Posted at 3:40 PM on July 30, 2009
by Paul Tosto
Filed under: Saving & spending
For savers who stashed money away tax free for decades in an IRA or a 401(k), it can be a little grating when the IRS starts telling you to start spending it or else. But the feds are offering a break this year on Required Minimum Distributions.
It's a break I didn't know about until Charles Turpin of Minneapolis, a source in our Public Insight Network, told me how important it is to him this year. He wrote:
If you are over 72, as I am, the elimination of RMD for this year has almost eliminated my income tax obligation...reduced my taxable income enough to eliminate the tax on my social security payments. (This one was a stunner. I recalculated my estimated taxes three times before I believed the results)
Without the RMD, my gross taxable income is low enough so that my (Social Security) is not taxable. It's also low enough that my dividend and capital gains income is not taxable. All that leaves is my pension income, which is low enough to generate a negligible income tax.
With Required Minimum Distributions, the IRS basically requires most people with tax deferred savings accounts to make annual withdraws, starting at age 70.5. (The rules don't apply to Roth IRAs while the owner is alive.)
The AARP has a useful page that helps calculate required minimum distribution. AARP also notes the suspending RMDs this year:
...helps to offset the large share of retirement funds that older individuals had to take in 2008 because of the way that RMD is calculated. Required withdrawals were high for 2008 because they were based on account totals as of December 31, 2007, when account values were up after years of stock market gains.
As a result, people who waited until the end of 2008 had to take high distributions out of greatly diminished retirement accounts.
Without the break, the penalty for not withdrawing the required minimum is pretty stiff -- a 50 percent penalty on the amount not withdrawn. So if you came up $4,000 short on your required withdrawal you'd be assessed a $2,000 tax the next year.
The IRS is firm about the penalty for non withdrawal of RMD, but not impossible.
My wife provided volunteer tax assistance to seniors for many years. For seniors of the past generation, it was common for the wife to know nothing about the family finances. When the husband died there was an awful mess, and things like RMDs and estimated taxes could easily be overlooked.
We found that a well written letter to the IRS outlining what happened and the circumstances involved could lead to forgiveness of the penalty.
The break ends December 31 unless it's extended. So, tax-wise, it'll be business as usual in 2010.