67 Year Old Advised by Accountant to Not Enroll in 401k – Should He Find a New Accountant?

I was working with an older gentleman who was going to be turning 68 later this year, and begin working next month, so he came to me with questions about enrolling in the 401k plan. He was curious as to what the contribution limits were, investment choices, and so on. So, I explained how the plan works, and that he can contribute up to $20,500 this year since he is over 50(the 401k limit 2013 is higher now), that there was a 5% employer match on contributions with a 3 year vesting period.

He seemed quite interested, and he said he would certainly contribute the maximum for the next few years, and planned on working more than 3 years so he would also vest the matching funds. But, before he could commit to anything, he wanted to check with his accountant, which is perfectly normal.

The Accountant Says No

He called back and said his accountant said he should not enroll because he is only a few years away from turning 71 1/2 and being required to take required minimum distributions. Wait a second, let’s back the truck up. This is the first red flag. For one, active employees can delay their RMD from their current employer’s qualified plan. So, as long as he was still working, he would not have to take an RMD from the 401k.

Using the RMD as a basis for this decision, the accountant also said it would create an unnecessary tax burden. Well, that could be true if you took a lump sum distribution, but an RMD for each year would be just a small amount based on life expectancy. This relatively small distribution would result in a small tax burden. But again, it is a moot point since he wouldn’t have to take the RMD until finally retiring for good.

What He Could Have Gained by Enrolling

From what I knew of his situation, he planned on maxing out the plan this year and for the next 4 or 5 years while still working. He is also at the highest tax rate. So, assuming contribution limits remained the same for the next five years, he would have contributed $102,500 on a pre-tax basis over the next five years. That would mean saving nearly $36,000 in taxes over the same period.

And just to factor in a few years of modest returns on the investment, let’s assume he kept the money in something conservative that made 4% annual returns over the same period. That would bring his account value to around $115,500 after five years. That is another $13,000 in interest/gains. And let’s not forget the company match, which would easily be a few thousand each year, probably giving him somewhere around $10,000 in free match money.

When you combine the tax savings and returns on the money, he is essentially missing out on nearly $60,000. While this may not seem like much to someone who is making $400k a year, it is still throwing money away for no reason.

Even if the RMD Applied

Assuming the RMD did apply to the situation, he would still have 3 years of contributions to make before needing the RMD. So, in those 3 years he would have still saved over $20,000 in taxes during those years. Then when the RMD kicked in, the first RMD based on this account value alone, would only be a little over $3,000 the first year. Taxed at the 35% rate, that is about $1,000 in taxes. So, his accountant basically told him that it is better to give up tens of thousands just to save a couple thousand in taxes that the RMD (which really doesn’t even apply) would cause.

Would You Find a New Accountant?

I have informed the person about the issue with the RMD, and I’m not sure if he will take that back to his accountant or not and change his mind. Even without the RMD issue, it still seems like with just three years of maximium contributions, he could have still delayed a large tax burden into the future when it is likely he would possibly be in a lower tax bracket (although depending on how the election turns out, who knows). Based on all of this, would you find a new accountant?

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.

13 comments
Nancy
Nancy

I would get them on a conference call together or meet with both and hash it out.

William E. Wheeler, CPA/PFS
William E. Wheeler, CPA/PFS

Being a CPA and a financial planner, I would say the man needs a new accountant. I am a huge fan of the 401(k) and I always recommend it to my clients. Especially if the employer is making a matching contribution, no matter how much. What a great way to save for retirement and save on the current year's income taxes.

Jeremy
Jeremy

Jhonny, you certainly could. After age 59.5, you're free to take your 401k money or other retirement assets and do with them as you please. But, paying off a mortgage may may or may not be the best use of that money. There are a lot of other things to consider such as the interest rate of the mortgage, how many years you have left on it, what your retirement account balances are, etc.

But to answer your question, there is nothing stopping you from applying those funds to pay off your mortgage.

Jhonny
Jhonny

Great comment.I have a question, I'm 67 years old and I planning to retire February 2009, and I have $48K mortgage loan.Can't I take this money and pay off this morgage?.

Regards

Jhonny Urrego

LMJ
LMJ

Sorry, clarification, I meant 401(k), not IRA. Currently jobless, and apparently nocturnal, I just got up.

LMJ
LMJ

Just one question: How does one earn money in an IRA? Might that be from a series of investments, often in money market funds or stock, things that are currently decreasing in value? I know my personal 401(k) has lost 10% since September. At that age, I wouldn't even be considering a 401(k), I'd be looking at more stable and secure investments. **MBA-Accounting student**

Mrs. Micah
Mrs. Micah

Well, I would look at the situation and figure out what I wanted. You make a convincing case for the 401(k). I'd probably find a new accountant, simply because he hadn't explained to me the possibility of deferring the RMD as long as I was employed. Especially if there was an employer match.

Jeremy
Jeremy

In terms of whether or not it is possible, yes, you could find a way to make this work. As long as you haven't begun taking the RMD from the IRA, and your new employer plan accepts rollovers from an IRA (usually they will only accept from a rollover or conduit IRA, not a contributory IRA), then you could effectively work just enough to qualify for the plan and prolong your RMDs.

But like you said, there are a lot of other considerations that go into a plan like this, and it isn't all that common, but it can be done.

Steve Austin
Steve Austin

I didn't know about the exception rule regarding 401(k) plan RMDs while still working. It makes me wonder about a workaround: IFF one is somehow in the position of not wanting to incur RMDs (at age *70.5*, isn't is, Jeremy?), could one join a company that has a plan that allows rollovers of other 401(k)s into it, couldn't that person just pull back to part time or less, be effectively retired and over age 70.5, and still not have to make the RMD if s/he did not want to?

An example where this might be useful is a 50 year old who retires with a $500,000 401(k) account balance, who rolls it over to a self-directed brokerage Rollover IRA. 15 years later, the retiree has done exceptionally well with the self-directed investments and has $2.5M in the Rollover IRA (and has been living off of a taxable accounts, Roth IRAs). The individual may start to receive SSA income soon and does not need/want the large RMDs from the Rollover IRA. Is a solution to go back to work full-time just long enough to get enrolled in a 401(k) plan that allows rollover *into* it? Then pull-back to part time or less and only take distributions needed to live, not the full RMDs? I realize there are SSA-related complications to the tax calculus to working and drawing SSA retirement, so my question is purely "is it possible", not "does it work for all cases"?

Chad @ Sentient Money
Chad @ Sentient Money

As an accountant, any personal accountant should know TAX LAW! If they don't, what are you paying them for?

Jeremy
Jeremy

That is a good point. It is hard to make too many assumptions based on the limited info. I only know what this employee told me, and I have no way of knowing what he actually told his accountant. So it could be a legitimate issue.

Of course, his accountant should be aware of how much money his client makes, and could have assumed he was going to max it out rather than saving 50 bucks per paycheck.

Jen
Jen

My mother is a CPA. An accountant should definitely know about tax law changes! From what's printed here, I'd say the accountant was a off in his or her advice. However, there could definitely be more to this person's finances that we don't know about. Further, the employee may not have told his accountant about his plan to max out his contributions, lowering his current taxable income.

However, it is true that a CPA and a financial planner may see the world a little differently, so it is a good idea to perhaps talk strategy with a financial planner. Ideally, it would be nice to have both in the room, because the CPA should be able to think of how certain moves may affect someone's taxes. For example, the planner may advise you to sell out of a particular fund and buy into a better, more diversified fund. The CPA may then point out that if you did so, you'd be paying through the nose in capital gains, so maybe it might be a better idea to gradually sell out of the first fund and buy into the second fund. On the flip side, the planner may say you'll be able to take a very nice loss on the first fund, whereas the CPA may point out that you cannot take the full loss in one year, but will have to spread out the loss across several years. (Not sure if that's still true, but I know it could happen in certain cases as of a few years ago.)

Diana
Diana

Maybe not - I think of accountant as a person that knows how to crunch numbers from what he/she is given, but may not be aware of all tax law changes/best strategy for retirement planning. That's why it is a good idea to work with a financial planner who has this part of knowledge.