Rules tell you how much you must take in an RMD, but not how much you can, or should, take.
The federal government is explicit about how much you must take from your tax-deferred employer plans and IRAs each year after you turn 70½. What’s not as clear is how much you should take each year to have enough to live the way you want while making sure that your assets will last as long as you do.
One guideline is that you should withdraw no more than 3% to 4% of your accumulated retirement assets in the first year you’re retired, increasing the withdrawal by the inflation rate in each subsequent year. So, for example, if you withdrew 3.5% of $500,000, or $17,500 in year one, and the inflation rate was 2%, you’d take $17,850 in the second year.
Limiting withdrawals from retirement plans means that you must be able to draw on other sources of income to meet your living expenses and cover unexpected costs. But you also have the flexibility to make modifications to your strategy when necessary.
Keeping it up
The rate of return you achieve on your retirement assets while you’re contributing is a key factor in determining the long-term value of your account. It’s no surprise that an average annual return of 6% produces a substantially larger account value than a return of 4%. And as retirement years stretch out, it’s equally important to achieve a strong return on the money that remains in your accounts.
That’s one of the reasons many retirement advisers stress the importance of holding equities — including stocks, ETFs, and stock mutual funds — in your retirement accounts much later into retirement than has traditionally been recommended. In the past, advisers often suggested that you allocate a percentage of your portfolio equal to your age to fixed-income investments.
In other words, if you were 65, then 65% of your holdings would be in bonds and similar investments. But you’re increasingly apt to hear that, at 65, up to 50% or more of your investment portfolio should still be in equities. The shift to a higher equity allocation is to allow you, when you begin withdrawing, to take as much as you’re required to take, and perhaps more, without running out of money. The risk, of course, is that the equity markets can drop at any time, reducing the value of your account and the amount that you can afford to withdraw without reducing your principal.
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A hypothetical plan
There’s no way to protect yourself completely from volatility in the equity markets without risking slow death by inflation. But there may be ways to produce a stream of income while maintaining some long-term growth.
One possible approach, which you might consider, is to think about your retirement as a series of three ten-year periods. To provide the income you need for each of those periods, divide your total account value into thirds. Invest one-third in secure fixed-income investments, such as an annuity with a ten-year, fixed-term payout period or a series of bonds with staggered maturity dates — a ladder — designed so that one bond matures each year over the ten years. Spend the income these investments produce. If you’ve created a bond ladder, you may need to withdraw some or all of the principal of the maturing bond each year to meet your required minimum distribution requirement if you hold these assets in an IRA.
Invest the remaining two-thirds in equities and don’t withdraw that principal or the earnings it produces for ten years. If the market is strong for much of the period, and you manage your investments wisely, they have potential to grow significantly in value. And even if there are periods of slow growth or market declines, not having to liquidate those assets may give your portfolio enough time to recover and resume growth.
Then, when the first ten-year period ends, begin the cycle again.
Here’s a hypothetical example of this approach: Suppose the value of your account when you begin is $300,000. You invest $100,000 in $10,000 bonds, one maturing each year for ten years, and the remaining $200,000 in equities, seeking an annualized return of 7% or better annually for ten years.
When the 10-year period ends, you can follow the same approach once more, allocating a third of your assets to spending, and investing the rest.
But remember, there are no guarantees in investing. It’s smart to work with a financial adviser before you invest. And you must weigh the risks of losing money against potential returns.
Anticipating the inevitable
While your required minimum distribution is based on life expectancy rather than stated as a percentage, what you withdraw is a percentage of your account value. For example, anyone who takes withdrawals with a distribution period of 22.9, which it is at 75, will have to take out 4.37% of his or her account value.
Each year, as your life expectancy decreases, the percentage of your account that you’re required to withdraw increases. If the account is not growing at least as fast as you’re taking money out, it will eventually run dry. That’s okay, provided you won’t need the income. But to offset these larger withdrawals, you might decide to invest at least some of your portfolio to realize higher returns at a level of risk you’re comfortable taking.
How Much Should You Withdraw From Your IRA? by Inna Rosputnia
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