Required minimum distributions are the minimum amounts that must be withdrawn from a retirement account annually when the retiree turns 72. They apply to 401(k) plans and similar company-provided plans, as well as most individual retirement accounts. While most account holders take more than their yearly RMD, the withdrawals can be a pain for those who don’t need the money.
As annoying as RMDs can be, they’re designed to make the money in retirement accounts last the retiree’s lifetime. Not to mention, failing to withdraw the required amount comes with a steep 50% penalty.
As is the case with most retirement strategies, retirees can’t rely on RMDs alone. Speaking with CNBC, Ed Slott, IRA distribution expert and founder of Ed Slott and Co., says: “You can use it as a plan — as a guideline — but it’s highly unlikely you’d stick to it throughout your whole life. You have to plan for life happening.”
The amount withdrawn each year is calculated by dividing the most recent year-end balance of each qualifying account by the retiree’s “life expectancy factor” as defined by the IRS. While the new tables assume a longer life expectancy, the amount that must be withdrawn will still increase over time, since one’s life expectancy declines each year.
Here’s how life expectancy gets factored into the RMD calculation: for someone who’s 72 years old, it’s 27.4 years. If that person has $1 million, the RMD would be about $36,500 ($1 million divided by 27.4). By comparison, someone with $1 million who is age 95 has a life expectancy of 12.2, which would mean an RMD of about $82,000. The tables carry out to age 120, at which point the factor becomes 2.
Using RMDs as a guideline to ensure not outliving one’s nest egg is like the “4% rule,” which involves withdrawing 4% in the first year of retirement and in subsequent years taking that same amount (adjusted for inflation annually). This withdrawal rate is intended to make sure a retiree’s assets last across a 30-year retirement, starting at age 65.
However, it’s impossible to predict how the market will impact a portfolio over time under either approach, which also depends on the investments in the portfolio and their risk exposure. Regardless of the income strategy, it’s important to have a cushion for unexpected expenses.
“It all sounds good until you need more than the amount you planned for,” Slott adds.
There is an assortment of retirement plan options for self-employed clients and for financial advisors looking to meet the income needs of their clients. Nationwide a variety of actively managed ETFs for advisors that cater to a range of investment exposures and strategies, including seeking a measure of downside protection within the major indexes.
For more news, information, and strategy, visit the Retirement Income Channel.