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RMDs Back on the Table in 2010

Retirees who are planning their finances need to be aware of an important change for 2010: After a one-year reprieve during 2009, required minimum distributions (RMDs) from qualified retirement accounts are once again mandatory for the 2010 tax year. As this rule impacts legions of retirees, it's important to take a quick review of RMDs at this time.

RMDs: A Quick Review

Retirees aged 70 1/2 and older are required to take RMDs every year from traditional retirement accounts such as 401(k)s, 403(b)s, and IRAs. (Note that RMDs are not required from Roth accounts.) The amount of the distribution is determined by dividing the account balance at the end of the prior year (in this case, as of December 31, 2009) by the account holder's life expectancy. Tables detailing life expectancy are available in IRS Publication 590. Failure to withdraw the required amount results in a penalty equal to 50% of the required withdrawal.

An individual normally is required to take the initial RMD by April 1 of the year after the individual turns age 70 1/2. But this requirement was suspended for 2009 only by legislation that former President Bush signed into law in December 2008. The Worker, Retiree, and Employer Recovery Act of 2008 suspended the requirement to take RMDs for the 2009 tax year. The law was enacted to prevent retirees from being forced into taking withdrawals from retirement accounts that had declined in value as a result of the former bear market in stocks. Taking withdrawals from an account that has declined can lock in losses that are difficult to make up in subsequent years.

Back on Track for 2010

According to the provisions of the Act, individuals who turned 70 1/2 in 2009 could delay their first distribution until December 31, 2010. Note that an RMD for the 2010 tax year is still required. Following the initial RMD, annual withdrawals typically must be completed by December 31 of the tax year.

Note that retirees are not the only ones who take RMDs from qualified retirement accounts. Nonspousal beneficiaries frequently take distributions from accounts that they have inherited. (A different set of rules applies to spouses.) Nonspousal beneficiaries who inherited retirement accounts and were taking distributions over a five-year period were able to suspend their distributions for 2009 only and resume withdrawals for 2010. Because of the one-year hiatus, these beneficiaries are able to extend withdrawals over a six-year period rather than a five-year period.

As an alternative to the five-year rule, nonspousal beneficiaries may be able to elect distributions based on either their life expectancy or the life expectancy of their spouse. If you are a nonspousal beneficiary of a qualified retirement account, you may want to consult a tax professional to determine how rules regarding these accounts could impact you.

Tax Issues

RMDs are taxed as ordinary income regardless of whether the distribution is taken by the account holder or a beneficiary after the account holder's death. Many retirees use their RMDs for living expenses in additional to income from Social Security and other sources.

RMDs are a complicated subject. If you are age 70 1/2 or older and maintain a traditional IRA, 401(k), or 403(b) plan -- or if you are a nonspousal beneficiary who has inherited one of these plans -- ask your financial advisor how the rules affecting RMDs apply to you.

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