Q. How are Required Minimum Distributions derived? I have seen the published tables, but there is no explanation as to where or how these amounts are derived. I'm retired and trying to adhere to the commonly held view that a retiree should try to limit his withdrawals from his retirement portfolio to about 4 percent annually. Are these government required withdrawals aligned with this same type of guideline? —J.H., San Antonio
A. Yes, they are. When IRAs were created the intention was to encourage people to save for their retirement. It was not to create a large pool of tax-deferred assets that could be passed on to the next generation. So Required Minimum Distributions are keyed to life expectancy. The distributions increase as life expectancy declines. As a result, the value of the account should decline over time.
According to a recent U.S. Life Table from the National Vital Statistics Reports, the life expectancy of all Americans at age 70 is 14.9 years. This figure combines both sexes and all races so it is possible to have a significantly longer, or shorter, expectancy depending on your race and gender.
The required distribution for a single 70 year old from the Uniform Life Table used by the IRS is based on a longer life of 17.0 years. That requires a distribution of 5.88 percent (100/17). This leaves a fudge factor for the actual time people are to live. By age 80 the RMD factor is 10.2, or a distribution of 9.8 percent. Since the distribution is always figured from the amount in the account at the end of the previous year, the account should be close to empty by the time of death.
The distribution requirement is lower for couples because the life expectancy of a couple is longer than the life expectancy of a single individual. The joint life expectancy of a 65-year-old couple (when the last is expected to die) is 26.2 years. The same figure for 70-year old couples is 21.8 years. This is significantly shorter than the 27.4-year figure used in the IRS Uniform Life Table for calculating RMDs. It would require an initial distribution of only 3.65 percent.
One consequence of the rising distribution rate is that if you have a reasonable return on your retirement account money, both your income and your asset balance are likely to increase for quite a few years before they start to decline. You can see this for yourself by using the RMD calculator on the Fidelity website and checking the projection of annual distributions and remaining assets. Assuming a 7 percent return, for instance, a couple would see their assets top out at age 85. Their income would top out at age 98. Barring dismal returns or annual distributions far in excess of the required amount, retirees should be able to plan on a rising retirement income for many years.
Q. I found your recent column on "good life decisions" very interesting but I am not sure how you worked up the numbers about powerful shelter decisions. My wife and I are retired, age 75 and 72. We have about $700,000 plus our house. The house is free and clear, and we have no debts, but don’t see how I could sell my $125,000 house, rent a house or condo or buy an RV and increase my savings or discretionary spending funds. Can you tell me how you came up with your numbers? I am a simple man so when I see figures I need to understand where they came from. —D.W., by email
A. The shelter opportunity may not apply to you because the value of your house is only a small part of your net worth. It is also about half the value of the median home— so shelter isn't the big lever on your retirement that it can be for many people, particularly those who live in high cost urban areas. The annual operating costs on your house (taxes, insurance, utilities, services, maintenance and replacements) probably don't exceed $8,000 a year. So it would be difficult for you, I think, to find a rental that would cost that little when utilities were included.
A more typical example would be a couple with a $300,000 house that cost about $18,000 a year to support. If they sold it they could pay up to $18,000 a year for a rental including utilities and have $300,000 to invest— more than the vast majority of workers have saved. If they drew on those savings at 4 percent a year it would increase their spending money by $12,000 a year.