The federal government has handed out assistance to just about everyone lately, from taxpayer stimulus payments earlier this year to the huge bailout payments that financial companies have already tapped into. A long line of prospective applicants hope to get a share as well -- and so far, Congress and the Treasury haven't been inclined to say no.

One group of investors who are facing having to make large withdrawals from retirement accounts at exactly the wrong time, however, had thought they might be in for some relief. In the end, the government's attempt at support fell short of their hopes.

Retirement accounts and required minimum distributions
If you've ever invested in a traditional IRA, 401(k), or other retirement plan, you're familiar with the basics of these accounts.  In exchange for saving your money now, you get a current tax break on your contribution. Also, you enjoy the benefit of tax-deferred growth throughout your career on the investments within your account. After you retire, you can withdraw the money at any time with no penalty -- although you will pay taxes on the money you take out.

  • However, you don't get to keep deferring taxes forever. At some point, the IRS forces you to start taking money out of your retirement accounts, whether you need it or not. This happens either:
  • When you turn 70 1/2; or
  • If you inherit an IRA from someone else and elect to stretch out distributions over time.

If you don't, you face a huge 50% penalty on the amount you should have taken out. The appropriate amount, also known as the required minimum distribution or RMD, is calculated from the value of your retirement accounts at the beginning of the year. You're required to take a fraction of your assets out, based on your life expectancy -- the older you are, the bigger the chunk you have to withdraw.

Bear market = big problem
It's that calculation that has created a huge problem for investors this year. The RMD calculation used account values at the end of 2007. But because many investors typically wait until much later in the year to think about RMDs, the market's collapse pushed their account balances downward -- while the RMD amount stayed the same.

Many hoped that the government would suspend the rules to allow retirement account holders to skip their RMDs this year. But Congress instead suspended the rules for 2009, while leaving them in place for this year.

How's that gonna help now?
Unfortunately, the problem is much larger in 2008 than 2009. Fears from those who say that RMDs will force investors to sell stocks at their low are overblown, as they can usually take the money and buy the same stocks in a taxable account. But the new law still forces account holders to take a huge tax hit this year.

Consider, as an example, the potential tax hit in a portfolio of seven dividend-paying stocks you might find among a typical conservative investor's holdings:


Value of 3,000 shares at end of 2007

Current value of same 3,000 shares

Chevron (NYSE:CVX)



General Electric (NYSE:GE)



Kellogg (NYSE:K)



Coca-Cola (NYSE:KO)






PepsiCo (NYSE:PEP)



United Technologies (NYSE:UTX)






For someone who turned 72 in 2008, the RMD would be $54,850. Next year, if account values on Dec. 31 are the same as they were yesterday, the RMD for that same person at age 73 would be $40,234 if it weren't suspended.

So while suspending the 2009 RMD will provide some help, the difference of $14,616 means that top-bracket taxpayers will pay over $5,000 more in tax in 2008 and 2009 than they would have if Congress had made the law effective for 2008.

One last chance?
Even though the congressional action didn't address 2008, some believe that the Treasury could unilaterally make changes to this year's RMD rules. But with time running out, it looks increasingly unlikely.

Regardless, for investors, the real damage has already been done. Although RMDs are an immediate concern, the more fundamental problems facing the economy, the financial markets, and programs like Social Security and Medicare are much more important to seniors in the long run. Without solutions to those bigger problems, relief for seniors will only have a minimal impact on their overall financial security.

For more on making the most of your retirement:

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.