As 2008 wound to a close with stock prices down 35 percent or more, one group of investors in particular had reason to be unhappy.
That group was retirees older than 70½ who were forced to take withdrawals from ravaged retirement accounts. Last year, many of these folks had postponed their withdrawals as long as possible, hoping the IRS or Congress would show them mercy by waiving their required withdrawals for 2008.
That never happened.
Instead, there is a measure of relief in place for 2009. Retirees and others will be allowed to skip their required minimum distributions this year, giving retirement accounts, hopefully, a chance to recover a bit from last year's beating.
The main beneficiaries of this waiver will be retirees who do not need to tap tax-deferred retirement accounts to cover expenses. If you're in that category, contact the company that holds your IRA or other retirement account to find out what you need to do to skip your usual withdrawals. This is particularly true if you receive your required distribution automatically each year.
The waiver of the minimum distributions requirement is the result of legislation passed by Congress and signed by former President Bush less than a month before he left office. It applies to traditional IRA, 401(k), 403(b) and 457 accounts, but not traditional, defined benefit pension plans.
The relief from the usual required minimum distributions affects mainly retirees older than 70½. But it will also benefit beneficiaries who inherited retirement accounts and were supposed to drawn down the accounts. They will now gain an extra year of deferred taxation.
The waiver is relatively straightforward, but there is one wrinkle. If you turned 70½ last year and postponed taking your first required distribution until early this year as allowed by law, you still must take that 2008 distribution by April 1 of this year. And then, like others, you can skip the 2009 withdrawal.
Understanding Minimum Distribution Requirements
To understand the significance of this waiver, you first need to understand the minimum distribution requirements that apply to most retirement accounts.
Normally, the owners of IRAs, 401(k)s and other retirement accounts are required to take minimum distributions that are based on their life expectancies and account values. The reason for the requirement is that the federal government wants its payments after years of sheltering the account from taxation.
The account owners typically received a tax benefit on the front end when they contributed money to these accounts, and then continued to benefit from years of tax-deferred growth. Without the required minimum distributions, retirement accounts could be used by the wealthy to shield income from taxation for their entire lives.
If you don't withdraw the amount required, the IRS will hit you with a 50 percent penalty on the amount that should have been taken but was not.
The major exceptions to the required minimum distribution rules are the Roth IRA and its newer cousins, Roth 401(k)s and Roth 403(b)s. These accounts are funded with income that has already been taxed on the front end, and their distributions in retirement are tax free if certain conditions are met.
For other retirement accounts, minimum distribution requirements kick in the year you turn 70½. But, as mentioned above, you can postpone the first distribution until April 1 of the following year and then later in the year take a second withdrawal.
The size of the required withdrawal is based on your age and the size of your retirement accounts as of Dec. 31 of the previous year.
That is the reason many older investors started howling in September and October when the stock market took its deepest dives. They knew the withdrawals they had to make by Dec. 31, 2008, were going to be based on significantly higher values from Dec. 31, 2007.
Many retirement accounts easily could have lost 40 or 50 percent of their value during that one-year span, depending on how the accounts were invested.
Lost Earning Potential
For example, suppose a retiree owned a mutual fund in his IRA that was worth $100 a share on Dec. 31, 2007, and that, based on his age and the account value as of that date, he was required to withdraw $1,000 by the end of 2008. That 2007 year-end value meant he would have needed to liquidate 10 shares of that fund to make his required withdrawal.
But suppose, by Dec. 31, 2008, that account might have only been worth $75 a share. Then he would be faced with selling 13.33 shares to meet his $1,000 required minimum distribution.
The sale of the additional 3.33 shares may not sound like much but it represents lost earning potential from capital gains and reinvested dividends.
Thanks to this year's waiver, our hypothetical investor should be able to recover somewhat by avoiding the need to sell additional shares in 2009.
Let's just hope for an economic recovery that paves the way to stock market gains that eases last year's pain for all investors, retirees and non-retirees alike.
This work is the opinion of the columnist and in no way reflects the opinion of ABC News.
David McPherson is founder and principal of Four Ponds Financial Planning in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at email@example.com.