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New 2009 IRA Rules Confuse Taxpayers

March 31st, 2009

ira-tax-changes-2009.jpgThis article by an author writing under the nickname of Moeursalen is an explanation of some changes in the tax code for 2009 that affect people who have individual retirement accounts (IRA) and are at least 70 and a half years old. I have no idea why they chose such an odd number for the age cutoff, but the gist of the recent changes is that if you happen to be above this threshold, you are now allowed an exemption from the otherwise mandatory withdrawals from your IRA if you want to avoid taking losses due to the declining values of most stocks.

A change in the federal tax code has left a wake of confusion among retirees aged 70 and ½ who must make annual withdrawals from their IRAs, 401K, or similar plans. The change was meant to help retired persons whose life savings sustained a hit from the precipitous decline of the stock markets.

It is not uncommon for retirement savings maintained in 401K, IRA or other qualified plans to have lost 40% or more. For many people, this means that retirement planning falls far short of expectations they had when the plans were initiated.

With the precipitous decline in mutual fund stocks, one million dollars previously saved for retirement could have shrunk to $600,000 or less. For those less fortunate or less savings minded, a $100,000 dollar IRA retirement account invested in a mutual fund might have shrunk to $60,000 or $70,000 dollars. In the latter case, a person withdrawing an annual amount of $10,000 would deplete all savings within six or seven years, as opposed to ten years.

The Wall Street Journal reported February 17 that the Dow Jones Industrial Average fell to within 65 points of its November 2008 lows. At those levels of fund performance, retirees are right to worry that their nest eggs won’t provide the anticipated retirement income.

As the result of the steep decline in retirement savings, the Internal Revenue Service granted an exemption from required IRA withdrawals in 2009. The presumption is that mutual and index funds will bounce back and extend the length of time that retirees might have to continue receiving periodic payments from their retirement plans. The owners of retirement accounts have the option of returning part or all of those disbursements, and they may direct the custodian to send another smaller periodic payment in lieu of the original amount. Mandatory withdrawals apply only to those who have attained the age of 70 and ½.

For many retirees, existing plan withdrawal rates mean that, in 2009, they have already received more from their retirement accounts than a more prudent withdrawal plan would dictate. The IRS solution allows re-deposit of disbursements without penalty within a 60 day period.

However, a problem has arisen among some custodians of such funds who have been blindsided by the new legislation and are unsure how to proceed. Many fund administrators report that they have not received enough guidance from the Internal Revenue Service.

Insurance companies responsible for annuity payments are also perplexed. Some insurance companies who pay out annuities are struggling under the weight of telephone calls from anxious clients, some of whom have become only recently aware of the rule change. While some fiduciary custodians have informed their clients of the changes and sent out letters providing guidance, others have not been as responsive to customer needs as they might be.

In spite of any confusion or lack of readiness for the changes, retirees should focus upon the certainties. The new law applies to almost all defined-contribution employer plans, including inherited, traditional, and Roth IRAs.

Retirees should be mindful of the “60-day rule.” If the retiree wants to take advantage of the law change and revert all or part of the withdrawals back to their account, they can simply write a check to the custodian of the funds in the amount which was disbursed. The retiree is allowed to do this just once in a twelve-month period for each account from which payments are received. Miss the deadline and the taxpayer is liable for income taxes due on the traditional IRA disbursements.

Workplace 401K plan custodians are often hesitant to make changes because of documentation already submitted to the government. In such cases, plan custodians fear that they may be found in violation of existing rules. The retiree should put their withdrawal requests in writing, keep copies of it, and send their requests to the account custodians. Without the retiree’s directive, custodians are pretty much free to do whatever they want in disbursement of the funds.

The new law is set to expire at the end of 2009, so it is important to consider 2010 when contacting the plan custodian. Must the retiree put into writing their requests for 2010 withdrawal amounts? That’s something to inquire of the plan custodian, too. Even so, some retirees may be frustrated enough to convert their conventional IRAs into Roth IRAs, a legitimate maneuver which will require the payment of federal income taxes based on the rollover amount. The advantage of rolling the funds into a Roth IRA, of course, is that future disbursements will no longer be taxable, nor would there be required distributions from the retirement account.

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