By Donald L. McCoy, J.D., CMFC
Donald L. McCoy, J.D., CMFC, is president of Planners Financial Services, Inc. a registered investment advisory firm and a broker-dealer member of FINRA, specializing in the discretionary management of portfolios employing mainly no-load mutual funds and exchange-traded funds for individuals and retirement plans designed to protect capital by reducing risk.
The new Worker, Retiree and Employer Recovery Act of 2008 was passed and signed into law by President Bush at the end of December 2008. This law provides a sorely needed respite for elderly taxpayers who normally have to take required minimum distributions from their IRAs and other qualified plans each year. For 2009, these required minimum distributions have been put on hiatus.
Required minimum distributions (RMDs) are the payback the government demands in exchange for allowing our retirement accounts to grow tax deferred. Starting at age 70½, individuals with qualified accounts must begin taking distributions from their accounts. The amount they must take out is determined by a combination of the value of the account as of the last day of the previous year and the age of the account owner reaches in the current year. The RMD is recalculated each year.
Some people begin IRA distributions before reaching 70½ to supplement other forms of retirement income. Not surprisingly, the IRS does not give you any credit toward RMDs for distributions taken by investors in the years before turning 70½. From a tax perspective, it is normally beneficial to withdraw money from taxable accounts before tapping into IRAs and other tax-deferred accounts. Generally, distributions from IRAs are considered income for tax purposes.
The longer a person can keep money in a tax-deferred account, the greater opportunity that money has to grow without the burden of paying taxes. This respite provides an opportunity for investors to begin the long path toward repairing some of the damage done to accounts by the current global recession.
Exceptions to the Exemption
This holiday does not apply to RMDs that have been postponed from 2008. If a client missed fulfilling the 2008 RMD, they are not exempt. The client must still complete that RMD withdrawal plus pay any resulting penalties to the IRS. Also, if clients turned 70½ in 2008, they have until April 1, 2009 to fulfill their 2008 RMD. Some people may have waited until 2009 to take that RMD. They still must take their RMD for 2008.
The tax holiday, however, does apply to people who have inherited IRAs. Individuals who have inherited IRAs have their own RMD calculation to make each year. These people tend to be younger and less likely to need the money that comes from the annual distribution required by the IRS. This group of clients will quite be happy to hear they can skip the distribution this year.
While this holiday will help millions of Americans lower their tax bill in 2009, the change does present a problem for those people who have been having their RMD automatically deducted from their account. It does provide an excellent opportunity for advisers to proactively contact their clients to discuss this opportunity. In these days when clients dread even opening their account statements, contacting them with good news regarding both their accounts and their taxes is a double bonus.
Many fund families and brokerage firms will not suspend these scheduled distributions on their own. The investor has previously given the fund families specific instructions, and they will continue to carry out them out until told otherwise. The burden is on the individual and that individual's financial adviser to stop these RMDs in 2009 with an equivalent burden to restart the distributions in 2010 once this holiday ends.
A financial adviser should be contacting his or her clients to assist them in deciding whether they want to take advantage of this tax holiday. The needs and situations of each client will differ. It may be that a person is dependent upon these ongoing RMDs to help meet monthly living expenses. In one case, the adviser was able to locate a non-qualified account and shifted the withdrawals from the IRA to the taxable account for one year. In 2010, barring any additional changes in legislation, the adviser will stop the withdrawals coming from the taxable account and restart the RMDs from the IRA after recalculating the new amount. In the interim, this client will have about $18,000 less in taxable income for 2009. That is a fact that any client would love to learn.
Some clients will not have the luxury of a large pool of non-taxable assets. These clients may need to continue their IRA distributions despite the RMD holiday. It is still a good idea to contact these clients to discuss their situation and let them know you are looking out for their best interests. The contact will deepen your understanding of the client's financial well-being and reinforce the strength of the relationship in the mind of the client.
Do not delay talking to clients. If distributions are done on a quarterly basis, the client may have already received their first distribution for 2009. The client should not panic. They have 60 days from the date of the distribution to put the money back without suffering a penalty from the IRS. If the client wants to keep the initial distribution, you can still discuss putting the remainder of the distribution on hiatus.
In the end, the client will make the decision that they feel is best. It is the adviser's obligation to give the client the appropriate information upon which he or she can make a decision and to offer potential outcomes of different decisions. Financial advisers have a great opportunity to deliver positive, actionable news to clients. Now is the time, despite the chaos and the negativity, to engage clients and work with them to improve their position. Clients need advice and guidance now more than ever.