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individual retirement accounts usually run a big risk -- in the form of a 50% excise tax on the amount they should have withdrawn.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, 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 70½. That means that someone who turned 70½ 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 70½ -- along with those who have inherited IRAs or 401(k)s -- will be forced to resume taking withdrawals in 2010.