How Can Government Help?

Overheard in a restaurant.

First man:  “I don’t have to take a Required Minimum Distribution this year. Isn’t that a nice break?”

Second man: “It sure is--- as long as you can get over the inconvenience of not eating all year.”

The immediate topic here is an odd tax break given to those at least 70 years of age by our ever-thoughtful friends in Washington. This year, 2009, it is not required to take a Required Minimum Distribution (RMD) from IRA accounts. The one-year suspension means that older retirees won’t be forced to sell stocks at depressed prices and then pay taxes on the distributed proceeds.

Of course, many retirees won’t have a choice. If they want to eat and pay the cable bill, they’ll need more money than they get from Social Security.  The cash will have to come from their retirement accounts. Basically, most oldsters have their own RMD from necessity, not Congress.

While required distributions are small at age 70--- about 3.65 percent--- the amount rises each year. By age 80 the RMD is 5.35 percent. By age 90 the RMD is 8.77 percent. Ultimately, the amount you must distribute may force the sale of securities at depressed prices. That, in turn, can damage your retirement security.

Young readers take note. This is not an academic problem. Contrary to popular belief, most Americans do not have one foot in the grave by age 70. The fastest growing population group in America isn’t the young. It is people at least 100 years old. According to the Life Expectancy Table for the U.S. population, 7 of every 10 people who reach age 70 will also reach age 80. And nearly 3 in 10 will reach age 90.

So unless you intend to take the poetic path and die a tragic premature death from one of our favored excesses, there is a very good chance you’ll be trying to remain solvent into your late 80s, or longer.

How can we help our savings survive as long as we do?

Here are three simple steps. Please note the complete absence of Wall Street magic.

  • Construct basic retirement portfolios that produce dividend and interest income that is at least the size of your RMD. This means a portfolio that yields at least 3.65 percent at age 70 and 5.35 percent by age 80. This isn’t a slam dunk, but it can be done. Among moderate allocation mutual funds, according to Morningstar data, Vanguard Wellington (ticker: VWELX) was recently yielding 4.31 percent. That would produce enough income to meet RMDs until around age 75. American Funds Income Fund of America, A shares (ticker: AMECX) was recently yielding an impressive 6.47 percent. That would produce enough income to meet RMDs until around age 84.
  • Leaven your portfolio yield with REIT dividends. Real estate investment trusts must distribute the bulk of their income to shareholders. One result is relatively high yields. The iShares FTSE Residential REIT exchange-traded fund (ticker: REZ), which tracks an index of apartment-owning REITs, was recently yielding 7.54 percent. Putting 20 percent of a portfolio yielding 3.65 percent into a REIT index fund would raise the overall portfolio yield to 4.4 percent--- providing current income for RMDs to age 75 instead of age 70. (Full disclosure: I own shares of this ETF.)
  • Avoid forced equity sales by having a near-cash cushion. Eventually, probably in your early 80s, it will be impossible to produce enough current investment income to meet your RMD. You can still avoid forced sales of equities by keeping a portion of your portfolio in near-cash. Then you add some cash to your distribution. If your portfolio was earning about 6 percent, for instance, you could keep about 10 percent in near-cash. Adding near-cash to the 6 percent yield could stave off forced sales of equities. Adding 2.5 percent a year, for instance, could sustain an 8.5 percent distribution for nearly 4 years. This could take you to about age 90.

What do you do after age 90?

Well, that’s a problem that kind of takes care of itself. By then the odds of dying have begun to exceed the odds of running out of money because of high withdrawals. About 13 percent of all those who survive to age 90 won’t survive to age 91. Basically, the rate of dying--- 13.3 percent, rising each year--- is far higher than the RMD, 8.8 percent, rising each year.

On the web:

United States Life Tables, 2004

Retirement Plans FAQs Regarding Required Minimum Distributions

The Uniform Lifetime Table in IRS publication 590

IRS Publication 590: Individual Retirement Arrangements (IRAs)