A Gift to Grow On

As the year ends, let us take time to reflect on some of the financial gifts that 2009 brought us.

Didn’t take long, did it?

But seriously, there is one gift that the recent economic unpleasantness did bring to people age 70 1/2 or older, at least for those who owned stocks in a tax-deferred retirement savings account. They got a one-year moratorium on their required minimum distribution (RMD).

Let’s start by explaining what a required minimum distribution is. It’s the withdrawal that you’re usually required to make from a pretax account such as a 401(k) or a traditional IRA once you reach the age of 70 1/2. (Non-spouse beneficiaries who inherit these accounts also are required to start taking distributions.) The RMD is required so that the federal government can finally start recovering the tax payments that were skipped while the account was accumulating savings.

How much you’re required to withdraw each year depends on your life expectancy. For instance, if you are 70, the IRS’s formula calculates that you will be around to pay taxes for 27.4 years. So you divide the amount in the account by 27.4, and that is your RMD for that year.

Congress approved the moratorium simply as a matter of fairness. In 2008, RMDs were based on account totals as of Dec. 31, 2007, a time when the market reflected several years of gains. By Dec. 31, 2008, however, the Dow Jones Industrial Average had fallen by more than a third. So the required RMDs in 2008 were based on the previous year’s healthy balances, and took a large chunk out of accounts that had been depleted by the worst downturn since 1937.

To redress that damage, Congress voted last December to allow retirement account owners to skip the RMD in 2009 without incurring the usual 50 percent penalty for doing so. As a result, the owners weren’t forced to sell stocks whose values were still depressed.

“It was certainly the right decision,” said Alicia H. Munnell, director of the Center on Retirement Research at Boston College. And it worked, because if you skipped the RMD this year, chances are your accounts have made a nice recovery.

Here’s an example from Vanguard for someone age 70 1/2 who had an IRA balance of $80,000 in Vanguard’s Target Rate Fund 2010 as of Dec. 31, 2008. If that person took an RMD at the beginning of 2009, by Dec. 15 the account had grown to $91,788. But if the person had not taken the RMD, the account would have grown to $95,264, or $3,476 more.

It’s not clear how many investors decided not to take the RMD this year. Some may not have been aware of the moratorium. Others might have had good reason to take the RMD despite the moratorium, such as an immediate need for the funds or an expectation of income next year that would increase their tax bracket.

The IRS allows taxpayers to return RMDs to their accounts this year to avoid paying taxes on them. The deadline for rollbacks, however, was either Nov. 30 or 60 days after receipt of the distribution, whichever is later.

So, if you haven’t taken an RMD this year, think about whether you want to do so. Or, if you recently took an RMD and are within the 60-day window, think about whether you want to undo it.

Martha M. Hamilton writes a regular column for AARP Bulletin Today on retirement and financial issues.