Sometimes good things come disguised as minor rule changes. And for retirees, that’s certainly true this year. In recent months senior citizens received two relatively small breaks designed to improve their retirement incomes—the suspension of required minimum distributions (RMDs) for IRA and 401(k) accounts for 2009, as well as a 5.8% cost of living adjustment (COLA) in Social Security payments. Nice, but no big deal, right? Actually, those changes could add up to a significant chunk of change, according to a soon-to-be-published analysis by T. Rowe Price. Here’s the scoop:
Skipping an RMD. If you are age 70 ½ or older, you are normally required to withdraw a regular minimum amount from your tax-deferred accounts each year. (The exact amount is determined by a formula that factors in the account values and life expectancy – see T. Rowe Price’s website for more information.) Problem is, taking those RMDs now, in the midst of an epic bear market, means locking in big losses. So in December, Congress enacted a new law that suspends the RMDs for 2009. (There’s no exception for 2008 RMDs.) That change allows you to leave a sizeable amount in your IRA or 401(k) that can continue to grow as the market recovers, whenever that may be. And you might be surprised at the difference forgoing a single RMD makes to your nest egg. For example, someone age 75 with a $500,000 account would typically withdraw $21,834 in 2009. If you could afford to skip the distribution this year and let that money grow until age 90, you could end up with an extra $47,327, after adjusting for inflation and assuming a 7% annual average return. That’s nearly 10% more than your original portfolio.
Collecting your Social Security COLA. The bout of inflation that raged in late 2007 and early 2008 (remember when we were worried about rising gas prices?) led to the 5.8% COLA for Social Security recipients this year. To put that in perspective, Social Security’s baseline assumption is for 2.8% annual increases. For a 70-year-old retiree who is drawing maximum Social Security payments, the difference might seem small—only about $84 extra a month. Still, those three extra percentage points added to your cost of living adjustment make a big difference over time, with the biggest cumulative benefit going, of course, to younger retirees. That 70-year-old retiree will end up with an extra $35,623 between now and age 95, according to T. Rowe Price research. Someone age 80 will bank an extra $19,902. Maybe it’s not enough to make up for your market losses, but every little bit helps.
— Penelope Wang