Mixed News for Senior IRA Holders

For IRA owners who were hoping the government would make an eleventh hour call to suspend or modify the minimum required distribution, or MRD, rules for 2008, we've got some bad news: the existing rules will remain in place. However, there is some relief for next year. A new law passed earlier this month suspended the MRD rules for 2009. So if you turned 70 1/2 this year, or if you're older than that, here's what you need to know.

After reaching age 70 1/2 , you're subject to the MRD rules which require you to take annual withdrawals from traditional IRAs set up in your name, including any simplified employee pension (SEP) accounts and SIMPLE-IRAs. And, of course, you have to pay the related tax hit. (Roth IRAs set up in your name do not have any minimum withdrawal requirements.) Failure to take your annual MRD means getting socked with a 50% penalty tax based on the difference between the amount you should have withdrawn and what you actually took out -- if anything. This is one of the stiffest penalties in the Internal Revenue Code.

Since so many seniors' traditional IRA balances were hammered by the stock market plunge, there was hope that either Congress or the IRS would grant some immediate relief. Now that it’s clear there will be no relief for 2008, this year’s mandatory withdrawal will be painfully large for many folks. Why? Because the amount you must withdraw is calculated by dividing the total of all your traditional IRA balances as of December 31, 2007 by a life expectancy divisor based on your age at the end of this year. The problem is, your IRA balances were probably considerably higher at the end of last year than they are now-- meaning you'll be forced to withdraw a larger amount and pay a larger tax hit.

Specifically, here’s the drill.

By April 1 of the year after you turn 70 1/2 (April 1, 2009 in your case), you must withdraw your initial MRD. This initial distribution is actually for the 2008 tax year -- even though you can take it as late as April 1, 2009. However, you also have the option of withdrawing your initial MRD by December 31 of this year. Either way, you must calculate the amount of that initial MRD using your IRA balances as of December 31, 2007.

One silver lining: The MRD rules are suspended for next year. Without this change, you would have had to withdraw two MRDs in 2009, unless you withdrew your initial MRD this year. So the tax-smart strategy now goes like this:

* If you expect to be in a significantly higher tax bracket next year, consider taking your initial MRD before 2008 is over. Just keep in mind that you'll have to forgo some tax deferral in exchange for potentially significant savings on your combined 2008 and 2009 federal-income tax bills.

* If you expect to be in the same or lower tax bracket next year, it generally makes sense to postpone your initial MRD until 2009. Just be sure to take it by the April 1 deadline so you can avoid the 50% penalty.

If you haven't already done so, you must take your MRD for the 2008 tax year by December 31, 2008. If you’ve already taken it, you're in the clear. And for 2009, you won’t have to take an MRD thanks to the recent law change.

If you inherit an IRA (including a Roth IRA) you must follow a special set of MRD rules for beneficiaries to avoid getting socked with the 50% penalty tax. These rules apply regardless of your age. (For details on how to calculate annual MRD amounts, see our stories Inheriting Your Spouse's IRA and Inheriting Your Uncle Henry's IRA.) If you haven't yet taken this year’s MRD, get it done by year-end. The good news: you won’t have to take any MRD in 2009.