How to Use RMD Withdrawal Strategies to Help Stretch Savings

It’s not uncommon for retirees to worry about how to make their savings last throughout their lives.

Some people rely on the so-called 4% rule – withdrawing 4% of their savings in the first year of retirement and in subsequent years by taking the same amount, adjusted for inflation each year. Another approach involves the required minimum distributions, or RMDs, which accompany most retirement accounts.

These mandatory withdrawals take effect at age 72 and apply to 401(k) plans — both traditional and the Roth version — and similar work plans, as well as most individual retirement accounts. (There is no RMD for Roth IRAs during the lifetime of the account holder.)

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Generally speaking, if you were only to take your annual RMDs, that would mean those accounts would not be depleted during your lifetime. Of course, as with most things in financial planning, strategy cannot be viewed in a vacuum.

“You can use it as a plan — as a guideline — but it’s very unlikely you’ll stick to it your whole life,” said Ed Slott, CPA and founder of Ed Slott and Co. “You have to plan life happening.”

While most account holders – 79.5%, according to the IRS – take more than their annual RMD, withdrawals can be a thorn in the side of those who don’t need the money. However, if you fail to withdraw the required amount, you risk a 50% penalty.

Current law states that you must take your first RMD for the year in which you turn 72, although this required initial withdrawal may be delayed until April 1 of the following year. If you are employed and contribute to your company’s pension plan, RMDs do not apply to that particular account until you retire.

The amount you must withdraw each year is determined by dividing the most recent year-end balance of each qualifying account by your “life expectancy factor” as defined by the IRS. The agency has new life expectancy tables that go into effect this year.

Although the new tables assume that you will live longer, which means a smaller RMD compared to earlier calculations, the amount you need to withdraw will generally increase as you get older, as your life expectancy decreases each year. (See table below for illustration.)

Here is an example of how life expectancy is taken into account in the calculation of RMD at different ages: for a 72 year old it is 27.4 years, according to the IRS table used for lifetime RMD . If that person has $1 million, the RMD would be about $36,500 ($1 million divided by 27.4).

By comparison, someone with $1 million aged 95 has a life expectancy of 12.2 years, which would mean an RMD of around $82,000. The tables apply up to age 120, at which time the factor becomes 2.

It should be noted that it is impossible to predict the impact of the market on your portfolio from year to year, regardless of the approach taken to making your savings last. It depends on the investments in your portfolio and their exposure to risk.

And whatever income strategy you implement, it’s also important to remember to have a cushion for unexpected expenses, Slott said.

“Everything looks good until you need more than the expected amount,” he said.