Dear Readers,
Hooray for the IRS! It just announced a major change in one of the rules governing IRAs which will be a welcome relief to thousands of taxpayers who had to tap their accounts before age 59 1/2.

Under Section 72(t) of the Tax Code, you can avoid the usual 10% penalty for taking an early withdrawal from your IRA provided you calculate the amount based on one of three IRS-approved methods. With two of these methods, your withdrawal amount is fixed. That is, every year you have to take out the same amount of money. With the third method, the amount of your withdrawal varies based on the changing value of your IRA.

Once you start "substantially equal periodic" withdrawals, you cannot stop or alter the way you figure them until either: 1) you reach age 59 1/2, or 2) you've taken withdrawals for 5 years -- whichever takes LONGER. If you violate these terms, then the 10% penalty will be applied retroactively to every dollar you've taken out of your IRA since you started.

Based on this, a few years ago when the Dow Jones Industrial Average was above 10,000 (no, you were not dreaming) and their IRAs were worth considerably more than they are today, thousands of people under age 59 1/2 began systematic withdrawals. For most it was a last resort: they had been laid off, were unable to find a new job and had no other source of money to pay their bills.

Although they owed income tax on their IRA withdrawals (assuming the money was coming from a tax-deductible, Traditional IRA), at least they could avoid the 10% penalty.

Then the stock market began its painful decline. Imagine a 52-year old who, in 1999, chose one of the fixed withdrawal methods thinking he'd have no problem taking, say, $30,000 a year from his $500,000 IRA for 7 1/2 years. Now, thanks to four years of withdrawals and investment losses, he has an account worth less than $150,000 and faces the real possibility that he will wipe out most of his entire retirement savings if he keeps this up for three and a half more years.

On the other hand, if his main concern is to preserve what is left of his nest egg, then his only choice was to stop his withdrawals completely or take out less -- either of which would trigger the retroactive penalty.

Financial advisors have deluged the IRS with pleas for flexibility on this matter, citing real-life horror stories about law-abiding clients who played by the rules, but got slammed by an unprecedented series of events: a stock market decline deepened by terrorist attacks, corporate accounting scandals and now the threat of war. These folks have seen what was supposed to be their main source of retirement income -- their IRAs-- decimated.

But thanks to this new ruling, individuals in this situation can slow down their IRA withdrawals to help preserve what's left in their accounts. The IRS will now allow them to change from one of the fixed withdrawal methods to the variable one and THIS WILL NOT TRIGGER THE 10% PENALTY!

If this applies to you, instead of having to take out the same amount year after year, you can now re-calculate your annual withdrawal based on what your IRA was worth at the end of the previous year. If your IRA is worth less than the year before, you will take out less; if it goes up in value, so will your withdrawal. Furthermore, YOU CAN MAKE THE SWITCH NOW AND REDUCE YOUR 2002 WITHDRAWAL.

The variable withdrawal method under Section 72(t) is based on either your life expectancy or the joint life expectancy of you and your IRA beneficiary. Hint: If you really want to reduce your required withdrawals, choose the latter. That's because two people have a longer life expectancy than one so you're allowed to take out less than if you base your withdrawal on your life expectancy alone.

(Be sure to use the new IRS tables issued in April which have been updated to incorporate Americans' longer life expectancies. You can find them at http://www.irs.gov or by requesting Publication 590 from the IRS.)

In the words of Pam Olson, Assistant Treasury Secretary for Tax Policy, "Taxpayers have worked hard to build their retirement savings. This change will help many... to preserve their retirement savings by allowing those individuals to slow their distributions down in the event of unexpected market downturns."

I couldn't have said it better myself. The only thing I would add is if you are unsure of how to do the calculation, consider working with a financial professional. The IRS might be understanding about market declines, but it might not be so lenient about mathematical errors.

Gail

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The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.