AUSWR
The Association of U S West Retirees
 

 

 

Some Breathing Room for IRA's
New Law Suspends Withdrawals in 2009. Here's How the Rules Will Work
By Anne Tergesen
The Wall Street Journal
Friday, December 26, 2008

Retirees who ignore the annual distributions they are required to take from their individual retirement accounts usually run a big risk -- in the form of a 50% excise tax on the amount they should have withdrawn.  But not next year.

On Tuesday (12-23-08), President Bush signed legislation that suspends the rule requiring older Americans to take withdrawals from tax-deferred retirement accounts, such as traditional IRAs and 401(k)s.

But there are hitches.  The suspension lasts for just one year, 2009.  And while intended to give beaten-down retirement accounts time to rebound, the new law may also present confusion, particularly for those just starting to take required withdrawals.

"The [existing] rules are confusing enough," says Ed Slott, an IRA consultant in Rockville Centre, N.Y. "Now, more people than ever are going to get tripped up."

Here are answers to questions about how the new law will affect taxpayers in 2009 and beyond.

Q:  How do the existing rules governing IRA withdrawals work?

A:  Those who contribute to tax-deferred retirement accounts, such as traditional IRAs and 401(k)s, don't pay income tax on the money they put into these plans.  But eventually, Uncle Sam requires them to take the money out, and pay income taxes in the process.  "The government gives you a tax break when you make your contributions.  When you retire and are presumably in a lower tax bracket, it wants the tax revenue it deferred," Mr. Slott says.

Normally, IRA owners must begin withdrawing money from these accounts by April 1 of the year after they turn 70.  That means that someone who turned 70 in 2008, for example, has until April 1, 2009, to take his or her first required distribution.  To calculate how much to withdraw, look at your account balance as of the previous Dec. 31, and then divide that figure by your remaining life expectancy.  (Life-expectancy data can be found in actuarial tables in IRS Publication 590.)

You can always withdraw more.  But if you take less, you will be subject to the 50% penalty.  These requirements also apply to 401(k)s and some other employer-sponsored plans, but not to defined-benefit pension plans or Roth IRAs.  (If you are still working, you aren't required to take distributions from your current employer's retirement plan.)

Q:  What impact will the new law have?

A:  The new law suspends required distributions in 2009.  This gives those who can afford to leave their nest eggs alone a better chance of recovering some of the losses they sustained this year.  Why?  "They'll have more dollars working for them in the event of a stock market rebound," says Elizabeth Drigotas, a principal at Deloitte Tax.

Unless Congress decides to extend the moratorium on mandatory distributions, those over age 70 -- along with those who have inherited IRAs or 401(k)s -- will be forced to resume taking withdrawals in 2010.

Q:  Do I have to take a withdrawal from my IRA in 2008?

A:  Yes. The new law has no impact on 2008.  So, if you are required under existing rules to withdraw funds in 2008, you still must do so.  Again, your withdrawal will be based on your account balance as of Dec. 31, 2007, and you will typically pay income taxes on the entire sum.

Some were betting the Treasury Department would act before year end to change the distribution rules for 2008, or maybe even extend some form of tax relief to those who have already taken distributions this year.

But recently, Kevin I. Fromer, assistant secretary for legislative affairs, wrote in a letter to Congress that "the Treasury Department and the Internal Revenue Service have determined that any further change to the required minimum distribution rules should not be undertaken."

He added:  "All individuals who are subject to required minimum distributions for 2008 should take their distribution under the existing rules."

Q:  If I turned 70 this year and had planned to take my first withdrawal by the April 1, 2009 deadline, does the new law permit me to skip it?

A:  No. The law suspends distributions only for 2009.  Although first-timers are allowed to delay 2008's distribution until April 1, 2009, the withdrawal still counts toward your obligation for 2008, Mr. Slott says.  So, if you turned 70 in 2008 and decided to wait until April 1, 2009, to make your first withdrawal, that deadline still applies.  To calculate this distribution, you would use your account balance as of Dec. 31, 2007.

Q:  What if I turn 70 in 2009?

A: This gets a bit more complicated.  In effect, you will have until Dec. 31, 2010, to take your first withdrawal -- even though the IRS will consider that withdrawal to be your second distribution.  Here's how it works:

Normally, people who reach age 70 in 2009, and who wait until April 2010 to take their first withdrawal, would have to take two distributions in 2010: one for 2009 (their first distribution) and one for 2010 (their second distribution).  That second distribution would have to be taken by Dec. 31, 2010.

The new law suspends distributions for 2009.  Thus, first-timers -- anyone who turns 70 in 2009 -- won't be required to make a 2009 withdrawal, which normally could take place until April 1, 2010.  But you will need to make the 2010 withdrawal, and Uncle Sam will consider that officially your "second" distribution, even though in reality it will be your first withdrawal.  Therefore you'll have to take it by Dec. 31, 2010.  (Put another way: individuals who turn 70 in 2009 would not be able to wait until April 1, 2011, to take their first withdrawal.)

Q:  Can I still donate money from my IRA to charity without paying income taxes first?

A:  Yes.  In the bailout package Congress enacted in October, lawmakers resurrected a tax break available to those who make donations from their IRAs to charity in 2008 and 2009.  Under the law, individuals age 70 or older can donate as much as $100,000 from an IRA to a public charity.  No taxes are due on the withdrawal, and the donation counts toward a person's required annual withdrawal. Next year, of course -- with mandatory distributions suspended -- the tactic loses a bit of its luster.  But those who wish to make a direct donation from an IRA can still do so income-tax free, says Mr. Slott.

Q:  Can I convert some or all of my IRA to a Roth IRA in 2009?

A:  Yes, provided your adjusted gross income is $100,000 or less, you'll be eligible to make such a move.  Typically, those taking mandatory distributions from a traditional IRA aren't allowed to turn around and deposit that money into a Roth IRA, Mr. Slott says.  But in 2009, any withdrawals can be used to fund a Roth, he says.

Mr. Slott believes now is a good time to convert a regular IRA to a Roth.  Not only are tax rates relatively low, but asset values are beaten down.  As a result, although you'll have to pay income taxes on any money you withdraw from your traditional IRA, you are likely to owe less than you would at any other time, he maintains.

Why bother?  Once you convert your account to a Roth and hold it for at least five years, future withdrawals are tax-free.  Moreover, you won't ever have to take a required distribution again.  Plus, there is little risk of failure:  If your account's value declines after you convert it to a Roth, you can "recharacterize" the transaction -- by turning the account back into a regular IRA.  As long as you do this by Oct. 15 of the year following the conversion, this will nullify the tax bill.

Q:  If I inherited an IRA and am taking money out under a five-year deadline, what should I do in 2009?

A: You can skip your withdrawal in 2009.  Effectively, this will stretch your five-year deadline out by another year, says Ms. Drigotas of Deloitte.

Write to Anne Tergesen at anne.tergesen@wsj.com

http://online.wsj.com/article/SB123033785000236433.html