It isn’t wise to complain about some things too loudly. Yes, I’m talking about the people who mutter about the cost of repairing their BMWs or the scare they had landing their jet at Aspen’s airport.
The cruel injustice of required minimum distributions is a bit further down my list of inappropriate complaints, but it’s there. If you don’t know what RMDs are, you’re probably well under age 70. So listen up: the exam is coming.
Required minimum distributions are what we all experience at the end of all those qualified plans that allow us to put aside income, tax-deferred, while we are working. We love those plans because they help reduce our tax bill. But all good things come to an end.
Required minimum distributions are the way our government collects, with interest, the taxes we deferred. They start the year you turn 70 ½. They dictate the percentage of your account value you have to take out each year. The initial rate starts at 3.65 percent at 70. It rises to 5.37 percent at 80 and 8.77 percent at 90. Each year, regardless of need, you must withdraw the prescribed percentage and pay taxes on it.
And that’s the rub. Some people don’t want to touch their retirement plan money. Complaints about required minimum distributions are inappropriate for two major reasons. One is that most people never face this “problem”— they need to start withdrawals much earlier. If you get to age 70 without making a withdrawal, you are one lucky dog. You’ve benefited from more years of tax deferral than the vast majority of retirees.
The other reason is that required minimum distributions also happen to be a remarkably simple, effective, and convenient way to manage your income in retirement. They escalate your withdrawal rate, year by year, and may actually be more efficient tools for using that money than the safe withdrawal rate plans that have been discussed in this column for years.
You can explore this by using a free online calculator on the Fidelity website. It calculates the RMDs for any starting sum at an assumed rate of return out to a wildly optimistic age 115. The calculator doesn’t figure the ups and downs of the markets, but it does give you a pretty good idea of what can happen under different return assumptions. Here are two sample results.
- Assuming a modest 5 percent return on $100,000, your initial withdrawal will be $3,774, rising to a peak of $8,126 at age 93. The account value will peak at $105,644 at age 78. The value of the account would be reduced to $40,225 by age 100, but your income would still be $7,164. It helps to consider, here, that only 18.5 percent of those surviving to age 70 will still be alive at age 93.
- Assuming a historical balanced fund return of about 8 percent on the same starting value, your initial withdrawal will be that same $3,774, but it will peak at $17,553 at age 98. The value of the account will peak at $157,030 at age 88. At age 100 the value of the account will be $100,361. Only 5.7 percent of those surviving to age 70 will still be alive at age 98.
Actual required distributions will vary, of course, because the value of your tax-deferred account can vary greatly from year to year.
What this tells us is that RMDs can deliver a nicely rising income for 20 years or more. At the same time, our mortality virtually guarantees that most people will leave some money on the table when they die.
Finally, a recent study at the Center for Retirement Research at Boston College found that Required Minimum Distributions were a very efficient way to distribute retirement income compared to a number of other well-known methods. Researchers Wei Sun and Anthony Webb created an efficiency index and found that RMDs scored better than the popular four percent rule. A modification of the RMD rule— taking the RMD plus dividend and interest income— was even better. (You can find the study on the Center for Retirement Research website.)
The message here? Taking your yearly RMD is a good way to prevent a lot of hand wringing. It’s simple and it works.