Retirement Account Rules Tweaked for 2009

Just before the holidays, President Bush signed a bill that eliminated the hefty penalty for not taking the required minimum distributions (RMDs) from certain tax-deferred retirement accounts such as traditional IRAs and 401(k) plans for the year 2009.

Under the traditional rules, you must begin RMDs for traditional IRAs and 401(k) plans by April 1 of the year after you reach age 70-1/2. In other words, the April 1 that follows your 70-1/2 birthday is the first day that you must take a RMD. The amount of the RMD is calculated by your life expectancy – you can figure it out yourself using the tables from the IRS but it’s usually much easier to have your financial advisor do it (they have fancy software). This amount is recalculated each year since your life expectancy changes each year. You can always take out more than the RMD but you can’t take out less without being subject to a fairly significant penalty.

In 2009, however, you catch a break. You won’t be subject to the penalty if you choose (for whatever reason) to leave your money in your retirement account and not take the RMD. Note that this is NOT applicable to 2008, 2010, or any other year – just 2009. Congress likes to do quirky things like that.

Of course, there are some complications. If you were required to make your first RMD in 2008 and chose to push it off until the April 1, 2009 deadline for newbies, you must still take your RMD. You wouldn’t be exempt under the new rules since it’s technically a 2008 obligation.

If you turn 70-1/2 in 2009, you won’t be required to make your first RMD in 2009. You will, however, have to make a 2010 withdrawal by the end of 2010 (assuming that the rules don’t change). It’s odd, but under the new rules, the 2010 withdrawal will be considered your “second” distribution by the IRS even though it’s really your first. So you don’t get to take advantage of the “extension” through April 1, 2011 – you have to take it by the end of 2010. I know. It’s weird. But there you go.

Similarly, if you inherit an IRA and you are required to take a RMD in 2009 under the 5 year rule, you can skip 2009 – if you want to.

Remember, these rules don’t mean that you can’t take out your RMD, just that you don’t have to – and it only applies to 2009.

And one more thing: I don’t want to play financial advisor – because I’m not. But I do know a thing or two about taxes. And with changes in the rules, there are investment folks who, having taking a beating in the market over the last year, may see this as an opportunity to sell you a Roth IRA.

I think Roth IRAs can be wonderful investment vehicles under the right circumstances. Shifting tax brackets – paying lower taxes now on the Roth to avoid higher taxes later – can work to your advantage. But, in the case of many (though admittedly not all), the tax bracket for retirees remains relatively flat, so there may not be a benefit to paying now. Roth IRAs can also be good if the period of time for tax free withdrawals is significant – not always the case for retirees who have already reached age 70-1/2. It’s also not optimal if you have to pay tax on the distribution out of the funds that you’re contributing to the Roth.

So, a conversion under the new rules may be a good idea but don’t assume that it is. Be smart. Ask questions. Run numbers.

Finally, there’s been some chatter that this RMD penalty exemption may be extended past 2009. For now, it’s just chatter, so don’t count on it. As of today, the only year for which the penalty is eliminated for not taking your RMD is 2009. Traditional income tax rules as they relate to distributions still apply.

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2 thoughts on “Retirement Account Rules Tweaked for 2009

  1. HI! I have heard about this for some time now, That it was passed by Congress. But are we sure that President Bush has signed it yet? I have been lootink for some news but have heard nothing untill I read your article. If so I want to tell my portfolio manager who normally withdraws my MRD the 1st week in January to stop it.

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