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LOTS OF RESEARCH has been done on the best way to generate retirement income. It’s one of the most popular topics on HumbleDollar. I think this popularity is driven by two things: its obvious importance—and the fact that there’s no one right answer.
By contrast, figuring out how much we need to save for retirement is relatively easy. It isn’t hard to pick a future retirement date, or at least a range of years during which we’ll likely retire, and then figure out how much we ought to be saving. But when it comes to generating retirement income, none of us knows how long we will live, what markets will do or what our health care needs will be. There are also subjective questions, like how much do we want to leave to our heirs?
Last November, Morningstar released a report analyzing a variety of methods to determine a retiree’s safe portfolio withdrawal rate. At 59 pages, it’s quite extensive, but well worth the read. It analyzes several withdrawal strategies, provides pros and cons for each, and ends with a process to develop an individual retirement income plan.
One of the options it considered is the so-called RMD withdrawal strategy. Under this plan, annual withdrawals are based on your portfolio’s previous year-end balance. You withdraw a percentage of your portfolio consistent with the required minimum distribution (RMD) guidelines provided by the IRS life expectancy tables. Under this scheme, your income would rise or fall as your portfolio’s value changes.
The online financial planning magazine ThinkAdvisor recently asked three retirement planning experts for their views of the RMD withdrawal strategy versus the better-known 4% rule. Under the 4% rule, you withdraw 4% of your portfolio in year one, and then increase that amount by inflation in year two and subsequent years. The 4% rule has been criticized for a host of reasons. Some say 4% is too high given today’s low bond yields and high stock valuations. Others say the strategy is too robotic in the face of plunging financial markets.
Michael Finke, a professor at the American College of Financial Services, doesn’t like the possible income shock of the RMD approach. If a retiree is heavily invested in stocks, a serious down year could slash her income the following year.
“A better retirement plan evaluates how much of the budget is flexible and how much is inflexible,” Finke said. “Then build an investment plan that doesn’t expose inflexible spending to either market or longevity risk.” Finke said his experience shows that about two-thirds of retirees’ expenses are fixed. The RMD strategy might work for just the subset of the portfolio devoted to flexible spending, because the strategy tends to deliver fluctuating amounts of income, Finke argued.
By contrast, David Blanchett, former head of retirement research at Morningstar, likes the RMD approach because it ties withdrawals to a retiree’s age. He recommends that retirees get a realistic estimate of their longevity, however, rather than just relying on the IRS tables.
Blanchett gave this example: If you estimate your life expectancy as 20 years, you could start with a 5% withdrawal rate. If you have 25 years left, then a 4% withdrawal rate is more appropriate. What if you’d previously been withdrawing 8%? The RMD strategy delivers a wakeup call that you need to cut back.
Christine Benz, director of personal finance at Morningstar, said the RMD method is efficient at “helping to ensure that a retiree spends most of his or her money.” But she said the method is “not very livable” because it can deliver extreme fluctuations in income to retirees with higher stock allocations.
Another concern Benz raised: The RMD life expectancy tables are based on average life expectancies. Retirees with longer-than-average lifespans run the risk of running out of money. Also, their balance might dwindle when they’re elderly—just when they may face huge expenses for medical or custodial care.
In short, three of the leading voices in retirement planning gave three different assessments of the RMD strategy. I find this same kind of disparity among my friends, family and colleagues. We each look at the retirement income question through our own lens.
For example, some might take modest withdrawals so they have plenty left to meet high medical costs late in life. Others might hope for the best and spend more freely. Yet others choose to live frugally throughout retirement, in hopes of leaving the maximum amount to their kids.
Each of us must answer questions like these for ourselves and plan accordingly. Figuring out what’s most important to you and your spouse is essential. Many people’s views are based on their experiences with their parents and family. This is useful and should be a part of the analysis. But we should also be open to new ideas. Retirement income planning is such a complex subject that we can all benefit from hearing what others think.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.
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It’s great to look at the RMD methodology as well as your income streams. Perhaps it’s just me but I am just as desperately looking at our spending projections, both needs and wants-based. I know that at age 80 we will not be able to do some of the things we want to do, so if that means our withdrawal rate for any particular year (within some degree of reason) prior thereto exceeds the magic 4% or any other metric, so be it.
It is interesting reading the replies on how to fund retirement. Two obvious facts: The H.D. readership (whether retired or still working) is extremely well off and so far above the average citizen it is as if we are all in Never-Never Land. Maybe we are. How we choose to invest and to spend is not too important as there seems to be plenty of “dry powder” to go around.
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Although I may be at the lower end of the spectrum reflected on Humble Dollar I am grateful for any advantage that may be available to me now that I am long out of the work force. I believe there is a real need to economically educate a much larger spectrum of America’s workers, but I have no idea how to accomplish that. Thank you all for sharing your ideas.
On a side note, I vaguely recall a HD contributor in the past sharing a table showing the draw-down percentages using the RMD formulas for ages prior to 72 1/2 (% for withdrawals based on IRS life expectancy tables).
For those that buy into the “RMD (or equivalent) drawn-down” approach based on life expectancy (and likely could need to begin TQ account withdrawals prior age 72 1/2) that table was very helpful for simplifying the math on a target % to take annually.
Of course, I cannot find a copy of it anywhere. Would welcome a link from any HD reader who finds it.
Try Appendix B of https://www.irs.gov/publications/p590b#en_US_2020_publink1000231236
Rick, thanks for a very nice review of a complicated subject. One thing I’m thankful for, now that my wife and I are at the withdrawal stage, is that we kept our cost of living modest during our working years. That baseline has made it a lot easier to continue funding a similar amount in retirement.
If you enjoyed work and didn’t retire until 60, like me, there’s a significant chance you’ll never have to worry about withdrawal rates. Social Security alone will pay my wife and me over $70K when we start drawing it in 4 years, and that’s in 2022 dollars. Adding a little to that from our investments is all we will have to do to maintain our current lifestyle. We could spend a lot more but we are already very happy, so why?
Apologies for the basic question, but its one that has dogged me over the years. Why do we equate withdrawal rate with spend rate? I’m not there yet, but the projections on my RMDs point to a high withdrawal amount. I honestly don’t see how I could spend it in addition to all the other income streams, so am planning on just putting it in a taxable brokerage account. As a general rule, do most spend what they withdrawal? To me its just a tax event but it seems thats not the general consensus.
I agree — just because the government says you have to withdraw the money doesn’t mean you have to spend it. But given that most retirees have relatively modest portfolios, I suspect most do.
The R in RMD stands for required. It’s not merely a possible strategy. A retiree must withdraw that much. Start with social security, add your RMD, add any pension and any fixed annuities, then try to figure out how much more, if any, you will need this year. See what your RMD plus any additional necessary withdrawal makes your total withdrawal rate and try to evaluate whether that rate is likely to be sustainable.
Yes, you are required to withdraw the money from your tax sheltered accounts, but you are not required to spend any of it. I had to start RMDs three years ago, but I simply moved the money into my taxable account, I have yet to spend any of it. Next year I will move into a CCRC, and at that point I will have to start withdrawing from my portfolio, but since the RMD formula is designed to exhaust the accounts, it does not attract me as a way to determine my spending.
RMDs are indeed required for retirement accounts, except Roth IRAs. But the RMD withdrawal strategy is the notion that you apply the resulting withdrawal percentages to all accounts, not just traditional retirement accounts, and you do so throughout retirement and not just starting at age 72, when RMDs become required for traditional retirement accounts.
All the expert talk seems to focus on withdrawals, but I think it should focus on income streams, steady streams. That could be a combination of interest, dividends or even annuities. I know annuity is a dirty word to some, but it’s steady income without the concerns mentioned.
Together with SS those streams might cover all or most of the basic expenses for many retirees.
The other thing is, if a person follows a percentage or RMD withdrawal strategy, there is nothing saying they have to spend each withdrawal, if not needed.
I sure don’t know the answer. I watch scores of those YouTube videos and I’m not sure anyone knows the right answer or there is no right answer.
It’s like the question about replacing pre-retirement income. I know people who insist they can be comfortable on 40% or pick any number between that and 100%. The great variable is lifestyle.
Thank you Sir R. I agree, steady, guaranteed incomes should be a big consideration in retirement. Knowing the amount deposited in the bank every month has a nice comfort to it. Being human is to be adaptable to change in economic circumstance and having a known income every month makes doing that easier.
Early in my work life, I was looking at the end of it and knew “well finished is well started.” I always learned the retirement benefits offered by a prospective employer as a consideration as a possible work place. I had two careers in life, both with good retirements. Both those lifetime incomes and S.S., started at it’s max are more than enough.
Having extra money while working, I also opened two IRA accounts and choose the annuity option for life. When I start the regular distributions, it will take care of the RMD and, knowing I’ll have extra disposable income, I’m working on where to put the funds.
I don’t see much conversation on HD about another traditional investment, that being real estate. A big consideration I have is passing it down. There’s several problems with doing it with IRA or regular account money.
Homes held in trust, paid for and professionally managed provide another ‘chunk O change’ that is inflation proof.
As I type, I’m in a city far from my home, investing in another home, to be passed on down. With the extra annuity income, I’ll be paying off this, another home in preparation for; obtaining another and so on. All with the intention to set my two sons up for a lifetime of extra income.
Yes once you know there is an amount of cash available every month, it’s far easier to plan.
A few years ago my mother was considering an annuity. My position was that the annuity doesn’t track inflation, so a period of high inflation would destroy purchasing power. The annuity would lock in that loss of purchasing power, with no way to recover from it. Even though you may not see a numerical loss, like you could with stocks, the loss in value is effectively the same, but with the annuity you no longer have optionality. She decided against the annuity, and at 7.5% inflation, that seems like it was a good move.
Annuity seems like a sweet word to me! I will annuitize three decades worth of contributions to TIAA-CREF next year. I’m astonished that the annual lifetime annuity payment will exceed my final salary. Had my 35-year old self fully understood that that I was saving towards my own “pension”, I would have commended the annuity product to anyone within earshot.
I do have some qualms about inflation’s effect on a fixed annuity, but plan to resolve those by deferring SS until age 70.
I have been (early) retired from the vineyards of academic administration for the last 7 years. My wife and I use a “multiple streams of income” approach, consisting of US social security; a TIAA two-life annuity; a focused dividend growth stock portfolio in a taxable account; and a small pension and “social security” from my final job outside the US.
The stock account provides 44% of our income; the balance derives from the other income streams, which act like a collective bond allocation. We also have funds in one T-IRA and two Roths, which we are reserving against long term care expenses. RMDs from these will start in a few years and they will be reinvested in a taxable account and held for the same purpose.
TIAA has worked out very nicely so far, providing 24% of our income: Over the last seven years our payments have increased 7.6% cumulatively. This increase has come from TIAA’s annual, voluntary increases (mostly small or occasionally zero in some years; but they have added up). We sleep well at night with little worries about volatility in the equity markets.
I have money in the TIAA ‘traditional’ account that I plan on using as an annuity. I’m always surprised by how many of my colleagues don’t invest any money in that particular account. It’s encouraging to hear your experience with it.