Mandatory IRA, 401(k) withdrawal bad for retirees now

— -- If 50 is the new 30, is 70 the new 50?

Many 70-year-olds believe that it is. They're running marathons, jumping out of airplanes and sending birthday cards to their mothers, who like to remind them that 90 is the new 70.

But no matter how young you feel, once you reach 70½, you're usually required to start taking minimum withdrawals from your individual retirement account or 401(k) plan. The amount of the withdrawal is based on IRS life expectancy tables and the value of your IRA at the end of the previous year.

This year, that's a real problem. Since Dec. 31, 2007, the Dow Jones Wilshire 5000 index, broad index of publicly traded stocks, has declined nearly 36%. That has blown a hole in most retirement portfolios, but younger retirees at least have the option of postponing withdrawals until the market recovers. Retirees who are older than 70½ don't have that choice.

Suppose, for example, that you're 73 years old and your IRA has declined from $100,000 at the end of 2007 to $70,000. According to IRS distribution tables, your life expectancy is 24.7 years. That means you're required to withdraw $4,049 from your IRA this year ($100,000 divided by 24.7), or about 4% of the value of your savings at the end of 2007. Based on your IRA's current value, however, the withdrawal represents 5.8% of your account.

If you're still working at age 70½, you can delay mandatory withdrawals from your employer's 401(k) plan until you retire. But you're still required to take minimum distributions from your IRA and any 401(k) plans you have with previous employers, says Ed Slott, an accountant and IRA expert in Rockville Centre, N.Y.

Ignoring the rule isn't an option. You'll face a fine equal to 50% of the amount you should have withdrawn.

But if you haven't already taken your minimum distribution, wait. Help may be on the way.

If Congress adopts an economic stimulus plan in a lame-duck session this year, there's a "reasonably good possibility" the legislation will include a provision suspending the required distribution rules for 2008, says Clint Stretch, managing principal of tax policy for Deloitte Tax.

The AARP, meanwhile, isn't waiting for Congress to act. The advocacy group for seniors has urged Treasury Secretary Henry Paulson to use his authority to temporarily freeze the mandatory withdrawal requirement. (A Treasury spokesman declined to comment on the AARP request.)

David Certner, legislative policy director for the AARP, says suspending mandatory withdrawals won't help retirees who have to take money out of their IRAs this year to pay the bills. But, he says, it would help many middle-income retirees who don't need the money now and would like to make their savings last as long as possible.

If you fall into that category, postponing your required withdrawals for a few more weeks, Stretch says, will give you "the maximum opportunity to find some relief, either in Treasury regulations or through legislative enactment."

A long-term solution

Whether you're retired or still working, there's a way to avoid having to wrestle with mandatory withdrawals: convert your IRA to a Roth.

And now "is the best time on earth to convert to a Roth IRA," Slott says.

When you convert an IRA to a Roth, you're required to pay taxes on all pretax contributions, plus any gains. But because the taxes are based on the value of your IRA when you convert, you'll pay a much lower tax bill now than you would have paid a year ago. If the market recovers after you convert, all of your future gains will be tax-free. Plus, there are no minimum withdrawal requirements for Roth IRAs.

"I've never seen such an opportunity to buy the tax man off this cheap," Slott says.

One caveat: You can't convert an IRA to a Roth unless your adjusted gross income is $100,000 or less. That cut-off applies to married and single taxpayers.

Mark Warshawsky, director of retirement research for Watson Wyatt, says he hopes the plight of IRA holders will encourage lawmakers to take a broader look at the mandatory withdrawal rules.

The current minimum withdrawal requirement, he says, was first put in place in 1962 to govern Keogh plans, a savings plan for the self-employed.

The rule was originally designed to prevent wealthy investors from squirreling away tax-deferred savings for their heirs, he says.

Now, though, IRAs and 401(k) plans "are the retirement plans of the masses," Warshawsky says. "People really use these plans to live on during retirement."

Sandra Block covers personal finance for USA TODAY. Her Your Money column appears Tuesdays. Click here for an index of Your Money columns. E-mail her at: