Worker, Retiree, and Employer Recovery Act

All eyes are on Washington as the Senate recently voted to release the second half of the financial industry bailout fund, and House Democrats unveiled an unprecedented $825 billion fiscal recovery plan. While the economic impact of the stimulus plan remains to be seen, Washington already has enacted the Worker, Retiree, and Employer Recovery Act of 2008 (WRERA) that contains provisions to alleviate some of the stress caused by the downturn in financial markets. Signed into law on December 23, 2008 by President Bush, WRERA suspends Required Minimum Distributions (RMDs) for the 2009 calendar year only. This applies to all Individual Retirement Accounts (IRAs) and employer-sponsored retirement plans, including qualified pension plans, qualified stock bonus plans, qualified profit-sharing plans, 401(k) plans, 457(b) plans, and 403(b) plans. The relief does not apply to distributions from defined benefit plans. Note, too, that the legislation suspends RMDs for IRA owners and plan participants as well as beneficiaries and trust beneficiaries.

So why did Congress grant the free pass? The rules for calculating RMDs for the current year are based on the account’s prior year-end market value. And a majority of account balances were much higher on December 31, 2007, than they are today. Here’s how the one-year suspension works:

If you reached age 70½ prior to 2009, you previously would have been required to take your 2009 RMD no later than December 31, 2009. Under the new legislation, that RMD will not have to be made in 2009. If you will reach age 70½ during 2009, you would have been required to take your first RMD on or before April 1, 2010. Because this legislation suspends required distributions for 2009, there is no requirement that a distribution be made by April 1, 2010. However, in both cases, you still will be responsible for taking your RMD for the 2010 calendar year on or by December 31, 2010. Also note that if you turned 70½ in 2008 and chose to wait until April 1, 2009 to get your first RMD, you still have to take that one in 2009.

Obviously, WRERA’s suspension of RMDs for 2009 offers the most help to retired taxpayers who do not rely on their RMDs for living expenses. By not taking your RMD for 2009, or withdrawing less than the RMD from your qualified plan accounts and/or IRAs, you will wind up with less taxable income for 2009, and, possibly, avoid or mitigate the effect of the adjusted gross income (AGI)-based phase-out of tax breaks. Additionally, if your retirement funds are invested in an account that’s now under water, forgoing your 2009 RMDs protects you from selling an asset when it’s down. Moreover, there is also the possibility that your investments could recover somewhat before you make withdrawals. The higher your previously scheduled RMD, the greater your benefit will be if you can delay your distribution. Also, if you are beyond age 70½ and continue to work, you are not required to take RMDs until you leave your job, unless you are a 5-percent owner of the company.

It’s important to note that your retirement plan account or IRA need not be “in distress” because of market conditions to qualify for the 2009 RMD suspension. In fact, the suspension applies equally to IRAs invested in Federal Deposit Insurance Corporation (FDIC)-insured bank CDs, as well as IRAs invested in depressed stocks or mutual funds. When distributions resume in 2010, there will be no change to the previous distribution schedule. That is, the required beginning date will be April 1 of the year after reaching age 70½ or, in some employer plans, April 1 of the year after retirement.

WRERA also grants additional investment flexibility by facilitating direct rollovers from retirement plans to Roth IRAs and nonspousal rollovers. Specifically, the Pension Protection Act of 2006 allowed for direct rollovers from qualified retirement plans, 403(b) plans, and governmental 457 plans to Roth IRAs, subject to the AGI limitations that generally apply to rollovers from traditional IRAs to Roth IRAs. However, the Act’s language led to some confusion as to whether a direct rollover from a Roth 401(k) or Roth 403(b) account to a Roth IRA would also be subject to an AGI limitation. WRERA clarifies that a rollover from a Roth 401(k) or Roth 403(b) account to a Roth IRA is not subject to the AGI limitation.

The Pension Protection Act of 2006 also provided that the designated beneficiary of a deceased employee’s eligible retirement plan (including qualified retirement plans, governmental 457 plans, and 403(b) plans) could transfer distributions from the plan directly to an IRA without tax consequence. Previously, only surviving spouses had this option. Subsequent interpretation of the provision held that plans could, but were not required to, offer this rollover option to nonspousal beneficiaries. WRERA provides that, for plan years beginning after December 31, 2009, plans must allow nonspousal beneficiaries to roll over funds to an IRA in a direct transfer, provided all requirements are met.

I will continue to monitor proposed new legislation, details of the Federal bailout effort, and the rulings of various Federal agencies. Going forward, I expect there will be other rulings like the RMD suspension that will offer relief to investors. For example, the U.S. Treasury Department and the Internal Revenue Service (IRS) recently issued a ruling that allows 529 college savings plan account owners to change their investment strategy twice this year. Previously, owners of 529 accounts were limited to only one strategy change per year. Like the RMD suspension, the ruling is in effect for 2009 only. However, the College Savings Plan Network is working with the Treasury and the IRS to make the ruling permanent.

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