not FDIC Insured: Here Is Why

    Find out why mutual funds are not insured by the FDIC, including why the FDIC was created and how to minimize your risk with educated mutual fund investments.
  6. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  7. Personal Finance

    How To Choose A Financial Advisor

    Many advisors display similar skillsets that can make distinguishing between them difficult. The following guidelines can help you better understand their qualifications and services.
  8. Professionals

    The Best Schools for Financial Planning

    Among the best universities for financial planning are the University of Georgia, Boston University, The College of Financial Planning, Texas Tech, San Diego State, Baylor, Fairleigh Dickinson ...
  9. Investing Basics

    Hiring a Financial Advisor? Look for the CFP Label

    Don’t skimp on the CFP designation. Here's why those three letters show that someone is qualified in financial and investment planning.
  10. Mutual Funds & ETFs

    Top 4 Investment Grade Corporate Bonds ETFs

    Discover detailed analysis and information about some of the top exchange-traded funds (ETFs) that offer exposure to the investment-grade corporate bond market.
  1. Equity Risk Premium

    The excess return that investing in the stock market provides ...
  2. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  3. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  4. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  5. Gross Exposure

    The absolute level of a fund's investments.
  6. Priori Loss Estimates

    A technique used by insurance companies to calculate loss reserves.
  1. Why have mutual funds become so popular?

    Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
  2. Can your car insurance company check your driving record?

    While your auto insurance company cannot pull your full motor vehicle report, or MVR, it does pull a record summary that ... Read Full Answer >>
  3. Do financial advisors work only in banks?

    While the majority of financial advisors work for financial institutions such as banks, a large proportion of them are self-employed ... Read Full Answer >>
  4. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
  5. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  6. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
Hot Definitions
  1. Purchasing Power

    The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
  2. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  3. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  4. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  5. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  6. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!