Q. Next year, 2017, will be my first year to take a required minimum distribution (RMD) and I am trying to find the best way to do it. Vanguard recommends waiting until the end of the year, then taking the money out in one lump sum. They believe waiting allows dividends and interest to compound. Some recommend taking it out at the beginning of the year. My thinking is to have the dividends, interest, and capital gains taken out as accrued, then take the remaining amount needed out in December. What is your recommendation? ---T.G., Plano, TX
A. The decision about when and how to take your required minimum distribution has two important elements, investment efficiency and personal budgeting. The Vanguard recommendation to wait until the end of the year is keyed to investment efficiency. It allows your money to grow for as long as possible.
The other element is practical— what’s the best way to deal with money you are likely to need and spend?
If you take the RMD at the end of a year, it can be held for spending in the next year. If you take the RMD at the beginning of a year, it can be held for spending in that year. Either way, it is useful to have a lump sum of cash available to spend over a 12-month period.
Why? Life is full of uneven spending lumps. You’ve got big annual bills, like real estate taxes and insurance. You’ve got other, less predictable, spending such as vacations, home repairs and major insurance deductibles. If you have a fixed reserve of cash at the beginning of a 12-month period, you’ll be able to deal with the lumps better than if you spread income evenly throughout the year.
If we ever have high interest rates again, it might pay to do some hand-wringing about investment efficiency, but with money earning nothing, convenience and simplicity are the goals to pursue.
Q. If bonds are risky, what do Couch Potato investors do? Do we get off the couch and use a CD ladder to replace the bonds? I realize the danger of inflation, but at least you wouldn’t lose the principal. ---K.G., Tyler, TX
A. The answer here depends on how dedicated you are as a Couch Potato investor. If you are fully committed to investment indolence, you will rest calmly with the notion that it will all work out pretty well. But if you want to be a bit more active, you could establish a ladder of certificates of deposit or Treasury obligations. This, of course, entails some effort, which a devoted Couch Potato investor will avoid if at all possible.
A fixed-income ladder is a portfolio of certificates of deposit or Treasury obligations that mature at different times. As a result, you will always have something maturing, and you’ll enjoy the yield of a longer maturity obligation while having a shorter average maturity.
A dirt-simple ladder would be a Treasury obligation maturing in one year and another in two years. When the first matures, a new two-year Treasury replaces it. This means half your investment is available, in cash, every year, but your yield will be from two-year maturity securities.
Another ladder would be CDs that mature in one, two, three, four and five years. As each matures it is replaced by a new five-year CD. Ultimately, you will be receiving a 5-year CD yield but have an average maturity of about 2.5 years.
Some people build taller ladders, reaching out to 10 years or more. How tall a ladder you build depends on how much money you have, how insulated you want to be from interest rate risk and how much easily available cash you want to have.
One of the nice features of fixed-income ladders is that if you have an emergency need for cash, you can sell or redeem your shortest maturities first. This will limit your losses.