By Anne Tergesen
If your tax-advantaged retirement accounts hold $75,000 or less, a little noticed provision of the Obama Administration’s budget proposal could free you forever from the required minimum distributions those ages 70 ½ and older must take from these accounts each year.
If the measure becomes law — which isn’t expected to happen anytime soon, given that we’re in an election year — it is estimated that as many as half of older plan and IRA owners will eventually escape required distributions. These withdrawals are calculated by dividing the cumulative balance of an individual’s tax-deferred accounts as of the previous Dec. 31 by his or her remaining life expectancy. Those who ignore or miscalculate these annual withdrawals usually run a big risk, in the form of a 50% excise tax on the amount they should have taken out.
“This is going to be of great interest to lots of people,” says David Certner, legislation policy director at AARP. Mr. Certner says that while there is little likelihood of the proposal being enacted before the election, he thinks it has a good chance of eventual passage, in part because it is likely to cost relatively little to implement.
“The rules have always been complicated,” he says. “It makes a lot of sense as a matter of administration to simplify the rules.”
The proposal would do away with required distributions for those who, on Jan. 1 of the year in which they turn 70 ½, have a combined balance of $75,000 or less in all of their tax-deferred retirement accounts and plans, says Mark Iwry, Senior Adviser to the Secretary of the Treasury and Deputy Assistant Secretary for Retirement and Health Policy. The proposal would allow those with combined balances between $75,000 and $85,000 to receive a partial exemption. Those thresholds would be adjusted annually for inflation.
Those who contribute to tax-deferred retirement accounts, such as traditional IRAs and 401(k)s, don’t pay income tax on the money they put into these accounts. But starting at age 70 ½, they must take the money out, and pay income taxes in the process. Because Uncle Sam gives you a tax break when you make your contributions, the government wants the tax revenue it deferred when you retire and are presumably in a lower tax bracket, says Ed Slott, an IRA expert in Rockville Centre, N.Y.
Under the proposal, account owners whose balances are $75,000 or below would be exempt from required distribution rules for the rest of their lives. The exemption would remain, even if their balances eventually appreciate above $75,000, says Mr. Iwry. (An exception would apply to those who are still working and contributing to or earning new benefits under tax-deferred retirement accounts, he adds.)
On the other hand, someone whose aggregate balance is above $75,000 at age 70 ½ will remain subject to required distributions even if his or her combined balance later dips below $75,000.
The Treasury’s goal, says Mr. Iwry, is to simplify life, by reducing regulatory requirements for retirees with smaller account balances, most of whom are likely to spend the money in these accounts during their lifetimes regardless.
“We are trying to give people more choice–enabling them to follow what they think is the best spending path for themselves, without having to worry about these regulations,” says Mr. Iwry. The Treasury settled on $75,000, he says, largely because it is approximately the median aggregate IRA and 401(k) account balance for retirees around age 70.
If enacted, the proposal is estimated to cost Uncle Sam about $355 million in lost revenues over a ten year period, according to Mr. Iwry. That’s because, freed from required distributions, some IRA owners are likely to withdraw less or liquidate their accounts at a slower pace.
The proposal will apply to those turning 70 ½ on or after Dec. 31, 2012. Those who are already over 70 ½ would remain subject to the required minimum distribution rules, regardless of how much their tax-deferred accounts contain.
Under the proposal, those who inherit tax-deferred money from someone with $75,000 or less in their combined tax-deferred retirement accounts would also be exempt from required distributions.
This is not the first time a proposal has been floated to grant taxpayers a reprieve from the rule requiring older Americans to take withdrawals from tax-deferred retirement accounts. After the market crash in 2008, Congress passed a law that suspended required distributions for just one year, 2009. Intended to give beaten-down retirement accounts time to rebound, the temporary suspension affected all taxpayers.