Let's review RMDs, a hot topic among retirees. When you earn money and put it into a tax-deferred vehicle like an IRA or a 401k, the money is not taxed until you withdraw it. This is a powerful way to save for retirement, courtesy of the federal government. However, good things don't last forever. When you turn 70½ you must take an RMD, a Required Minimum Distribution; the government forces you to take some money out so that they can (finally) get the taxes on it. Remember that this is earned income that has never been taxed.
The amount that you must take is determined by a divisor, which varies as the account holder ages, according to an IRS table, called the Uniform Lifetime Table. (Exceptions: if your beneficiary is your spouse and they are more than 10 years younger, or if this is an inherited IRA, you use different tables.) The divisor at age 70½ is 27.4.
So in the year in which you turn 70½, you use the value of your retirement account on December 31st of the prior year, and divide it by 27.4. For example, if you turn 70½ this year, you would look at your account balance on December 31, 2016.
Say your total retirement account balance was $100,000 on that date. Your RMD is calculated as follows: $100,000 / 27.4 = $3,650. This is the same as saying you take 3.65% from your retirement portfolio because 100 / 27.4 = 3.65. Each year thereafter you go to the table and repeat the exercise.
This is for illustrative proposes only and may not be indicative of your specific situation. Your results may vary.
If you have more than one retirement account you may take your distribution from any or all of them and in whatever proportions you choose, as long as the
minimum requirement is met.
Hold Off at First?
There is, as usual with the IRS, a little quirk. You do not have to actually take your first RMD in the year in which you turn 70½. You can wait as long as April 1 of the following year. The reason to wait would be to put off paying tax on that income for one more year. The downside to doing this is that you then must take two RMDs in that year: the one for the year in which you turn 70½ plus the one for the current year. This would presumably increase your tax bill, and you'd want to be wary that this doesn't float your income up to the next tax bracket for that year.
Back to the Numbers
Assuming you take your first RMD in the year in which you turn 70½ ... in the
second year there is a different divisor, and that is
26.4. If the account balance is still $100,000, you would take $3,787.88. This is the same as saying you take roughly
3.77% from your portfolio. Note that this is a slightly higher percentage than that of the prior year.
Here are the percentages for each year:
Data Source: Craig L. Israelsen, PhD
Even if the money does not grow at all, if you're only withdrawing the required minimum, the portfolio will last beyond age 100. Thus,
the RMD is designed to protect the portfolio. Whether the amounts withdrawn are enough to live on is of course another matter. But if they are, the government has provided us with a perfectly reasonable "sustainable withdrawal rate."
A Recent Conversation
The other day a potential client expressed interest in doing planning work with me and he commented that his money is with a
"big downtown firm." I said, "Then why do you need me?" He replied that they haven't done any planning,
"just handle the investments."
"So you pay them for the investments, then pay me for the plan?"
Our work with you begins with a plan. The investments flow from the plan. Otherwise, how can you construct an appropriate portfolio? On what basis? How do you judge its success?