IRS rule could sap retirees' already depleted savings

The shaky economy and plunging stock market are leading many Americans to cut back on their spending.

If you're retired, you might also be inclined to pull less money out of your retirement account.

But efforts to preserve as much of your depleted nest egg as possible could be thwarted by the Internal Revenue Service.

If you're older than 70 1/2 , IRS rules require you each year to take a minimum amount of assets out of your traditional individual retirement account or 401(k) plan. (The rules don't apply to Roth IRAs.)

Worse, the calculation of how much you need to withdraw this year is based on the value of your account at the end of 2007. Because stock prices have plunged, your account is probably worth much less than at the end of last year. So the mandatory withdrawal based on how much your nest egg was worth about 10 months ago might seem excessive given its current depressed value.

As a result, there has been a chorus of calls to suspend the rules. President-elect Barack Obama and Sen. John McCain both endorsed such a move during the campaign.

How much money are we talking about?

Let's say you're 72 years old and your retirement assets have plunged 40%, from $500,000 on Dec. 31 to $300,000 today. Under existing rules, you would have to withdraw $19,531. If your minimum withdrawal was calculated using today's account value instead, you would have to take out only $11,719.

Of course, if you withdraw more than you need you don't have to spend it all. You can put the money in a taxable investment account. But you'll have to pay income tax on the amount you withdraw, so you'll have less to invest.

And you can always take out more than the mandatory amount. The IRS simply sets minimums because the government wants you to pay tax on this tax-deferred money before you die. In fact, the minimum is calculated by dividing your retirement account value by your life expectancy in years remaining, based on IRS data.

What happens if you don't withdraw the minimum?

You'll "get hit with a killer penalty" equal to 50% of the amount that you should have withdrawn but didn't, said Ed Slott, a tax accountant and author of "Your Complete Retirement Planning Road Map."

To continue with the above example, if you're required to withdraw $19,531 but you take out only $11,719, you would fall $7,812 short and incur a 50% penalty of $3,906.