Accumulation is easy. Save money. Decumulation is tougher because now you need to pick a strategy and stick with it. Strategies abound: Spend your interest and dividends and never touch the principal (which is difficult in today’s low-interest-rate environment); follow the “4% rule” and index that for inflation; or annuitization (though most people do not want to give up control of their assets while living, or lose the ability to leave their children whatever is left over). The other day I was reminded of another option that is rarely discussed: The RMD approach.
I have written about required minimum distributions (RMDs) in the past. RMDs are the minimum amount you have to pull out of your IRA starting at age 70½ based on an IRS table (IRS Publication 590). The distribution strategy I was reminded of is based off of RMD tables. The strategy is simple: Using your total portfolio value every December 31, take distributions from your portfolio based off the IRS tables (there are several tables to choose from but I will use Table III – Uniform Lifetime for this blog). For example, if you start taking distributions at age 70, the table tells you your distribution period (life expectancy) is 27.4 years, so you would take approximately 1/27th (about 3.65%) of your total portfolio value (not just from your IRAs since this strategy involves your whole portfolio). If you retired earlier, you can work the math backwards-say to age 65-to figure out approximately how much you should spend.
At a very basic level, this approach is appealing because as long as you follow the table, you would never run out of money. Yet at a different level, this strategy might actually detract from enjoying retirement. A recent research paper (“Should Households Base Asset Decumulation Strategies on Required Minimum Distribution Tables” by Wei Sun and Anthony Webb from the Center for Retirement Research at Boston College) discussed this exact approach. The question the paper was trying to answer was, “Is this an optimal strategy?” There are several moving parts to consider before answering this question:
Wei and Webb also discuss how risk (your investment allocation to stocks and bonds) affects an RMD strategy. At lower investment returns risk is more attractive, and at higher returns it is less attractive. That is a whole other discussion. The one thing to take away is that there is never an easy rule-of-thumb when it comes to complex questions. The real answer to the decumulation strategy puzzle is probably taking the strengths of each model out there and trying to adapt it to your situation, which is a lot easier said than done.