The Worker, Retiree, and Employer Recovery Act of 2008 was passed by the Senate on December 12th, and signed into law by President Bush on December 23rd. This new law provides a temporary waiver of the Required Minimum Distribution (RMD) payment of your Individual Retirement Account (IRA) and other qualified retirement plans for the year 2009.
Under normal legislation, traditional IRA owners and many pension plan participants are required to begin taking distributions from their retirement accounts when reaching the age of 70 1/2, and every year thereafter. The first distribution must be withdrawn by April 1st of the year following the year the IRA owner turns 70 1/2. The minimum amount that must be taken is calculated by using the value of the retirement account as of December 31st of the previous year, divided by an age-based distribution factor. This factor decreases annually which normally increases the withdrawal year by year. The distribution is taxable at ordinary income tax rates. Congress, however, has chosen to give you a reprieve for 2009, mostly due to stock market losses felt in 2008.
In my experience, most affluent clients do not like being forced to take a distribution from an account that is not currently taxable and being forced to pay taxes on money they do not need. Many wealthy CEO's, family business owners, doctors, actors and athletes, to name a few, have taken advantage of saving as much of their annual income as possible on a tax-deferred basis using different retirement programs available to companies and self-employed individuals. These accounts have grown and compounded over the years to be worth millions of dollars. Then comes the time to pay the piper. The IRS set that time at age 70 1/2.
Prior to the new legislation, a taxpayer who turned 70 1/2 by December 31st of this year with an IRA worth $3 million at the end of last year, would be required to take an RMD of $109,498. This would generate a tax of more than $38,000 if in a 35% tax bracket. If that same taxpayer was 80 years old, they would be required to pay taxes on a withdrawal of $160,428, or approximately $56,000. Because of the new tax law, neither the 70 1/2 year old, nor the 80 year old, will be forced to take a withdrawal and can save a lot of taxes for 2009.
As with all IRS tax rules, you must be very careful of the pitfalls as they tend to be complicated and you have to read between the lines or pay very large penalties. This law change has no affect on RMD payments due for 2008. If you turned 70 1/2 in that year, you must still take a mandatory withdrawal by April 1st of 2009. If you chose to wait until April, 2009, to withdraw the money because you wanted to put it off as long as possible, you are still required to take it. (I usually recommend against waiting until April 1st after the year you turn 70 1/2 as you would have to take two distributions that year. This year you can avoid that drawback.) Do not believe that you can evade 2008's withdrawal because you waited or you will pay a penalty of 50% of the amount not withdrawn, or nearly $55,000, plus the income taxes of $38,000, in the case of the $3 million IRA.
There is another pitfall that could generate the 50% penalty: If you turn 70 1/2 in 2009, you do not have to take an RMD by April 1st of 2010. Therefore, your first RMD will begin in 2010, however, you lose the option of waiting until April 1st of the following year to take it. If you do not withdraw the money by December 31st, 2010, you will ignite the penalty.
This new ruling also applies to beneficiaries of an inherited IRA as well. This will allow younger generations who inherited large IRA's from parents or grandparents to lower their tax liability in 2009 and give the IRA's that lost money in recent market volatility a chance to make a quicker comeback.
If you have already taken the RMD payment for 2009, you are allowed to "put it back". This could be done as a rollover as long as it is put into another IRA, (or back into the same IRA if allowed by your IRA custodian), within 60 days of the withdrawal, without incurring a tax liability.
I highly recommend discussing the benefits of taking advantage of this temporary ruling with your financial consultant and/or tax advisor. As I always say, if the IRS is giving you a gift, take it!
Robin S. Davis is a Certified Financial Planner™, a member of the Financial Planning Association, and is the owner of Davis Wealth Enhancement Group, Inc., in Stuart, Florida. She has been advising retirees since 1984 and has held over 500 public seminars on financial issues. She is the author of the book Who's Sitting On Your Nest Egg? Why You Need a Financial Advisor and Ten Easy Tests for Finding the Best One. Davis expresses the importance of utilizing a competent financial advisor. For more information, please call (800) 896-5422 or (772) 463-4441, visit www.robindaviscfp.com, or email: firstname.lastname@example.org.