How Not To Deplete Your IRA

Like many ideas pursued during the late 1990s’ bull market, taking early withdrawals from bulging IRAs may not have been such a hot notion to begin with. It normally makes sense to leave money in retirement accounts to accumulate for as long as possible, to take advantage of tax-deferred compounding. But many people did begin making so-called 72(t) distributions from IRAs, in some cases lured by the sense that such withdrawals would hardly be noticed, if account balances continued to grow as briskly as they had from 1995 through 1999. Of course, just the opposite has occurred—most retirement accounts have lost value, and those having annual distributions siphoned off may be shrinking toward oblivion. Now the IRS has stepped in to provide some relief.

The 72(t) loophole lets you take money out of tax-deferred retirement plans before you reach age 59½, the normal starting time for withdrawals not subject to a 10% penalty. The catch is, you have to commit to taking “substantially equal periodic payments” for at least five years or until you hit 59½, whichever comes later. And at the outset, you have to choose how those payments will be calculated. There are three options, the first two of which involve taking fixed payments that are designed, according to actuarial tables and assumptions about your account’s rate of growth, to exhaust your savings during your expected lifespan. The third possibility calls for recalculating withdrawals annually, depending on the actual account balance.

It is those first options that have gotten people into trouble. With account balances being drained by the bear market, those equal payments may amount to a larger and larger percentage of a nest egg, and could deplete the account entirely with years of retirement still ahead. So the IRS has decided to let IRA holders change their minds, and in October issued a revenue ruling that allows a one-time switch in distribution methods for 72(t) withdrawals. Those who opt for yearly recalculation of withdrawals will be able to adjust the amount they take out to reflect whether their portfolio has fared well or poorly in the preceding year. In today’s volatile market, that may be almost as good an idea as not taking early withdrawals at all.