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Your retirement account might get smaller this year

By Blake Ellis, staff reporter


NEW YORK (CNNMoney.com) -- Older Americans whose retirement accounts took a beating from the market's downturn caught a break last year: The government suspended rules that required them to make annual withdrawals, buying them time for their portfolios to recover.

But now that the markets are starting to come back, Uncle Sam wants his share again.

That means if you're 70 ½ or older and have a retirement account -- including a 401(k) or IRA -- you must resume withdrawing the annual minimum from those plans this year, so that the money can be taxed. The so-called "Required Minimum Distribution," or RMD, you must take out depends on your age and the size of your retirement account.

Of course, if you're retired and using your account to live on, this probably isn't an issue. But if like many people, you still have other sources of income and want to keep as much money in your account as possible to let it grow, now is the time to plan ahead.

"With [RMDs] back on this year, folks shouldn't wait until the last minute to figure out what they need to withdraw," said Ken Hevert, vice president, personal retirement products at Fidelity. "You need to be forward-looking if you don't want to find yourself in a situation where your request doesn't get processed on time."

Failing to withdraw the correct amount of money from your account on time means serious penalties -- a 50% tax on the amount that should have been withdrawn.

Who takes RMDs, and when?: Anyone turning 70 ½ this year can either take their first minimum distribution by Dec. 31 or postpone it until April 1 of 2011. But if you choose to delay it, you will be required to take a second distribution by Dec. 31 of 2011 as well. After the first year, all RMDs must be made by Dec. 31 each year.

Because RMDs were suspended last year, if you turned 70 ½ in 2009, your first RMD must be taken by Dec. 31 this year.

The rules are similar for beneficiaries who inherit the retirement account of someone over 70 ½.

How much do I withdraw?: The amount you need to withdraw is calculated by dividing the total balance of your retirement accounts as of Dec. 31 of the previous year by the distribution period of your life expectancy.

For example, if you have an IRA with a balance of $200,000 as of Dec. 31, 2009 and you're turning 72 in 2010, you would divide that $200,000 by a life expectancy factor of 25.6 years, resulting in an RMD of $7,812.50.

To find the life expectancy factor for your age, you can use the distribution table in IRS Publication 590 on the IRS website.

The IRS and retirement planning Web sites like Fidelity's provide calculators that make figuring out your RMDs easier.

Once you determine how much to take out, check it over with your tax accountant or retirement account adviser and enter the amount on an account distribution form. The money that is withdrawn will then be taxed at your income tax rate.

Many firms -- including Fidelity -- also will help you track your withdrawals and create automatic distribution plans for you.

Ways to save: In some cases, it could save you a little money in the long run to withdraw more than the minimum this year, said Shomari Hearn, a client service manager at Palisades Hudson Financial Group.

RMDs are taxed at your current income tax level, so taking out more than the required amount and investing the excess in a non-retirement account is one way to reduce your future tax liability, since the long-term capital gains tax you will pay is likely to be less than the amount you would pay in ordinary income tax.

Another reason to take out more than the minimum: If your income took a hit this year and you're in a lower income tax bracket than usual, you could benefit from withdrawing more money now and having it taxed at that lower rate.

In addition, if the Bush tax cuts expire at the end of the year, many wealthy Americans will face higher taxes next year. So if you're in the top income brackets, this gives you another reason to withdraw more than the minimum.

"There's a good possibility that tax income rates will increase if Congress doesn't do anything to extend the Bush era tax cuts, so it may make sense to accelerate your distributions and take more than the minimum," said Hearn. "It's very possible to save on your income tax liability if you take more out this year than if you wait until next year to take it out." To top of page

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