UPDATE: The Treasury Dept. has announced it will NOT step in and provide regulatory relief for seniors who need to take Required Minimum Distributions (RMDs) for 2008.

As most people know, you can’t leave your money in a tax-sheltered retirement plan such as a 401(k) or IRA forever. You have to start withdrawing at least a minimum amount each year once you turn 70½.(1) These annual withdrawals are called “required minimum distributions,” or RMDs. Failure to take an RMD results in the stiffest penalty in the tax code: 50%.

The formula that determines each year’s RMD is:

Your Account Value as of 12/31 of the Previous Year
Your Life Expectancy Factor (2)

The problem is that much of the decline in the financial markets occurred after December 31, 2007. Basing your 2008 RMD on that out-dated (and presumably much higher) value means taking out a bigger chunk of your retirement nest egg -- and depleting your assets sooner -- than if you used the current value of your account or skipped your 2008 RMD altogether.

For instance, say your IRA was worth $150,000 at the end of last year, but is worth only $100,000 today. You turned 80 in 2008 and your 78-year-old spouse is your only beneficiary.

Based on the value of your IRA on December 31st of last year, your 2008 minimum withdrawal would be calculated as follows:

$150,000 / 18.7 = $8,021

If, instead, your withdrawal were based on its current value, it would be considerably less:

$100,000 / 18.7 = $5,348

Assuming you didn’t need the money, the second scenario would result in a lower tax bill. It would also leave more assets in your IRA that could potentially increase in value when the markets recover.

AARP and other organizations that represent the over-65 crowd lobbied strongly for relief. Unfortunately, Congress didn’t get around to granting it until mid-December. Reasoning that, by then, most seniors had already withdrawn their 2008 RMD, lawmakers decided to grant a reprieve only for 2009.

The “Worker, Retiree, and Employer Recovery Act of 2008” allows someone who has to take a required minimum distribution in 2009 to skip their withdrawal and not be penalized.

CPA Bob Keebler, a partner with the firm Virchow, Krause in Green Bay, Wis., says he’s convinced that the ability to skip a required distribution also applies to beneficiaries who inherit a retirement account. “If you’re in the fifth year of a five-year payout, you can defer that for one year.” That would give the investments in the inherited IRA additional time to recuperate.

Keebler, an IRA expert who speaks at national conferences, says the way he interprets the legislation, the same privilege to “turn off” a 2009 RMD also extends to a beneficiary who is stretching withdrawals over their own life expectancy. “They can also skip a year,” he says.

Mark Luscombe, principal analyst with the Tax & Accounting Group at CCH, agrees. However, he adds that the ability to skip a 2009 withdrawal doesn’t automatically apply to a 401(k). “The plan itself has to agree to the [RMD] suspension,” he says. If your plan doesn’t adopt this provision, you could still avoid a 2009 RMD by rolling your account balance into an IRA. Just make sure you complete the rollover before your 401(k) sends you next year’s distribution.

According to Lucsombe, the last chance for RMD relief for 2008 lies with the Treasury Department, which is officially looking into it. However, as he points out, “time is running out.”

(1) Technically, the deadline is April 1st in the year after you reach age 70½. The exception to this is if your money is in a 401(k) plan and you are still working for the employer sponsoring the plan and you do not own 5% or more of the company.

(2) Your “Life Expectancy Factor” depends upon your age and who your beneficiary is. It can be found in the back of IRS Publication 590. You can access this at www.irs.gov.

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