NEW YORK (MainStreet) Here's a term you may not have heard: decumulation, the opposite of accumulation.
It's a real word, and The Center for Retirement Research at Boston College uses it for a novel approach to figuring out how much of one's savings can be spent each year in retirement. The study suggests retirees use the required minimum distribution set by the IRS rather than the "4% Rule" used by many financial planners, investors and retirees.
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Under the 4% Rule, a new retiree can withdraw and spend 4% of her retirement savings in the first year, then increase the sum each year at the inflation rate. If you had $1 million, you could spend $40,000 the first year, $41,200 the second and $42,436 the third, assuming 3% inflation.
Studies show this has a good chance of keeping the income flowing for a 30-year retirement, though results depend on investment returns and inflation.
Anthony Webb, an economist at the center, and Wei Sun, of the Hanquing Advanced Institute of Economics and Finance at Renmin University in China, say their research shows a system based on RMD should work better.
The required distributions " were not created for this purpose. Rather, the IRS requires that a certain amount of the investor's tax-favored assets be withdrawn each year after turning 70.5. The goal is to have the taxes owed on withdrawals from IRAs, 401(k)s and similar plans paid during the investor's expected lifetime, according to government actuarial tables.
The retiree does not have to spend the withdrawals, but taking them out of the tax-favored account triggers income tax on any money that has not been taxed before, such as tax-deductible contributions and investment gains.
But the center researchers say the system can be applied to retirement savings. Unlike the 4% rule, the RMD approach responds every year to fluctuations in investment returns, they argue. The system allows annual increases in withdrawals as the retiree's life expectancy gets shorter, rather than relying on the inflation rate.
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In the case of a single person or married one less than 10 years older than a spouse, the IRS tables require withdrawing 3.65% of the assets in the accounts in the year the investor turns 70.5, 5.35% at age 80, 8.77% at 90 and 15.9% at 100.
The IRS does not require withdrawals before 70.5, but furnishes a table that shows a 65-year-old would withdraw 3.13%. The withdrawals apply only to principal. Interest and dividend earnings could be spent as well, in many cases allowing a 65-year-old to spend as much as he would under the 4% rule.
Because the percentages are applied to the account values on the previous Dec. 31, the actual amount withdrawn will depend on investment performance. The researchers assume a mix of stocks and bonds. With a lot of math, they conclude the RMD approach would be safer than the alternatives, which, in addition to the 4% Rule, include spending only interest and dividends and not principal, or setting a pace of withdrawals designed to reach zero at the end of the investor's life expectancy.
The RMD strategy does not have to be restricted to IRAs and 401(k)s. It could be applied just as well to ordinary taxable holdings.
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Nothing is guaranteed, of course, because we don't know how our cost of living will change during retirement, how long we will live or how well our investments will do. But the RMD approach is another alternative to explore as you wrestle with retirement issues.
--Written by Jeff Brown for MainStreet