USING TABLE III UNIFORM LIFE DIVISOR
Most investors are more likely to be worrying about their
own IRA and required minimum distributions (RMD) than an inherited IRA
where they are the only beneficiary. The
IRS uses two tables to calculate typical IRA distributions. Table II is for an owner of an IRA whose spouse is more than 10 years
younger. Table III is for IRS owners who are married. In this post I will use Table III for all calculations. I am assuming 2016 is the year of the first distribution.
It is extremely important to determine which table applies to you because failure to distribute at least the minimal amount required comes
with big penalties. You may take out all
you want once you turn 59.5 years. All
distributions are taxed as ordinary income no matter when you take them 59.5 or
70.5 or 90 and a half.
Let's look at several options.
Let's look at several options.
SPEND ALL YOUR RMD BUY a BENTLEY
Some people fund their lifestyle with income from pensions
or savings and do not need their IRA distributions to maintain their
lifestyle. These folks do not
particularly want to save the distributions for their heirs or planned
gifts. They are also not the kind of
investor who intend to deplete the IRA before they die. These folks just want to receive their RMD,
pay taxes on it and if there is some left in 20 years that is o.k.
If you tap your IRA’s and spend the RMD, in other words you simply
withdraw the amount you are required to withdraw without consideration of
portfolio income or portfolio growth, what will happen to the portfolio. Will
you deplete it in 20 years? I am using a starting value of $1,000,000.
This table and all tables in this post use Table III the uniform
joint life expectancy table provided by the IRS in pamphlet 590 see
link. Each year you get older you must take out a larger percentage of your
IRA assets. You can take out cash or you
can move a security out of the account.
You must pay tax on the distribution no matter whether you distribute
cash or a security.
As you can see from this table, it is highly unlikely you
will run out of money in the next 20 years.
Your total income over the next 20 years will be $717,293.
Caveat, markets could tank and portfolio values vary so much
that these calculations are totally wrong.
However, I have done this for a long time and these scenarios work out pretty
much as predicted when you look out 20 years.
DISTRIBUTE A SET AMOUNT PER
YEAR
Let’s say you do expect to supplement your income with your
IRA. You have lived through the real
“donut hole” age 65 through 70.5, you have $1,000,000 in your IRA and you are
looking forward to having income from your IRA for the next 20 years.
Some people distribute money from their IRA before they are
required. This post does not
deal with that scenario. Whether you
start early or when required, this analysis uses the starting value of $1,000,000
on December 31 of the year before you turn 70.5 when distributions are
required.
How many dollars can you withdraw annually and end up with
about 0 dollars in 20 years. See the
table below.
Without adding in investment growth or investment income,
you can distribute about $47,500 pretax per year and when you are 90.5 you will
have $2,500 left. Your pretax income will be about $1,000,000 over 20
years. That was the point; take it all
out. You will have to pay tax on your
distribution. Using a 25% tax bracket,
your net income per year would be about $35,625 nearly $3,000 per month.
DISTRIBUTE THE AMOUNT YOU
NEED TO MEET YOUR FUTURE EXPENSES
In this scenario, we have someone who is counting on their
IRA to fund their expenses. Now we have
two metrics to consider one is the IRA distribution and the second is expenses.
Let’s start with expenses.
Your expenses will basically double in 20 years no matter how you measure it. I have seen it over and over again and I have
experienced it myself. While I would not
count on government figures like CPI, you can use 3% as an average inflation
rate which means your expenses will nearly double in 20 years. At 90 you will not experience a reduction
of expenses. Medical and household care
will eat up any reductions you conceive of as a result of aging.
Next, what do you expect your IRA principle to
be in 20 years. Are you willing to draw
down some, all, none? Only you can make
that determination. I
explore a few ideas.
If you expect about $3,000 per month in 2016 to supplement
your income today, in 20 years you will need $6,000 per month to fund the same
expenses. (Remember that in real life you have to pay tax on your distribution
so $3,000 at ordinary income rates of 25% will net you $2,250 per month. How long will your stash last when you start with a distribution of about $36,000?
This table shows the effect of inflation. It is hard to create double your income in 20 years with no income or growth of your portfolio. In fact, you will just make it 19 years.. You can see why we call this investor a "sinking fund" investor.
This scenario is not typical. You should make money on your portfolio and that can make a big difference. Let's look at a couple more scenarios.
Three Percent Total Return and Distribute only your RMD in 2016.
If
inflation increases on average 3% per year, let’s see what happens to this IRA
if it creates a 3% total return per year.
With a three percent return, you will be able to take your minimal distribution in 2016 and increase over time to almost double in 2036 without running out of money. (Three percent is not a perfect double in 20 years.) In fact you should have about half of your original portfolio intact in 20 years.
Three Percent Return and distribute more than your RMD
What if you want $4,000 per month pre tax from your IRA. Moreover, you expect that $4,000 per month to double in 20 years. Let's see what happens.
Under these conditions, you will have enough money to double your income in 20 years without running out of money but it is close. At the end of 20 years you will have only 12.6% of portfolio left.
Portfolio Capital Appreciation Model
The last table presents a cheery analysis. I am using a 7% total return as that is the average stock market return over time. Portfolio values are adjusted for the required RMD. If you save some or all of the distribution good for you. This table shows the portfolio value at the end of 20 years with a 7% return and distributions equal to the required amount.
Nirvana: not only will your income from RMD's double it will double twice and your principle will increase by 27.4 %.
Look back at your most recent 20 years of investing and see if your think you can duplicate a 7% return on assets adjusted for the RMD.
SUMMARY
There are an unlimited number of scenarios to consider. Only you can determine which scenario is best for
you. Twenty years is a long time and
yet when you are 70.5, you know how quickly those years pass. The analyses presented above show how your
IRA investment might fare using a few typical scenarios. Caveat, as a retired investment advisor, when
it comes to investments, I can tell you, few real life stories are typical.
M* MONEYMADAM
