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Investing Specialists

Your RMD Amounts Are More Conservative Than You Might Think

Retirees are often concerned that RMDs could lead to premature asset depletion, but should they be?

We know this: Affluent retirees love to hate their required minimum distributions.

Taxes are the major reason. The amounts that people who are age 70 1/2 or older must begin withdrawing from their tax-deferred accounts can push them into higher marginal tax rates than in the pre-RMD period, and can also increase the percentage of their Social Security benefits that are taxable. 

But there's another complaint I've heard about RMDs: that these mandatory withdrawals could lead retirees to prematurely deplete their assets if it turns out that their RMDs were too rich, especially if they live way longer than the "average" life expectancies that underpin the IRS' tables for RMDs. Required minimum distributions start at a comfortable 3.6%, but ramp up to 5.3% at age 80 and are at 6.8% at age 85.

I have a few responses to that concern. First, just because the RMD rules require you to get the money outside of a tax-sheltered wrapper and pay taxes on it, there's nothing saying you have to spend that withdrawal. I've written about how to reinvest unneeded RMDs in a tax-efficient way: If you find yourself with the high-class problem of your RMDs exceeding your living expenses, you can keep that money working for you in a taxable account or even in a Roth IRA if you or your spouse has earned income. 

Nor should you be worried about too-high RMD amounts if you also have substantial assets that aren't subject to RMDs. After all, it's total portfolio withdrawals that matter to portfolio sustainability, so if you're concerned your RMDs are too high, you can hold down your total portfolio withdrawal rate by withdrawing limited sums from your non-RMD-subject accounts.

In addition, your withdrawals should ramp up as you age and your life expectancy declines, especially if you don't have a goal of leaving substantial assets behind for heirs or charity. 

Finally, it's worth noting that the assumptions underpinning the distribution periods for RMDs on the Uniform Lifetime Table, which is what the IRS requires most people to use to calculate their RMDs, are conservative. Understanding that might help allay fears about RMDs being too rich.

A Closer Look at the RMD Formula
If you've looked closely at the Uniform Lifetime Table, you've probably observed that the distribution periods seem pretty long. For a 70-year-old just starting RMDs, the distribution period is more than 27 years. At age 80, the distribution period is almost 19 years. (As with all actuarial tables, the longer you live, the longer you're expected to live.) Those periods are longer than life expectancy: For example, the average life expectancy for a 70-year-old male in 2015 was 14 years, according to the Social Security Administration's website, and 16 years for women. At age 80, the average life expectancy for men is eight years and 10 for women.

Why the disconnect? For one thing, the Social Security figures are based on a single person's life expectancy, whereas the Uniform Lifetime Tables are based on joint life expectancies. As Morningstar director of policy research Aron Szapiro writes, RMDs are designed to ensure that money comes out of tax-deferred mode--and that taxes on those distributions are paid--during the account owner's lifetime. But many account owners are also concerned about leaving assets for their surviving spouse. The distribution periods for the Uniform Lifetime Table seem relatively long because they're meant to account for two lifetimes.

In addition, the formula now used to determine an IRA account owner's distribution period makes the very generous assumption that the beneficiary spouse is 10 years younger than the account owner, even though that may well not be the case. (There's a separate table for IRA owners whose spouses are more than 10 years younger; the distribution periods on that table are longer still.) The net effect of this assumption, especially for singe people or spouses who are close in age and have similar life expectancies, is that RMD-based withdrawals are quite conservative.

Take, a 75-year-old husband and a 72-year-old wife, each of whom owns a $1 million IRA. The 75-year-old is using a 22.9-year distribution period, whereas the 72-year-old is using a 25.6-year distribution period. The 72-year-old's spouse is actually three years older, but her distribution period is calculated with the assumption that he's 10 years younger. Even if both partners have reason to believe their life expectancies will exceed the averages, there's still plenty of wiggle room built into their withdrawals. The 75-year-old would have an RMD of $43,668, or 4.4% of his balance, whereas the 72-year-old’s withdrawal would be $39,063, or 3.9% of her balance. Given their ages, those withdrawal rates easily pass the sniff test of sustainability. In fact, their withdrawal rates are arguably too conservative, especially if they're not aiming to leave assets behind for family or charity.

For spouses who are further apart in age, the Uniform Lifetime Table is a more accurate depiction of their actual life expectancies. (As noted above, there's a separate table for use by IRA account owners whose spouses are more than 10 years younger; it takes into account both partners' actual life expectancies.) If one or both such partners believe they'll exceed average life expectancies, it's reasonable to reinvest a portion of RMDs as a safeguard against premature asset depletion.

For example, let's assume a 75-year-old account owner and a 66-year-old spouse; the older spouse's IRA account makes up most of the couple's assets. They don't have a more than 10-year gap, which would necessitate use of the separate table for calculating RMDs, but it's still a significant age discrepancy. The 75-year-old account owner's distribution period on the Uniform Lifetime Table is 22.9 years, and the average life expectancy for a 66-year-old woman is about 20 years. If the younger spouse believes that she'll live longer than average, that's a good case for reinvesting a portion of the RMDs into the portfolio as a guard against prematurely depleting assets.

Takeaways
To sum up, similarly aged partners shouldn't be too concerned about premature asset depletion due to RMDs unless they're hoping to leave substantial assets behind or one or both partners expects to dramatically exceed average life expectancies. The same is true for singles, whose RMDs are automatically based on a distribution period that's longer than their life expectancy.That's especially true if they have substantial non-RMD-subject assets that they can withdraw at a slower pace. They can even use required minimum distributions as a guide to ensuring that their withdrawals tie in with their portfolio's value and sync up with changes in their life expectancies over time.

On the other hand, married couples with a significant age difference have good reason to be more conservative about their RMD amounts, reinvesting a portion of their withdrawals back into their accounts.