A better retirement withdrawal strategy — from the tax man

Oct 21, 2012 @ 12:01 am

By Darla Mercado

Uncle Sam may have helped crack the code for the optimal income withdrawal percentage in retirement.

The Internal Revenue Service's formula for required minimum distributions — the amount that individual retirement account holders and participants in qualified plans must take after reaching 701/2 — can form a reasonable basis for sustainable income withdrawals.

A new brief from the Center for Retirement Research at Boston College suggests that not only does the IRS' RMD perform as well as the traditional option of living on stock dividends and interest, it also outperforms the tried-and-true 4% rule. The rule assumes that most retired clients can spend up to 4% of their nest egg annually, adjusted for inflation, without worrying about running out of money.

Researchers analyzed a hypothetical married couple of 65-year-old retirees.

The husband receives a Social Security benefit of $12,000 annually, while the wife receives $6,000 through a spousal benefit, making their total household income $18,000 per year. Excluding the value of their home, the couple also holds $250,000 in financial assets invested in a mix of stocks and risk-free bonds, with an allocation that changes with age, realized returns and the assumed coefficient of risk aversion.

The bonds have an assumed real interest rate of 3%, while stocks are assumed to have a real return of 6.5%.

Tweaking the RMD formula so that withdrawals for the couple begin at 65, the retirees pull a growing percentage of assets each year for their income, starting at a rate of 3.13% and then going as high as 15.87% at 100.

To compare this strategy with others, the paper used a measure called Strategy Equivalent Wealth, which represents the factor by which the dollar value of the couple's wealth at 65 must be multiplied so that they are as well off as a household that follows the optimal strategy. Researchers gave the optimal strategy an SEW of 1, while those that are suboptimal are greater than 1.

The 4% rule had an SEW of 1.49, making it the worst method of the four strategies analyzed.

The RMD formula had an SEW of 1.39, while living on interest and dividends had an SEW of 1.36.

Basing withdrawals on life expectancy had an SEW of 1.29.

A modified RMD strategy that would consume interest and dividends, plus the RMD percentage, fared best, with an SEW of 1.03, according to the CRR's research.

The success of the RMD strategy lies in its simplicity and the fact that it reduces the temptation to chase down dividends, according to the paper.

However, its use of actuarial data is also a factor.

The IRS intended IRAs — at least at the very beginning — to help people save for and live in retirement, and not for savers to turn the accounts into estate-planning vehicles, according to Eric Smith, an agency spokesman.

The IRS' life expectancy tables assume that a 55-year-old will live to 84.6.

dmercado@investmentnews.com Twitter: @darla_mercado

0
Comments

What do you think?

View comments

Recommended for you

Sponsored financial news

Featured video

INTV

Diversity & Inclusion Awards: 2018 nominations are open

Editor Fred Gabriel and special projects editor Liz Skinner discuss the nomination process for InvestmentNews' inaugural Diversity & Inclusion awards.

Latest news & opinion

Cetera reportedly exploring $1.5 billion sale

The company confirmed it's talking to investment bankers to 'explore how to best optimize [its] capital structure at lower costs.'

SEC Chairman Jay Clayton outlines goals for a new fiduciary standard

Rule should provide clarity on role of adviser, enhanced investor protection and regulatory coordination.

Advisers bemoan LPL's technology platform change

Those in a private LinkedIn chat room were sounding off about fears the independent broker-dealer will require a move to ClientWorks before it is fully ready.

Speculation mounts on whether others will follow UBS' latest move to prevent brokers from leaving

UBS brokers must sign a 12-month non-solicit agreement if they want their 2017 bonuses.

Maryland jumps into fiduciary fray with legislation requiring brokers to act in best interests of clients

Legislation requires brokers to act in the best interests of clients.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print