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Those pesky minimum withdrawals required from retirement accounts that take effect at age 72 can have a nice upside: helping you make your money last for a lifetime.
Generally speaking, if you were only to take your annual RMDs, that would mean those accounts would not be depleted during your lifetime. Of course, as with most things in financial planning, strategy cannot be viewed in a vacuum.
“You can use it as a plan — as a guideline — but it’s very unlikely you’ll stick to it your whole life,” said Ed Slott, CPA and founder of Ed Slott and Co. “You have to plan life happening.”
RMDs apply to 401(k) plans — both traditional and the Roth version — and similar work plans, as well as most individual retirement accounts. (There are no RMDs for Roth IRAs during the account holder’s lifetime. However, beneficiaries who inherit Roth IRAs must take RMDs.)
While most account holders – 79.5%, according to the IRS – take more than their annual RMD, withdrawals can be a thorn in the side of those who don’t need the money. However, if you fail to withdraw the required amount, you incur a 50% penalty.
Current law states that you must take your first RMD for the year in which you turn 72, although this required initial withdrawal may be delayed until April 1 of the following year. If you are employed and contribute to your company’s pension plan, RMDs do not apply to that particular account until you retire.
The amount you must withdraw each year is determined by dividing the most recent year-end balance of each qualifying account by your “life expectancy factor” as defined by the IRS. The agency has new life expectancy tables which are effective this year.
Although the new tables assume that you will live longer, which means a smaller RMD compared to earlier calculations, the amount you need to withdraw will generally increase as you age, as your life expectancy decreases each year. (See chart below for illustration.)
Here’s how life expectancy is factored into the RMD calculation at different ages: For a 72-year-old, it’s 27.4 years, according to the IRS chart used for lifetime RMDs. 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 aged 95 has a life expectancy of 12.2 years, which would mean an RMD of around $82,000. The tables apply up to age 120, at which time the factor becomes 2.
Using RMDs as a guideline to ensure you don’t outlive your assets is similar to the so-called 4% rule, generally speaking.
This strategy is to withdraw 4% in the first year of retirement and in subsequent years to take the same amount, only adjusted for inflation annually. This withdrawal rate is intended to ensure that a retiree’s assets extend over a 30-year retirement, beginning at age 65. (However, recent research suggests that a better rate would be closer to 3%).
It should be noted that it is impossible to predict the market impact on your portfolio from year to year using either approach, which also depends on the investments in your portfolio and their exposure to the risk.
And whatever income strategy you implement, it’s also important to remember to have a cushion for unexpected expenses, Slott said.
“Everything looks good until you need more than the expected amount,” he said.