What's the difference between a contractor and an employee?

Dear Liz,

You said in a previous column that you don’t have to take withdrawals from your 401(k) at 70 1/2 years of age “if you continue to work.” My question is: What constitutes “continuing to work?”

I currently receive a pension and draw Social Security, but I still work part time for my previous employer. Under this scenario, if I continue to work part time beyond 70 1/2, can I still defer my 401(k) and IRA withdrawals, or does the “continuing to work” exception apply only to full-time employment?

— Earl

Dear Earl,

The IRS doesn’t specify the number of hours you have to work to put off mandatory withdrawals from your 401(k), as long as you are a current employee of the company that sponsors the plan and you don’t own 5 percent or more of the company.

“Employee” is an important word here. If the company rehired you as an independent contractor, the IRS could question whether you’re eligible for the deferral.

“If the part-time work has evolved into an independent contractor relationship where your reader is receiving a 1099 rather than a W-2, I think that could be a problem for deferring RMDs from the 401(k) plan,” says tax expert Mark Luscombe, principal analyst for Wolters Kluwer CCH.

The penalty for being wrong, or late, is severe. You have to pay 50 percent of the amount you should have withdrawn but didn’t.

The exception for required minimum distributions applies only to your current 401(k) plan. You have to start withdrawals from your IRA and any previous employer plans after you turn 70 1/2.

The benefit to delaying withdrawals is that your account can continue to grow tax-deferred. When you do start withdrawals, though, they’re likely to be larger (because RMDs are based on life expectancy, and you’ll be older). Larger withdrawals mean a larger tax bill.

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