It's bad enough that many retirees' portfolios sustained significant losses during 2008. But income tax regulations on required minimum distributions, or RMDs, can make a bad scenario even worse because they force investors over age 70.5, and those who inherited IRAs or other retirement-plan accounts, to sell during a down market.
Fortunately, Congress recognized the problem, and in December then President George W. Bush signed legislation suspending the RMD rule for 2009.
"The required minimum distribution is suspended for the 2009 calendar year," says Valerie Adelman, CFP, Financial Asset Management Corp., of New York. "This applies to all qualified plans such as 401(k)s, IRAs, and 403(b) plans."
The RMD rules are fairly straightforward. The regulations require taxpayers to start withdrawing funds from their retirement plans by April 1 of the year after they turn age 70.5. The RMD is determined by life expectancy based on the values in IRS Publication 590 (www.irs.gov/pub/irs-pdf/p590.pdf).
Gil Armour, a financial advisor with Sage Point Financial Inc., in San Diego, gives an example. "If you have a couple, both age 70, the IRS life tables say that 27.4 years is the joint life expectancy. You divide the retirement plans' account value by 27.4 and that would be the dollar amount you'd have to take out of the IRA during that particular year. It amounts to about a 4 percent withdrawal."
There are several drawbacks to the new rule.
First, it doesn't affect RMDs for 2008 -- those are still required.
Second, taxpayers who turned age 70.5 in 2008 must still take their initial distribution by April 1, 2009, based on the account balance of December 31, 2007.
"The requirement doesn't change," says Adelman. "People who had to take their first distribution in 2009 will still need to do that."
Still, advisors are reacting favorably to the recent change. Adelman says her clients, of whom 25 percent are over age 70, have been concerned about the prospect of selling positions at a loss from their accounts to meet the RMD.
Ken Robinson, senior planner with the Monitor Group in McLean, Va., estimates that roughly half his firm's clients are 70.5 or older.
Many of his older clients don't need income from their retirement plans and welcome the opportunity for another year of tax-deferral. "For the client that doesn't actually need the money, what we end up doing is simply shifting the money from the IRA account to a regular non-retirement account, and that's it -- it stays within their long-term portfolio," says Robinson.
"But we've had to move the money out of the IRA because of the required minimum distribution rule, and they have to pay tax on it," he explains. "So for those people that don't actually need the money, this will be a good year, because they can avoid having to make that distribution and pay the tax for 2009."
Robinson notes that the change gives advisors and clients additional planning flexibility. He cites cases in which a client has large Schedule A deductions. Even though the client isn't required to take a distribution for 2009, Robinson says, he might recommend a distribution to absorb those deductions.