IRA withdrawals hurt in tough times

Nobody likes to lose money in the stock market. But it gets worse if you’re forced to sell shares while your investments are in the dumps.

Yet that’s exactly the predicament faced by some retirement-account investors right now.

Seniors with traditional Individual Retirement Accounts and retirees with stakes in 401(k) plans are required to start withdrawing a portion of their accounts each year after reaching age 70 1/2 – a rule designed to ensure the cash gets used during retirement and Uncle Sam gets to start collecting revenue from these tax-deferred accounts.

When financial markets are rising, mandatory required distributions aren’t such a big deal. But with stock and even many bond prices in a tailspin, the rule poses a challenge for some seniors, especially since the amounts you must withdraw are based on inflated, prior-year figures.

“The problem stems from the fact that 2008 minimum distributions are based on a Dec. 31, 2007, valuation,” notes Glenn Sulzer, senior tax analyst at researcher CCH in suburban Chicago. “Because asset values were relatively high at the end of 2007, the dollar amount that must be distributed is based on a higher value than would apply if the same percentage were applied to today’s asset values.”

People who fail to take mandatory IRA distributions face a stiff penalty: a 50-percent tax on any required amount that wasn’t withdrawn. Investors in 401(k)-style plans also must start taking out money after reaching 70 1/2 or when they retire, whichever comes later.

With some retirees facing forced selling with their stocks down more than 40 percent this year, some groups want Congress to relax the rules. In fact, Congress is considering temporary relief for retired IRA and 401(k) investors fairly soon.

Sulzer said Congress could take up the issue in its current lame-duck session. He notes a provision in the recently introduced Worker, Retiree and Employer Recovery Act of 2008 would impose a one-year moratorium on required distributions for 2009.

As things stand now, IRA investors and retired 401(k) workers, after reaching 70 1/2, must take out a slice of their accounts each year that reflects remaining life expectancies based on Internal Revenue Service tables. Withdrawals must commence by April 1 of the calendar year after the year when you hit 70 1/2.