The secret to generating sustainable retirement income is right in front of you, and the IRS has had it all along.
Retirees generally know everything about the minimum required distributions. This is the annual withdrawal you must take from your individual retirement account and 401 (k) plans after you turn 70½, or, as of this year, 72.
This calculation is based on the value of your account at the end of the previous year, as well as your remaining life expectancy.
“RMD can continue until you are 100 or 110, if you live that long,” said Steven Vernon, an actuary and researcher at the Stanford Longevity Center.
“It’s a pretty low retirement rate in its 70s, and if you combine it with equity investments, it will have time to grow.”
Vernon co-authored a 2017 article that discussed 292 different retirement income strategies.
Of these, using the RMD tables to extract from your IRA or 401 (k), which must be invested in a balanced fund or a target date fund, while also maintaining Social Security until age 70, was a simple way of creating income without buying an annuity.
Vernon will expand on the strategy in a new book to be released in July, titled “Don’t Break in Retirement: A Simple Plan to Generate Retirement Income for Life.”
Two key factors
The RMD formula works as an income strategy because the amount changes each year to account for the remaining life expectancy.
At age 70, RMD’s formula assumes he has another 27.4 years of distributions ahead of him, and his retirement will be based on that. The withdrawal rate is around 3.65%.
With each subsequent year, your number of future distributions decreases and the percentage you withdraw will adjust accordingly.
In addition, the calculation considers the performance of your account. Each withdrawal is based on the value of the previous year’s account.
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“RMD’s approach will be continually adjusted each year based on expected life expectancy,” said Jamie Hopkins, director of retirement research at Carson Group.
“And then there is volatility, things like this year,” Hopkins added. “By reducing or increasing withdrawals, it allows you to stay on track not to run out of money too soon.”
Stock exposure is required
As restless as investors may be in the midst of current market volatility, some exposure to stocks is an important part of RMD’s strategy.
“The market is up and down, and staying on track is the best thing you can do,” Vernon said. “Most people don’t measure the market very well.”
Vernon recommends maintaining exposure to equities through a target date fund, which could have around 50% of its assets invested in equities, or a balance fund with equity exposures ranging from 40% to 60%.
For middle-income retirees, whom Vernon defines as having less than $ 1 million in retirement savings, the RMD strategy should generate one-third to one-quarter of their total retirement income, he said.
Role of Social Security
Your 401 (k) and IRA accounts can generate a third of your retirement income, but it is Social Security that will cover most of your expenses.
“It is protected against the risk of inflation,” said Vernon. “You get a high degree of Social Security protection.”
In this strategy, you are expected to maximize your Social Security income by waiting until age 70 to claim benefits. For each year after full retirement age, which could be 66 or 67, depending on the year you were born, you will earn 8% late retirement credit.
Naturally, not everyone will be able to stay in the workplace until they are 70 years old.
In that case, instead of going to Social Security too soon, your portfolio can help you bridge the gap until you hit 70th birthday, Vernon said.
Know your risks
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While this strategy gives retirees some peace of mind about income, they still need to pay close attention to their expenses, particularly the cost of long-term care.
Those early retirement years can be filled as new retirees travel. But at some point, those expenses decrease, while healthcare costs rise.
It’s a pattern known as the “spending smile,” and it begins to increase when retirees reach their 80s and risk requiring long-term care, said Wade Pfau, professor of retirement income at the American College.
The cost is enough to shake up even the best-prepared income strategies. In 2019, the average annual cost of a private room in a nursing home was $ 102,200, according to Genworth.
Retirees don’t have many ways to address this cost. Fewer insurers offer traditional long-term care insurance coverage, and those with it face the possibility of higher premiums.
Other solutions combine life insurance and an additional clause to cover the cost of care.
“The threat of long-term care needs a separate strategy in addition to generating income,” Vernon said. “There are no perfect solutions here, but something is better than nothing.”