By Edward Zelinsky
In normal times, the minimum required distribution (MRD) rules of the Internal Revenue Code engender little controversy. These, however, are not normal times.
Adopted by Congress in their current form in 1982, the MRD rules apply to individuals who are at least 70 and one-half years of age and who are covered by pension and profit sharing plans. The rules mandate that these older persons must annually receive and pay income tax on minimum payments from their respective retirement plans. The MRD rules apply to such older persons whether they participate in traditional pensions, in 401(k) arrangements or in individual retirement accounts (IRAs). Mechanically, the MRD rules require older account holders to determine the value of their accounts as of each December 31st and to withdraw a minimum amount from such accounts during the immediately following year. This minimum amount is based upon the account holder’s adjusted actuarial life expectancy and the account’s December 31st value.
Consider, for example, a 72 year old who had $100,000 in his IRA as of December 31, 2007. According to tables promulgated by the U.S. Treasury, in 2008 this individual had to receive and pay income tax on a distribution from his IRA of at least $3,906. This required amount reflected the December 31st value of his IRA ($100,000) divided by his adjusted life expectancy (25.6). This 72 year old could take more from his IRA in 2008 than this MRD but he could not take less.
To see the controversy which arose in the wake of the Crash of 2008, let us assume that this 72 year old had invested his IRA in a common stock mutual fund and that, as is common, he delayed his MRD for 2008 until early December of that year. At that point, the IRA which had been worth $100,000 a year earlier had declined in value to $60,000. However, the MRD rules still required this individual to withdraw $3,906 from his IRA in 2008, a figure which reflected the previous and now vanished value of his IRA as of December 31, 2007.
Unsurprisingly, many individuals caught in these rules in the fall of 2008 thought it unfair to require them to withdraw amounts based on the high December 31, 2007 values of their IRAs and 401(k) accounts, values these diminished accounts no longer possessed.
Following the 2008 crash, there occurred an Alphonse-and-Gaston routine under which Congress and President Bush suspended the MRD rules for 2009 on the theory that the Treasury would, pursuant to its regulatory authority, abate the MRD rules for 2008. The Treasury, however, concluded (correctly, in my judgment) that, under the Code, it lacked authority to suspend or modify the rules for 2008. Thus, Congress and the President relieved our 72 year old of the need to take an MRD withdrawal from his IRA in 2009 but gave him no relief from the MRD rules in 2008 – even though his plight in 2008 was the immediate motivation for lifting the rules.
And, starting in 2010, the MRD rules will come back with full force, requiring individuals who are seventy and one-half or older to take minimum annual distributions annually from their IRAs and 401(k) accounts based on their respective adjusted life expectancies and the value of their accounts as of the preceding December 31st.
I propose a simple fate for the MRD rules: Abolish them permanently. The MRD rules make life unnecessarily complicated for older persons. The rules also discourage saving and accumulation by requiring such older persons to withdraw annually from their IRAs and 401(k) accounts amounts they would otherwise leave intact.
The principal rationale for the MRD rules is that an older person covered by a pension or profit sharing arrangement has benefitted from many years of tax deferral, accumulating amounts in his pension plan, IRA or 401(k) account free of federal income tax. It is, the argument runs, now time for our theoretical 72 year old to pay federal income tax by withdrawing ongoing, minimal amounts from his tax-deferred IRA.
Without belittling the revenue requirements of the federal Treasury, there are many other and better places to satisfy those requirements.
The other rationale advanced by defenders of the MRD is distributional in nature. Retirees with modest incomes need to draw on their IRAs and 401(k) balances to live. It is only more affluent persons, with other sources of income, who can afford to leave their account balances untouched and who thus will benefit from the permanent repeal of the MRD rules.
Viewing the MRD rules in isolation, this is a plausible argument. However, when placed in the context of the many tax preferences benefitting affluent persons’ unearned incomes, this argument loses its bite. The pensions and accounts regulated by the MRD rules constitute earned income, deferred wages from work. The Code extends many tax preferences to investment income concentrated among the wealthiest of taxpayers, e.g., preferential rates for long-term capital gains, basis step-up of inherited property. Placed in this broader setting, repeal of the MRD rules is a comparatively anodyne tax benefit, extending to people who have worked the privilege of tax-deferral on their earned retirement incomes.
The MRD rules make the tax law unnecessarily complex for older individuals while forcing them to withdraw from their IRAs and 401(k) accounts amounts these individuals would rather leave untouched. We lived quite well without the MRD rules before 1982. If, as Congress and President Bush have already decided, we can live without the MRD rules in 2009, we can live without them thereafter.
Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America.