Determining When to Switch to the RMD

by Charles Rotblut, CFA

The decision as to how much to withdraw from a retirement portfolio is complicated not only by longevity risk, but also by tax issues. The commonly cited 4% withdrawal rate can be trumped by the Internal Revenue Service’s (IRS) required minimum distribution (RMD) rules for retirement plan accounts. Determining which withdrawal rate to use requires an understanding of the RMD rules and a calculator.

The Required Minimum Distribution

An RMD is the annual minimum amount a retirement plan account owner must withdraw beginning in the year he reaches 70½. An individual can delay the RMD if he retires after age 70½. However, if an individual holds an individual retirement account (IRA) or owns 5% or more of the business sponsoring the retirement plan, an RMD must be taken starting the year the individual turns 70½.

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Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/charlesrotblut.


Discussion

Dave Gilmer from Washington posted 10 months ago:

Charles,
I just don't see how you can make any reasonable prediction on when the "Classic" 4% rule and the RMD rates will "come together," since one is based on a starting dollar amount and the other is based on a portfolio percentage. The intersection is thus highly dependent on market returns and how much money is actually withdrawn from the portfolio.

The biggest issue, which you do mention, is that very few have 100% of their retirement money in an IRA type investment. If they do, it seems like very poor planning on their part, especially as more and more 401k Roths become available.


Charles Rotblut from Illinois posted 10 months ago:

Hi,

I gave an example of when the change would have occurred based on a model, but in the very next paragraph, I wrote:
"In a real-life scenario, the point at which the RMD becomes larger than the 4% withdrawal rate depends on many factors, including when a person retired, the rate of inflation and the type of accounts held. "

-Charles


Kenneth Espanola from Rhode Island posted 10 months ago:

Not sure what "Loading" is talking about as we have been sold a bill of goods over the years. Stash money in tax deferred vehicles and the government will not tax you on the principal or the interest, capital gains etc until it is taken out. I don't see that as poor planning. Hindsight is always 20/20.


John Horman from Illinois posted 10 months ago:

I was told to use tax deferred money last by my tax accountant because ira's are growing deferred util withdrawal.


bob from New Jersey posted 10 months ago:

you don't mention annuities,i would like to see how to withdraw from annuities someday.


Macallan from Texas posted 10 months ago:

If you don't need more, take the RMD. Why not?


ras from Colorado posted 10 months ago:

I am 76 and need to take more than 4% out of the total of my accounts. The figures show I can only live until 92..so be it.


David Lamb from Utah posted 10 months ago:

Percentage rules of thumb are worthless. Nobody needs the same percent. I don't happen to need any (being an AAII member) so I either take the MRD by moving stock from my IRA acct to our joint account, or moving cash there. That's not complicated. But for those who do need the money it seems to me they should figure out the absolute minimum amount (not percentage) they need to get by at and go with that amount. It will either get them through or it won't. But diddling with percentages is a waste of time and most likely gives false hope where it's not justified.


hmarrett from New York posted 10 months ago:

Remember the RMD take out is required even if you do not need the money for living expenses. Also the 4% amount and the inflatiion adjustment amount are maximum amounts. If you do not need the mony do not take it out.


Robert from Pennsylvania posted 10 months ago:

I have been retired for a year now and am receiving monthly distributions amounting to six percent.I am very blessed to average 10 to 12 % annually and investing very conservative.Not only have I doubled my working salary,but also my 401 continues to flourish.I give all credit to GOD,you can not out give him.Praise the Lord.


Richard Billington from Michigan posted 10 months ago:

Just because the RMD requires you to take the money out of your IRA/401K does not mean you have to spend it. Managing your money needs and complying with the RMD are different issues.


Dave from Washington posted 10 months ago:

It seems the site is having trouble displaying the names on the post. This has been going on for some time??

In any event the comment I made about having all your money in just one tax-deferred vehicle is poor planning relates to a couple of well know facts:

1. One, there is no mathematical difference in the long term return of a Roth or non-Roth account, given the same tax situations on both ends of the transaction and since we really have no way to predict tax rates 20-50 years in the future the only logical assumption is to hedge our bets by doing some of each. How much of each should be based on your own personal situation.

2. Given #1 above if you have some of both types of accounts, tax-free and tax-deferred, you are a lot closer to essentially controlling whatever tax rate you want in retirement. In so doing - which I would hope would be to lower your tax rate and even bring it to zero in some cases, you will have a "chunk" of money (based on your IRS exemptions and deductions) that you can get out of your "tax-deferred" IRA and pay very little or no tax at all - thus making it a very valuable investment indeed.


Dave from Washington posted 10 months ago:

Charles,
My earlier comment about the 4% crossover was really more to find out if you have corrected your thinking on how the 4% rule is suppose to work, because in your article last month you seemed to have mis-represented how the classic 4% rule actually works and if you are still using the same calculation, then it stands to reason that the only correct statement is the conclusion - that you can't really tell when it will cross over the RMD.


Charles Rotblut from Illinois posted 10 months ago:

Dave,

An addendum assuming the initial withdrawal amount is changed can be found at:
http://www.aaii.com/journal/article/addendum-adjusting-retirement-withdrawals-for-inflation

The different calculation really does not change the example I gave in this article about when to switch to the RMD. As I said earlier, it is just an example and the actual point as to when the RMD exceeds 4% withdrawals depends on several factors.

-Charles


M N. Becci from Virginia posted 10 months ago:

Talking about "when to switch" shows a misunderstnding of the two separate issues.

No matter how one calculates their annual investment portfolio withdrawal amount (fixed 4%, initial 4% with annual inflationary increases in amount or in w/d %, % with an annual cap & floor, or recalculated each year, etc.) he or she should figure out which method works best & easiest for them & stick to it, regardless of age or RMD issues. The "investment portfolio" is not limited to the various retirement accounts but also includes all taxable accounts other than one's "current spending account" & emergency reserve account.

RMDs only involve withdrawals from IRAs, 403b & similar tax-deferred retirement accounts, and are totally independent of and separate from "investment portfolio" withdrawals. In any year that the RMD amount exceeds the annual investment portfolio withdrawal amount (determined by the 4% rule or whatever varient one is using), the excess is just transferred to one of the taxable accounts in the investment portfolio, where it continues to grow until needed to fund a future 4% withdrawal.

The two distributions really operate independently & do not affect each other.



William from California posted 10 months ago:

The Virginia post is correct. Hopefully, you have saved and invested well so you will have a comfortable retirement. If you have always lived below your means, you may be able to splurge a little in retirement - and even help your children and grandchildren if you want to do so. I have been retired now for about 20 years and my net worth is increasing in spite of a 6+% withdrawal rate this year(RMD) from my IRA.


rdv from Florida posted 10 months ago:

Thanks for the article. Any that leads to more thinking by the readers is worthwhile.
This instance appears rather straightforward to me (as to wonder what I'm missing):

1) If I'll manage to get by on only the 3.65% withdrawal imposed by RMD, great, stick to it (plus inflation) rather than 4%.
2) If too much even at 3.65%, reinvest the excess (or better yet, get a life, lol)
3) If RMD is not enough to live on, increase to 4% withdrawal rate (and adjust expenditures if still strained).
4) If and when RMD exceeds what would be the corresponding inflation adjusted 4%, reinvest the amount in excess of 4%.


GaryOwen from New Hampshire posted 10 months ago:

Three years ago I converted part of my traditional IRA to a Roth. Having channeled all my savings during working years into my 401K, I converted it to an IRA, which I do not consider unwise. My only regret: not having converted it all to a Roth at the outset. savings or income, I had to pay taxes due out of the amount converted, which, of course could immediately be withdrawn tax free. However, I needed to wait three years before any gains could be withdrawn. Now the Roth is worth about 20% more than the traditional, and I will not withdraw anything from it until the traditional is depleted.
The Roth being immune to required minimum withdrawal is no advantage to me unless, at 74, I am fortunate enough to get a job. My small Army pension and monthly ss payments fall short of my needs so I'm withdrawing more than the required minimum anyhow.
If I were to get a decent job I'd immediately convert the remaining traditional to a Roth (paying the taxes out of my income), and begin tax free withdrawals from the three year old Roth. Absent that happy situation, the plan is to withdraw exclusively from the traditional until it's exhausted, then go to the Roth, which (I hope) will have increased more.


harryrich from Ohio posted 10 months ago:

Charles,

I simply can't see a safe alternative to calculating both the RMD and the percentage based draw goal each year. I'm signing up for automatic RMD services and have created a spreadsheet where I plug in yearend balances, CPI-U and the IRS span. It gives me the added draw or percentage reinvestment needed to reconcile the draw goal with the RMD.

As you point out, cases differ. In my case, the initial draw will be 3% which effectively reserves 25%+ of assets for contingencies not covered in other ways.

Thanks for you insights,

Harry


Mike S. from Illinois posted 10 months ago:

Charles,

I think you need to clarify exactly what is the original "4% rule." (I thought Bengen meant to increase the original draw amount by inflation, not the draw percent. The former is more conservative if the portfolio value is increasing.) To run the calculations both ways is fine, but it's really two different rules of thumb.

Why would that make a difference? - Only to someone using a rule blindly as a guide for how much to withdraw. I would hope that most investors are smart enough and able to make adjustments to portfolio withdrawal rate (and standard of living) in response to changing market conditions. If not, which rule they follow is more important.


Rob Blue from Florida posted 9 months ago:

Your article about RMD's and the 4% rule got me thinking about how interest and dividend income play into the mix. None of the portfolio trackers that I am familiar with have a spreadsheet column that automatically pulls in the past 12 month's interest or dividend income for a given investment. I know interest and dividend information is available, but would like to avoid having to key it in manually.

Do you have a portfolio tracker or spreadsheet in mind that automates this information input?

Rob


Anthony Babich from Massachusetts posted 8 months ago:

Kudos for pointing out the Minimum Required Distribution, which most articles on withdrawals tend to ignore. As you pointed out, at age 70, the amount required is the December 31 value of the account divided by 27.4, which was taken from IRS Publication 590, Appendix C Uniform Lifetime Table - this is slightly less than 4%. However, by 75 this number is 22.9 and by 80 it's18.7 (over 5%). If you don't take out the minimum, the IRS will charge you 50% of the difference - the latter is sufficient incentive to withdraw the minimum. Every retiree should download a copy of Publication 590.


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