Withdrawal Rules Are an Added Torment
As bad as the long bear market has been for most investors, the steep decline in stock prices holds special torment for retirees with savings in tax-deferred retirement accounts.
And they can thank Uncle Sam for the added pain.
U.S. tax rules require retirees to begin withdrawing money from their tax-deferred savings plans -- such as individual retirement accounts and 401(k) and 403(b) plans -- after they reach age 70 1/2. The withdrawals must occur whether or not a retiree needs the cash.
The idea is to make sure retirees pay tax on at least some of the money before they die. Hence, the minimum annual withdrawal percentages are smaller for younger retirees and larger for older ones.
But when the government wrote the rules in the late 1970s, the assumption may have been that assets in retirement accounts would grow in value most years, preventing relatively small mandatory withdrawals from draining accounts too quickly.
That assumption didn’t allow for an era in which the stock market has fallen for two consecutive years and is poised to make it three in a row.
Retirees Are Worried
Gerald Shearer of Orange knows just how painful the rules can be. Shearer, 70, must start withdrawing money from his tax-deferred retirement plans this year. And under Internal Revenue Service requirements, the amount he is forced to withdraw is based on the value of his account at the end of last year -- when it was worth about 40% more than it is now, after 10 months of losses.
If Shearer were able to base withdrawals on a more current balance, he would be able to leave thousands of dollars more in his tax-deferred accounts. That would reduce his current income tax bill and give his savings more time to recover from the market’s losses.
“Everybody is being hit,” Shearer said. “It’s really an irritation that you can’t account for that.”
Retirees such as Shearer, who had a significant portion of his savings in stocks, are learning firsthand just how the withdrawal rules can drain a retirement account in an extended bear market.
For example, a retiree who reached the age of required withdrawals three years ago, and whose tax-deferred account was fully invested in a Standard & Poor’s 500 index mutual fund worth $100,000 when the market began to slide, would have been forced to withdraw $9,816 from savings over the last three years -- while his retirement account balance plunged from $100,000 to about $55,000.
If the retiree had been allowed to make withdrawals at the end of each year based on the then-current account balance, the required withdrawals would have been as much as $1,600 less.
Naturally, the biggest hit retirees are taking is from market losses, not mandatory withdrawals. However, mandatory withdrawals do two things: They force the retiree to make paper losses real by selling securities, and they require that tax be paid on the amount withdrawn at ordinary income tax rates.
Last month, the government revamped rules to help early retirees -- those younger than 59 1/2 -- who were suffering with the same problem. The new rules allow early retirees taking regular payments from retirement plans to calculate their mandatory withdrawals based on more up-to-date portfolio values.
But once they set a new date to figure the proper withdrawal amount, they must stick with that date each year in calculating the account’s value and their withdrawals.
Rules for 70 1/2 or Older
Retirees age 70 1/2 or older, however, still are required to use portfolio calculations from the previous year.
One reason the government can’t cut older retirees a break: Mandatory distribution rules for those older than 70 were revamped earlier this year to require that retirement plan administrators -- the mutual fund firms and other investment companies that hold IRA and other defined contribution balances -- calculate mandatory distributions for their customers.
That makes it much easier for the IRS to match the amount retirees are supposed to withdraw with what they actually declared in taxable income for a given year. For simplicity’s sake, the IRS wants a set date for that calculation, and the natural choice was year’s end.
There has been some movement in Congress to find other ways to address the effect of the stock market’s slide on retirement savings and withdrawal rates. The solution that has the most support is a simple one: raise the age at which retirees must start making withdrawals from 70 1/2to 75.
“Our legislation is designed to help retirees and near-retirees who have been hurt the most by the downturn in the stock market,” said Rep. Rob Portman (R-Ohio), one of the main sponsors of a bill to boost the withdrawal age. “By raising the age, we are making sure that workers can hold on to their assets for a longer period of time.”
However, tax experts said the bill’s chances appear slim, partly because of federal budget shortfalls and partly because there are more pressing issues for legislators to address.
On the bright side, if the stock market manages to continue its recovery in 2003, the current withdrawal rules might benefit retirees for the same reason that they’re hurting them now: Next year’s withdrawal calculations would be based on this year’s depressed balances.
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Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past Personal Finance columns, visit The Times’ Web site at www.latimes.com/perfin.
