Four changes that would simplify retirement savings

Researchers say that our financial acumen peaks in our early 50s and starts a long slide by age 60. Just as we are losing our ability to navigate financial complexities, we are faced with deciphering baffling government rules about tapping our retirement funds.

Take the regulations governing when people are required to begin withdrawals from their accounts, which is by April 1 in the year following the year they turn 70½.

"It's extraordinarily complex and unnecessary," said Melissa Labant, director of tax advocacy for the American Institute of CPAs (AICPA).

Making matters worse is the fact that different types of retirement accounts have different rules. Required minimum distributions cannot be delayed for IRAs, but they can be put off for 401(k)s if the account owner is still working — and does not own more than 5 percent of the company sponsoring the plan.

People who get confused can pay a big price. Failure to take a required minimum distribution on time, for example, can result in a penalty equal to 50 percent of the amount that should have been withdrawn.

The AICPA has the following eminently reasonable suggestions for simplifying tax law for retirement accounts:

The government wants its due, of course, but required minimum distributions can shove people into higher tax brackets and make more of their Social Security benefits taxable.

The ability to delay mandatory withdrawals from 401(k)s but not IRAs is just one example of inconsistent rules. Another difference is in how early withdrawals are penalized. Those from IRAs do not incur a 10 percent federal tax penalty if the money is used to pay higher education expenses or finance a first-time home purchase. Withdrawals from a 401(k) for those purposes would incur the penalty.

When you make nondeductible contributions to a retirement plan, which means you have already paid the tax on that amount as income, they are not taxed when you later make withdrawals. But the specifics vary by account.

When you make withdrawals from a Roth IRA and a 401(k), the rules treat it as if you were first taking out the nondeductible contributions, Labant said. If you do not withdraw more than the amount of those contributions, the distribution is not taxed.

The same withdrawals from an IRA and a nondeductible Roth IRA, however, would be taxed proportionately. If nondeductible contributions made up 20 percent of the account's value, then only 20 percent of the withdrawal would escape tax. Changing the rules so all distributions are deemed to come first from any nondeductible contributions would simplify matters and reduce tax bills, Labant said.

Roths are hugely popular among savvy taxpayers because both contributions and earnings can be withdrawn tax-free in retirement. Also, Roths do not have required minimum distributions, which means the money can keep growing for a lifetime.

If the taxpayer does not have other regular IRA savings, she does not incur much if any tax on the conversion. President Obama in his budget proposal for fiscal-year 2016 suggested closing this loophole, but the AICPA would rather see income limits removed on contributions.

Income limits and phase-outs "have contributed to the complexity and opaqueness of our tax law," Labant said. "Good tax policy requires simplicity and transparency."