Retirement account rules a surprise to seniors

updated 3:14 p.m. ET Sept. 2, 2008

DES MOINES, Iowa - There's some sentiment that a government rule that forces retirees to withdraw money from their IRA and 401(k) accounts when they turn 70 1/2 may need to be changed. That's because people are living longer and need to keep as much of their retirement money for as long as possible, said several financial advisers and a leader of the Senate Finance Committee.

The required minimum distribution, or RMD, rules force tens of millions of retirees to take money out of their tax-deferred retirement accounts each year. The reason for the forced disbursement is simple — the government figures it's waited long enough for the taxes on that sheltered cash. The rule to force withdrawals, developed more than 20 years ago, also was intended to make sure that tax-deferred retirement accounts are used for their intended purpose and not by those who would accumulate money tax-free to pass on to heirs.

A persistent problem is that many seniors are caught off guard by the rules and end up paying a hefty penalty, of 50 percent of the amount that should be withdrawn, for failing to comply.

Bobby Brown, 78, a retired telephone worker in Fort Worth, Texas, said he and his wife, Priscilla, didn't want to take money out of their retirement accounts when their financial adviser told them they'd have to.

"We had no intention of using the money itself, but the government says you have to take it out or pay a big penalty," he said. "I didn't need it. I figure why mess with a wheel if it's not broken."

Brown, who represents retirees of the Communication Workers of America union on regional and national boards, said his financial adviser prepared him in advance for the distribution.

Now, he tells the union retirees he represents to be sure they're ready for the RMD.

According to the Investment Company Institute, a trade group, about $4.7 trillion was held in IRA accounts last year. Most of that amount, about 89 percent, was held in traditional IRAs that must comply with the minimum distribution rules.

Trillions of assets Retirement assets held in the United States as of December 2007: — Held in IRAs: $4.7 trillion — Defined Contribution Plans (401(k) and similar accounts): $4.5 trillion — State and local government pensions: $3.3 trillion — Private defined benefit plans: $2.5 trillion — Federal pensions: $1.2 trillion — Annuities: $1.7 trillion — Total U.S. Retirement Assets: $17.6 trillion Note: Components don’t add up to $17.6 trillion due to rounding Source: Investment Company Institute

The group also said 46.2 million Americans own IRAs, and six out of 10 households owning traditional IRAs that made withdrawals in 2006 did so just to satisfy the RMD requirement.

In terms of tax revenue, the IRS couldn't provide the exact number of people who must comply annually with the RMD rule or give figures for how much money it collects from mandatory distributions.

Individual requirements
The amount that an account holder is required to withdraw is based on the amount of savings in the tax-deferred account divided by the retiree's life expectancy, as estimated by the government. The details and tables can be found in IRS publication 590.

People who aren't actively managing their retirement savings may forget to take money out when they should and lose thousands of dollars to the government's penalty.

Many who miss the first withdrawal are forced to take two the next year, which frequently puts them in a higher tax bracket, costing them even more, advisers say.

"These are some of the more complex tax rules in existence, and some custodians, and even some tax pros, may get the RMD wrong," said Jeremy Welther, a financial adviser in Morristown, N.J. "It's amazing how many people don't take their RMDs, sometimes for years."

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