Understanding IRAs, Required Minimum Distributions &
The Worker, Retiree, and Employer Recovery Act of 2008

By John W. Vires, CFP^®

Partner

Trust Company of Illinois

Traditionally, many of our IRA clients wait until the end of the calendar year to take their Required Minimum Distributions (RMDs) to allow their funds to remain tax-free for as long as possible.  As we are nearing this time once again, we thought it would be helpful to remind everyone of an important change in this year’s rules.

In the wake of last year’s market turbulence, Congress passed legislation to help alleviate the immediate effects of investment losses for retirees owning IRA accounts.  Through its Worker, Retiree, and Employer Recovery Act of 2008, Congress suspended, for 2009 only, the necessity for investors 70½ years and older to take Required Minimum Distributions from their IRAs or defined contribution pension plans. To appreciate the importance of this legislation, it is necessary to understand RMDs under the regular system.

IRAs were created in 1974 to encourage people to save for retirement. One advantage to having an IRA is that contributions grow tax-deferred until the funds are withdrawn.  This means that interest, dividends and capital gains are not currently taxed to the owner as they would be in a traditional investment account, allowing the account to grow and compound at an even faster rate. 

As these vehicles were designed to help boost the incomes of retirees, the Internal Revenue Code requires IRA owners to begin withdrawing funds on an annual basis upon reaching age 70½.  The amount they must take is called the Required Minimum Distribution, and it is calculated each year using a life expectancy table.

When the time comes to take a distribution, a portion of the IRA investments must be liquidated to cover the RMD.  After a severe downturn in the markets such as the one we just experienced, IRA owners can be left at a disadvantage.  They might be forced to sell investments at a market low to raise cash for the distribution, and the RMD leaves less funds remaining in their portfolios to participate in an eventual recovery – both of which can hinder their ability to recoup the losses sustained.

Thanks to the Worker, Retiree, and Employer Recovery Act of 2008, IRA owners are able to skip their 2009 RMD in order to better position their accounts for distributions in 2010 and beyond.  Another advantage to those forgoing their RMD will be a corresponding reduction in their 2009 taxable income.

IRAs are a great vehicle for deferring taxes, however the rules can be quite complex.  If you have any questions about Required Minimum Distributions, or other IRA requirements, please don’t hesitate to contact any of the relationship managers at TCI. Also, stay tuned to a future edition of Trust Company Insight for information on changes to ROTH conversion rules beginning in 2010.