Hold on to your money! - Relief for your retirement plan
December, 2008
The beauty of investing in individual retirement plans is tax deferred growth. Unfortunately, the Internal Revenue Service knows how to bring most good things to an end. The government must collect their tax revenue at some point, and they do so by way of the required minimum distribution (the "RMD"). In the past, individuals sought ways to avoid the RMD in order to bypass taxable distributions. Now, however, the RMD is proving to be more than a mere annoyance for those seeking to escape taxation as individuals are forced to sell diminished investments and withdraw significant sums from their deteriorating retirement plans.
The RMD requirement compels individuals who reach the age of 70½ to withdraw funds from their individual retirement accounts or defined contribution plans, including 401(k) and 457 plans. These withdrawals are mandatory and result in ordinary income to the owner in the year received. A failure to take your RMD results in a 50% penalty tax on the difference between the RMD and the amount distributed.
The amount of the distribution is based on the owner's life expectancy and the fair market value of the owner's account balance as of the close of the business day on December 31st of the preceding year. In wake of the economic crisis, the RMD mandate has presented an increasing problem for many older individuals whose investments took a plunge in 2008 due to stock market turmoil. Since the RMD is calculated by valuing the account balance as of December 31st of the preceding year, the RMD for 2008 is based on the value of a taxpayer's retirement account as of December 2007. Since most retirement accounts were worth significantly more in 2007 than they are in 2008, many age 70½ will have to withdraw a higher percentage of their hard-earned savings than initially anticipated.
The "Worker, Retiree, and Employer Recovery Act of 2008" (the "Act"), recently passed by Congress and signed into law on December 23 by the President, implements a temporary waiver of the RMD rules for certain retirement plans. Unfortunately, the provision is only effective for calendar year 2009. Relief came too late and does not assist individuals for 2008 who must still take their RMD in 2008 or face a stiff 50% penalty tax from the Internal Revenue Service.
Nevertheless, the one-year moratorium on RMDs for tax year 2009 is a step in the right direction. This provision assists older individuals and beneficiaries of retirement accounts who would otherwise be forced to sell depleted assets held in their retirement accounts in order to make their RMD. Instead of being forced to sell investments, individuals have one year to wait for the market to rebound, and thus regain some of their lost investment. Many politicians are pushing for legislation that will further help by delaying the mandatory withdrawal of savings an extra year through 2010. This two-year window would allow extra time to recoup financial losses. In addition, the new rule helps well-off individuals escape taxation by reducing their overall taxable income for the year.
If you are interested in learning more about whether the Act applies to your retirement plan, or if you want advice on any aspect of the RMD requirement including how the required distribution impacts your wealth management plan, contact the Tax Group at Bullivant Houser Bailey PC for assistance.