RMDs: An IRS Change is Making Them Smaller in 2022

 The way you calculate your required minimum distribution (RMD) just changed.

"The methodology of calculating your required minimum distribution (RMD) is rather simple. Your yearly RMD is calculated using a formula based on the IRS’ Uniform Lifetime Table. Basically, this table estimates the maximum number of years (also known as distribution periods) your retirement account may need to make RMDs to you and your surviving spouse" writes CFP Chris Gullotti, for Kiplinger's. 

"Your distribution period gets shorter every year, based on your age. For example, if you take your first RMD in 2022 at age 72, your distribution period is 27.4 years." When you turn 74 it will be 25.5 years . When you turn 80 it will be 20.2 years, etc.  

The RMD amount is based on the value of your retirement accounts at the end of the previous year. "Say your IRA was worth $500,000 at the end of 2021 and you’re turning 72 in 2022. The IRS distribution period for 72-year-olds is 27.4 years. So, if you divide $500,000 by 27.4 years, you get $18,248. That’s what your RMD for 2022." 

"With 401(k) plan accounts... most plan providers will calculate your annual RMD and make the distribution on your behalf."

"With other accounts you have more flexibility, and thus more options to consider. For example, if you have several traditional or rollover IRAs, you first need to calculate the RMD for each individual account. Many IRA custodians will do this for you. The challenge comes when you decide how much to withdraw from each account."

• You can take separate RMDs from each account.
• You can take the total combined RMD from one account.
• Or you can withdraw different amounts from several accounts that, when combined, add up to the total RMD amount.

"Or, you might want to consolidate all of your various IRA and 401(k) accounts into a single rollover IRA with a custodian that calculates your RMDs for you."

"Another option: You may fulfill your annual RMD requirements without having to pay taxes on them by making a qualified charitable distribution of the RMD directly from your IRA custodian to a qualified public charity."

Forget the 4% guideline in these low interst rate times

Based on past investment returns a 1994 study found one could expect their retirement assets to last 30 years if they took out no more than 4% each year, adjusted for inflation. If you aren't familiar with the 4% guideline for withdrawing assets in retirement, search for 4% rule in this blog. The problem with following this guideline today is that interest rates on bonds and stock returns are much lower than when the study was conducted.

The 4% rule doesn’t apply in today’s low-interest world, said retirement researcher Dr. Wade Pfau who is the author of several books on retirement planning and spending.

"The 4% rule is a rule of thumb that says you can withdraw 4% of your portfolio value each year in retirement without incurring a substantial risk of running out of money." “But interest rates are so low today that’s it’s tough to get up to the 4% withdrawal rate without risking running out of money,” Pfau said."
"Low interest rates are not the only risk to clients’ retirement today, Pfau said. Significant market losses as well as continuing market volatility and uncertainty also can destroy a client’s retirement portfolio. In addition, sequence of returns risk – or the timing of withdrawals from a retirement account – also is a factor in a client potentially running out of money. Withdrawing money early in retirement during a down market means that a retirement account balance may never recover."

Pfau listed four ways to manage volatility and longevity in retirement. They are:
1.    Spend conservatively.
2.    Spending flexibility.
3.    Reduce volatility.
4.    Use buffer assets – avoid selling at losses. Examples of buffer assets are cash, cash-value permanent life insurance and a line of credit on a reverse mortgage.

Annuities can be a good way for retirees to overcome low interest rates, Pfau said. “Annuity mortality credits are not affected by interest rates, and that makes annuities attractive in the low-interest rate environment,” he said.
Putting some of the retirement portfolio in an annuity can enable retirees to increase their withdrawal rate while managing risk, he added.


Get the details from writer Susan Rupe: https://insurancenewsnet.com/innarticle/low-interest-rates-challenge-retirement-investors#.Xqjgq5l7mCg

To ease stock-turmoil jitters, try these strategies

Writing for The Wall Street Journal (3/9/20), Anne Tergesen interviewed Dr. Wade Pfau, a leading investing researcher and professor at the American College of Financial Services. For investors far from retirement, there is no need to panic but now is a good time to review your asset allocation. But for those nearing or in retirement, Pfau advises:
1. Check in with Your Accounts. are you investing enough to meet your goals? A quick reminder, using the 4% guideline, you need $1 million to be able to withdraw $40,000/year in retirement with a portfolio of 50-75% stocks. If your tolerance for risk doesn't allow such a high % in stocks, prepare to save a lot more.
Are you appropriately diversified both across and within asset categories?
2. Go More Conservative. Research by Pfau and colleagues suggest entering retirement with 20-30% in stocks and gradually increase the % over time to 50-75%. This recommendation should serve you well to ensure your assets last 30 years even with extended bear markets. This strategy is designed to provide downside protection at the beginning of retirement when you are most vulnerable to losses.
3. Work Longer. If you haven't invested enough, the best strategy is to work longer. If already retired, the current economy offers plenty of part-time work. Working longer, combined with delaying Social Security, is a powerful strategy for ensuring you won't run out of money before you run out of breath. For every year you delay taking SS (up to age 70), your benefit increases 7-8%.
4. Cut Spending. For retirees who are willing to be flexible and cut their spending when investment earnings are down, you can adjust withdrawals to a 4-6% range. You recalculate the "safe" withdrawal rate each year based on the previous years growth (or loss) in your investments. To ensure you don't run out of money you can follow the IRS's Required Minimum Distribution table.
5. Spend from Winners. Start by setting aside 5 years of expense in cash/savings to avoid having to sell investments at a loss. A better strategy is to selectively take your living expenses from assets that have increased in value. Rebalance your assets by moving money from categories that have increased in value to assets that have lost value. This automatically results in buying low and selling high.

Stop 'Dollar-Cost Ravaging' Your Portfolio in Retirement

Your Retirement Paycheck: the 4% retirement withdrawal rate and realistic alternatives

Writing for Kiplinger's Jason Lambert explains why retirees need to shift from the old 4% withdrawal guideline to focus on income generation.
Researchers and thoughtful advisors understand that the 4% withdrawal rate guideline makes too many assumptions based on historic returns that don’t  translate to lower stock and bond returns in current (and future) market.

Lambert explains the 4%"rule" and why it is no longer an appropriate guide to retirement withdrawals.

"Accumulation gets all the glory in retirement planning, but it’s a thoughtful decumulation process that will make your retirement a true success." 

Lambert advocates a significant mindset shift, from “How much return do I hope to get from my portfolio?” to “How much reliable income can I count on?”

https://www.kiplinger.com/article/retirement/T037-C032-S014-stop-dollar-cost-ravaging-your-retirement-savings.html

How to Create a Personal Retirement Plan

Rachel Hartman explains that
Finding the right retirement plan involves:

    Thinking about your values and goals.
    Identifying your risk tolerance.
    Considering your age.
    Projecting your retirement lifestyle.
    Adjusting your plan as needed.


https://money.usnews.com/money/retirement/baby-boomers/articles/how-to-create-a-personal-retirement-plan

Safety-First Retirement Planning

"Two fundamentally different philosophies for retirement income planning, which I call probability-based and safety-first, diverge on the critical issue of where a retirement plan is best served: in the risk/reward trade-offs of a diversified and aggressive investment portfolio that relies primarily on the stock market, or in the contractual protections of insurance products that integrate the power of risk pooling and actuarial science alongside investments. The probability-based approach is generally better understood by the public. It advocates using an aggressive investment portfolio with a large allocation to stocks to meet retirement goals. My earlier book How Much Can I Spend in Retirement? A Guide to Investment-Based Retirement Strategies provides an extensive investigation of probability-based approaches. But this investments-only attitude is not the optimal way to build a retirement income plan." Read more on the Amazon website about the contrast between "Probability based" and Safety first" approaches to retirement income strategies.

Probability based strategies rely on investing heavily in the stock market. A safety first approach is built upon a lifetime annuity to ensure income lasts as long as you do.

Dr. Wade Pfau is one of the most respected retirement researchers writing and sharing his wisdom today. His new book, Safety-First Retirement Planning: An Integrated Approach for a Worry-Free Retirement is available at Amazon.

Check out Dr. Pfau's list of important questions to answer for the three major types of annuity products.

https://www.advisorperspectives.com/articles/2019/10/18/safety-first-retirement-planning

Is 4% withdrawal rule for retirement still a reliable guideline?

The general guideline of withdrawing no more than 4% of your portfolio each year during retirement has come under fire as of late. This guideline was the result of a study conducted almost 30-years ago by William Bengen, at a time when it was believed that 5% was a safe withdrawal rate. In the study William determined that 5% was too risky, and proposed the change to 4%. 

 

Based on PAST historical returns, the 4% rule appears to be valid BUT prolonged periods of very low returns on bonds in recent years suggest that withdrawing 4% per year adjusted for inflation is no longer a safe guideline. 

Research by Michael Finke, Ph.D., CFP®
Wade D. Pfau, Ph.D., CFA
David M. Blanchett, CFA, CFP®
suggests that the rule is no longer a valid guide because of persistently low interest rates.

The 4% Rule is Not Safe in a Low-Yield World

Executive Summary:
"The safety of a 4% initial withdrawal strategy depends on asset return assumptions. Using historical averages to guide simulations for failure rates for retirees spending an inflation-adjusted 4% of retirement date assets over 30 years results in an estimated failure rate of about 6%. This modest projected failure rate rises sharply if real returns decline.
 As of January 2013, intermediate-term real interest rates are about 4% less than their historical average. Calibrating bond returns to the January 2013 real yields offered on 5-year TIPS, while maintaining the historical equity premium, causes the projected failure rate for retirement account withdrawals to jump to 57%. The 4% rule cannot be treated as a safe initial withdrawal rate in today’s low interest rate environment.
 Some planners may wish to assume that today’s low interest rates are an aberration and that higher real interest rates will return in the medium-term horizon. Although there is little evidence to support this assumption, we estimate how a reversion to historical real yields will impact failure rates.
 Because of sequence of returns risk, portfolio withdrawals can cause the events in early retirement to have a disproportionate effect on the sustainability of an income strategy. We simulate failure rates if today's bond rates return to their historical average after either 5 or 10 years and find that failure rates are much higher (18% and 32%, respectively for a 50% stock allocation) than many retirees may be willing to accept.
 The success of the 4% rule in the U.S. may be an historical anomaly, and clients may wish to consider their retirement income strategies more broadly than relying solely on systematic withdrawals from a volatile portfolio."

SO... what to do. No one ever really recommended that you rigidly follow the 4% guideline every year regardless of portfolio returns. Besides, our need for income fluctuates over a 25-30 year period. Duh! Thus, it is prudent to to make adjustments to balance out returns and needs over a retirement lifetime.
What is "sequence of returns risk"?? If you are lucky to retire during a decade of high investment returns, you may end up with more money than you started with at retirement. However, if the first 5-10 years of your retirement yield negative returns... you're in trouble. 

Another factor to consider is the benefit of investing a portion of your retirement into a lifetime annuity to ensure that, along with Social Security, you won't run out of money.

Single Premium Immediate Annuity vs. "Safe Withdrawal" Strategy

"Economist and mathematician Michael Edesess compares a "safe withdrawal" strategy from a 60/40 stock-and-bond retirement portfolio with a single premium immediate annuity of the same value. He found the SPIA offers retirees a bigger monthly payout and decreases their chances of running out of money."

Author/researcher Michael Edesess explains:
"A safe withdrawal rate is the percentage of your assets you can withdraw each year without danger of running out of money, no matter how long you live. The seminal work on the subject was written by financial planner William P. Bengen and published in the Journal of Financial Planning in October 1994."
Bengen asked the question, with a portfolio of 60% stocks and 40% bonds, “What percentage of your starting assets can you withdraw yearly for the rest of your life without fear that you will run out?”
"His answer, based on simulations using past history, was that you can withdraw 4% a year (adjusted for inflation)."

"But in recent years, stock and bond market conditions have changed. Interest rates are historically low. This has caused some researchers to argue that 4% is not a safe withdrawal rate anymore.
In 2013, three researchers found, using their revised stock and bond market parameters, that as low as a 3% withdrawal rate would still mean a 10% chance of running out of money — too big a chance for comfort."

Edesess compared the "safe withdrawal rate" strategy to buying a Single Premium Immediate Annuity (SPIA):  A SPIA "is a financial instrument that guarantees you a consistent monthly income as long as you live."  Don't confuse a SPIA with the "more complicated, expensive, and much less useful annuities with other names, such as variable annuities or fixed-income annuities."

According to Edesess, "My own calculations show that for an investor to be 95% certain of not running out of money with a safe withdrawal strategy from a 60%/40% stock-bond portfolio, the strategy would be to withdraw 3.5% of the initial investment in real (inflation-adjusted) dollars each year."
"If the portfolio started with $500,000, for example, the average annual lifetime income would be $23,000. With the SPIA, the average annual lifetime income would be $33,500, and the certainty of achieving it is greater than 95%."
"Thus, both the certainty of not running out of money, and the lifetime income, are much greater with the SPIA than with the 'safe withdrawal' strategy."

By purchasing a SPIA you are creating your own pension. 

Read the full article at: https://www.marketwatch.com/story/this-one-investment-move-can-give-you-lifetime-yearly-income-in-retirement-2019-04-29

Sequence of Returns Risk in Retirement

Many have heard that it is "safe" to spend 4% of one's nest egg (adjusted for inflation) each year in retirement, expecting funds to last for a 30 year retirement.
Michael Kitces explains both the up and down side risk:
https://www.kitces.com/blog/url-upside-potential-sequence-of-return-risk-in-retirement-median-final-wealth/
There are many reasons for adjusting one's spending during a lengthy retirement rather than expecting to spend the same inflation-adjusted amount each year. First, most retirees spend much more in the first few years of retirement than they did while working because of pent-up demand for leisure. This often translates to extensive travel, purchase of recreational vehicles, and more time in costly leisure activities such as golf or other sports and hobbies.
Second, U.S. Consumer Expenditure Survey data documents the decline in spending with age as retirees transition from the Go-Go years to the Slow-Go years to the No-Go period at the end of life.

Compare popular retirement withdrawal strategies

Saving for retirement is hard enough but now comes the real test: how to spend the money to provide maximum enjoyment without living too long and running out of money. Andrea Coombes, writing for NerdWallet, review the most popular strategies:

• The 4% Rule (really a guideline)
• Dynamic Withdrawals
• The Bucket Strategy

and provides tips for whichever strategy (or combination) you choose to follow. Her article provides a brief primer on the 3 strategies but this is a decision that requires careful consideration and perhaps the input from a professional (one who is a fiduciary).
Keep in mind that an immediate life annuity will insure against running out of money before your run out of breath. Check out my posts on annuities.
Read Andrea's article: https://www.nerdwallet.com/blog/investing/retirement-withdrawal-strategies-which-should-you-use/

How much can you expect to spend in retirement?

"Households run by people 65 or older tend to spend about $3,800 a month, according to the Bureau of Labor Statistics. Here is a look at how that spending breaks down into categories, such as housing, transportation and health care." Will you be able to live on $45,756 per year $45,756 per year?  Read the article by Dayana Yochim based on the Bureau of Labor Statistics data on the NerdWallet website: https://www.nerdwallet.com/article/lets-get-real-what-an-average-retirement-costs

Let’s Get Real: What an Average Retirement Costs

Here’s a monthly breakdown of how households headed by a retirement-age person spend money, on average, in seven major categories:

Housing: $1,322

Transportation: $567

Health care: $499

Food: $483

Personal insurance/pensions: $237

Cash contributions: $202

Entertainment: $197

 

How to spend just the right amount in retirement

"Retirees tend to gravitate to opposing poles in how they spend their nest eggs, with some too parsimonious and others too carefree. The best course lies somewhere in between, as Steve Vernon explains" in Forbes.
The Spend Safely in Retirement Strategy 
is simple enough that you can implement it on your own.
1. optimize your social Security benefits.
2. Follow IRS Required Minimum Distribution (RMD) guidelines for withdrawals from retirement accounts.
3. Work (maybe just part-time) until age 70, enabling delay of Social Security claiming to ensure the highest benefits.
4. Consider tapping home equity (you ARE on track to pay off your mortgage before retiring, right?)
For a summary: 
https://www.forbes.com/sites/nextavenue/2018/01/16/the-best-way-to-spend-money-safely-in-retirement/#3ae0641b4fdd
For details: http://longevity.stanford.edu/blog/2017/11/29/optimizing-retirement-income-by-integrating-retirement-plans-iras-and-home-equity-a-framework-for-evaluating-retirement-income-decisions/ 
The main drawback here is that MANY retirees want to do extensive, expensive travel, buy an RV or new vehicles, and splurge during the first few years of retirement. When you are first free of work, have good health and time, and want to enjoy life, it is not uncommon to spend much more in the first years of retirement than you did when working. You can do this with proper planning but be sure you pay off all credit obligations and mortgage before you take the plunge. 

Take account of how spending varies throughout retirement

"Spending during retirement tends to vary as retirees age, rather than being a matter of steadily drawing down funds, writes Michael Kitces of Pinnacle Advisory Group. A projection of spending based on age banding can show that 'retirees may not actually need to save as much or accumulate as large of a nest egg to retire in the first place,' he writes." Kitces is one of the top resources for retirement planning info; he is up to date on the most recent research and has an analytical mind to slice through to the core of the implications for consumers. Read: “Kitces: A better baseline for retirement planning.” http://www.bankinvestmentconsultant.com/news/kitces-a-better-baseline-for-retirement-planning