I love January. It’s when my wife and I escape the winter blahs and head for Puerto Vallarta. But I also love January for something else. January is when we take required minimum distributions from our retirement accounts.
The event puts a lump of cash in our checking account. Who doesn’t like seeing lumps of cash? And since I’m 78, we’ve been taking those distributions long enough that we don’t worry about them. Whether the actual amount is higher or lower, a lump of cash is a good thing.
Our world is not unraveling.
Sadly, lots of retirees don’t feel that way about their RMDs. Some feel that every distribution is the-beginning-of-the-end. Others rail about taking them at all. Either way, lots of retirees have turned a very nice annual event into a source of worry or resentment.
So let me tell you something.
It doesn’t have to be that way. I’m hoping to convince you, by the end of this column, that RMDs are a good thing — a really good thing that’s free, simple and a source of security, not worry.
How can this be?
Easy. It turns out that RMDs are a remarkably efficient way to manage your retirement income. They are also a great substitute for the many (usually costly) investment products being offered by what amounts to a new financial service. Let’s call it the retirement income management industry.
Here’s why.
Life expectancy is a good tool for metering retirement spending. And RMDs are conservatively related to your life expectancy. The basis for your RMD increases each year. At age 70, for instance, your RMD number is 27.4, reflecting an expectancy of 27.4 years. In fact, the life expectancy of a man or woman at 70 is 14.4 and 16.6 years, respectively. By age 90 the RMD number has declined to 11.4 years, but expectancy has declined to 4.1 and 5.2 years.
This means it’s just about impossible to outlive your money.
According to a joint life mortality calculator created by financial planner Michael Kitces, for instance, the probability that a man or woman will be alive at age 97 (age 70 plus 27 years) is only 3 percent for a man, 7 percent for a woman. And there is a zero percent chance that bothwill still be alive.
So the odds are pretty much against running out of money because you take RMDs.
RMDs are also a very efficient way to draw retirement income. A 2012 study by Wei Sun and Anthony Webb for the Center for Retirement Research at Boston College found that RMDs were more efficient than the 4 percent rule. It also found that a “modified required minimum distribution” was the most efficient method by far.
What was the modification? Spend according to your life expectancy plus dividends and interest. So if your retirement account earns 2 percent in dividends and interest, you could spend 5.65 percent at age 70. That would reflect the RMD itself (100/27.4)=3.65 percent plus 2 percent, or 5.65 percent).
Will your distribution vary? Yes. But you can minimize that variation by reducing your investment risk. You can test this by using the Monte Carlo tool on the www.portfoliovisualizer.com website. With it, I found that a basic Couch Potato portfolio (50 percent U.S. Total Stock Market and 50 percent U.S. Total Bond Market) would produce a rising real (inflation-adjusted) income for 20 years in 90 percent of all test runs. Even at 30 years, as you turn age 100, the inflation-adjusted income would be greater than the initial income in 90 percent of all test runs.
To put that risk in perspective, a male has only a 20 percent probability of being alive 20 years after turning 70; a woman has a 32 percent chance. Push the age out to 100 and a man has a 1 percent chance of still being alive and a woman has a 3 percent chance.
Take the issue of retirement spending head on and you come up with a fundamental reality: We are far more likely to die before we run out of money or suffer a major decline in real spending power.
Expressed another way: We’re likely to go, long before we lose the flow.
Readers who would like to learn more about this issue should read “The Only Spending Rule Article You Will Ever Need”by M. Barton Waring and Laurence B. Siegel. It provides a good history of the issue and, for students, a thorough list of references for understanding what’s now known as the Safe Withdrawal Problem.
Sources and References:
Wei Sun and Anthony Webb, “Can Retirees Base Wealth Withdrawals On The IRS’ Required Minimum Distributions?”. October, 2012, https://crr.bc.edu/wp-content/uploads/2012/10/IB_12-19-508.pdf
Barton Waring and Laurence B. Siegal, “The Only Spending Rule Aticle You’ll Ever Need,” July 2014 https://larrysiegeldotorg.files.wordpress.com/2014/09/siegel_waring_only-spending-rule-article-youll-ever-need.pdf
Actuarial Life Table, Social Security https://www.ssa.gov/oact/STATS/table4c6.html
Michael Kitces, Joint Life Expectancy and Mortality Calculator https://www.kitces.com/joint-life-expectancy-and-mortality-calculator/
4 thoughts on “Falling in Love with Required Minimum Distributions”
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Thanks for this article. I agree with you about RMDs. I’m wondering why you take yours in January instead of letting it grow tax free until later in the year.
My wife and I like having a lump of money at the beginning of the year. It funds expensive projects that aren’t part of predictable day-to-day expenses.
That said, it would be possible to delay taking the RMD in January and take it in December so the lump of cash is ready for January in the next year. If we ever have a year without lumpy projects, that’s probably what we’ll do. But I’m not holding my breath!
I’m so glad you are once again writing in the Dallas Morning News. I VERY much enjoy your columns and your simple, yet detailed and intricate explanations. You are a treasure! Keep writing!
This works fine unless there’s a significant difference in ages and the younger spouse(typically a woman) has minimal assets of their own. Then it becomes a little more complicated when it comes to spending that “bounty”.