Proposals that have been swirling around Washington that would relax minimum-distribution rules for retirement accounts are impractical and likely to be unfair.
One of many frustrations for investors during the current economic crisis has been watching a string of knee-jerk reactions and Band-Aid solutions from politicians, aimed at solving the headline-grabbing problem of the day and quelling investor anger.
It’s not just that the quick fixes don’t necessarily work, it’s that they tend to be poorly thought out and good mostly for one special-interest group at the expense of others.
And that’s why people in power need to remember that all the king’s horses and men could not repair the nation’s broken retirement nest eggs overnight, and that quick relief from required retirement-savings withdrawals will not help the people who actually need assistance.
Proposals that have been swirling around Washington, D.C., that would relax minimum-distribution rules for retirement accounts are impractical and likely to be unfair.
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To see why that is, you have to start out with the problem facing seniors 70-½ and up.
Internal Revenue Service rules require that tax-deferred savers must take a “required minimum distribution,” or RMD, each year, cashing out a piece of their individual retirement accounts (IRAs) or 401(k) plans and paying taxes due on the amount withdrawn.
The requirement is designed to make sure that Uncle Sam gets a piece of the tax deferral every year, as a saver who has amassed more funds than they need to live on might otherwise avoid paying taxes on those IRA dollars.
RMD rules are confusing, but one key issue is that the annual minimum withdrawal is based on the value of your account at the end of the previous year.
News flash: the stock market has tanked in 2008. Many investors are just now realizing that, despite their losses, they must withdraw funds as if they still had last year’s higher account balance. That means that this year’s minimum withdrawal represents a larger percentage of their holdings.
House Education and Labor Committee Chairman George Miller, D-Calif., and Rep. Robert Andrews, D-N.J., have called for the Treasury Department to suspend tax penalties for those not taking their RMD, and plan to push legislation that would exempt seniors who had up to $200,000 in retirement accounts from mandatory minimum distributions.
Among the groups backing this idea is the AARP, which submitted a letter to the Treasury urging a temporary freeze on mandatory withdrawals.
“Fairness dictates that we provide relief to these individuals who have no other recourse than to use their retirement savings to meet current living expenses,” said Bill Novelli, AARP’s chief executive, in a letter to Treasury Secretary Henry Paulson.
Yes, required distributions will be bigger than if they were based on current valuations, but any relief will only go to those seniors who don’t need to withdraw the money in the first place, not the person experiencing problems.
Seniors in desperate straits will get no relief. If they must withdraw dollars to live — whether it’s the RMD amount or much more — they’re on the hook for the taxes. Suspending the IRS requirement makes no difference if your life requires that the money come out.
“The situation is unpleasant, but it’s not unfair,” says Ted Benna, the benefits consultant who founded the first 401(k) plan. “When the market was up, the same people benefitted from the distribution rules, which had them take out less money during those times. … Suspending distributions doesn’t make the problem go away, it will simply come back worse at a later point in time.”
And while legislators present scary images of investors being “compelled to sell,” the truth is that distributions don’t require a sale; fund firms and brokerage companies allow shareholders to move assets from an IRA into a taxable account without selling. Taxes are due on the value of the assets, but liquidation is not compulsory.
Further, rushing to enact this kind of fix is impractical if not unfair. Many seniors have already taken distributions for 2008; those people would either miss out on the quick-fix tax break, or they’d have to put the money back on account, something neither the individual nor their investment companies are prepared to account for.
Says retirement-planning specialist Ed Slott: “Nobody likes to pay taxes before they have to, but these changes won’t help the people who have real financial troubles and have to withdraw their retirement savings, they’d only help the people who can afford to keep their money at work but who don’t want to pay taxes on it now.”
Chuck Jaffe is a senior columnist at MarketWatch columnist. He can be reached at firstname.lastname@example.org or Box 70, Cohasset, MA 02025-0070.