Tax Relief for IRAs: Too little, much too late
Posted
Dec 29 2008, 10:40 PM
by
Andrew Horowitz
Rating:
In what appears to be too little, much too late, a new legislative action has been enacted that waives the Required Minimum Distribution (RMD) from IRAs and other types of pension plans for 2009. The idea is to help retirees who have seen their account values drastically reduced by the recent market disaster by allowing for the monies to remain in a tax advantaged account for at least one more year.
Traditionally, when an IRA owner turns 70-1/2 they are required to take an annual distribution and pay taxes on the withdrawal. The RMD calculation applies the prior year's account balances against a life expectancy factor to arrive at the minimum amount to be withdrawn by December 31. As most accounts were valued significantly higher than they are now at the end of 2007, the amount of money that was required to be withdrawn in 2008 is disproportional to the current account value. Unfortunately, while it seems to be a nice plan to help seniors, this new law misses the intended mark by a mile. Here's why.
The need to reduce the burden of paying tax on withdrawn funds during 2008 is the main reason why AARP and other senior advocate groups pushed Congress for tax relief. As account balances have dramatically decreased, the withdrawal during 2008 will take an additional chunk out of accounts that have already been decimated. The waiver for 2009 really does nothing significant as we are now close to the low point for markets...and many buy-and-hold portfolios.
If they were really trying to help, Congress would have provided this benefit for the 2008 tax year. For sure it would be complicated to administer since many have already withdrawn their RMD, but the law could have provided the ability to extend the time for funds to be rolled-back into the plan without tax or penalty. Currently, there is a 60-day rollover rule that allows withdrawn funds to be re-deposited back to IRAs without an adverse consequence, as long as it is done no more than once every 12 months.
AARP praised Congress for passing the Worker, Retiree and Employer Recovery Act of 2008:
“By making minimum withdrawals from retirement savings accounts optional rather than mandatory for next year, older Americans are poised to hold on to more of their diminished nest eggs,” says AARP Legislative Policy Director David Certner. “Now every older American, who was forced to make a choice between taking a withdrawal that was calculated based on a much higher value in their retirement account or face a high tax penalty, will be eligible for this financial relief.”
Somehow, the praise seems to be misplaced. Beyond the fact that the much needed benefit for 2008 was overlooked, there is one more potential pitfall that should be considered. Simply, we don't know what 2009 will bring. Congress is supposedly looking to help by allowing funds to remain invested as long as possible. Since the RMD uses the ending balance of the prior year for the calculation, a lower amount would be used for the 2009 calculation as compared to 2008. By keeping the funds invested and assuming that markets will slowly begin to work their way higher, the amount that will be calculated for 2010 could actually be much higher (as will the tax) as compared to what would have been paid if they implemented this for 2008. Moreover, if the markets continue to move lower, more money stays invested which creates more losses.
It appears that what Congress has done is to provide temporary relief in return for a higher tax in the future. If they were really looking to help, they will have certainly done all they could to have this effective for the 2008 tax year.
Once again taxpayers get the proverbial: "Heads they win, tails you lose" treatment.
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Related reading:
MSN Tax Center
Bankrate RMD Calculator
10 Key trends for 2009
Andrew Horowitz is a money manager and the founder of Horowitz & Company. He is also the author of the bestselling book, The Disciplined Investor . Check out his latest investment idea or listen in as he hosts, The Disciplined Investor Podcast.
