Understanding Required Minimum Distributions

The idea behind required minimum distributions, or RMDs, is that the government wants
to give us a tax incentive to save for retirement – but they also want to make sure we don’t
misuse it. So, if we’re in the 30% tax bracket and we put money into a tax deductible IRA or a
401k, each dollar we put in really only costs us 70 cents because it’s a before-tax contribution.
So the government is helping us save and that’s nice. However, it’s also true that the government
really wants this to be retirement money. In other words, they don’t want it to be money that you
never spend or leave for your heirs. They want to make sure you pay tax on it eventually.

IRAs are one example of a use-specific plan, which the government loves. The 529
college tuition plan is another example; it’s extremely tax-efficient for the investor if used for
college, but extremely tax-inefficient if used for retirement. Similarly, IRAs are designed to
encourage people to save money for retirement, and if the money is used for that purpose then
it’s taxed in a friendly manner. If it’s used for anything else, it’s not….


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Are Your Allocations Right for RMDs?

Making sure your IRAs are allocated properly for required minimum distributions
(RMDs) once you reach the age at which you must take them is as simple as following a bit of
advice your parents probably used to tell you: live off your interest, don’t touch your principal.
That may sound simple enough, but there are many factors to consider in order to ensure the
interest and dividends you’re generating from your savings and investments is sufficient to cover
your RMDs and satisfy your other income needs throughout retirement.

Again, RMDs are distributions the IRS requires you to make on your retirement savings
each year after you’ve reached age 70-and-a-half. The amount changes each year in conjunction
with your estimated life expectancy and the balance of your IRAs and other qualified plans as of
December 31st the preceding year.

Ideally, an asset allocation right for taking RMDs should be able to generate at least 3.7%
dividend or interest. If your interest and dividend income isn’t sufficient to cover RMDs, then
the distributions will most likely have to come from principal. Why is that so bad? Well, with
average life expectancy rates today higher than they’ve ever been, most people need to plan for
30 years of retirement. That being the case, spending any principal at all, especially during the
early years of retirement, can be a slippery and dangerous slope….

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Understanding Social Security Benefits

Before you can retire, you should know what all of your sources of income are going to
be, and how much you can expect to receive from each. Social Security benefits will, obviously,
be one of those sources, but how much you can expect to receive depends on a variety of factors.
There are ways to maximize your benefits and get the very most to which you are entitled, and
there are strategies to minimize your tax burden from Social Security. The most important thing
you need to consider in working toward those goals, however, is whether your Social Security
benefits are coordinated properly with your other assets and sources of income.

Let’s start with some basic facts about social security:

  • Money you can’t outlive – Social Security is one of the few sources of income you can’t
    outlive. Once you start taking them, your benefits continue to your death, and the longer you live
    the more you will extract from the system. If your benefit starts at $2,000 per month, and you
    live 10 more years, you will receive over $300,000 in lifetime benefits. If you live 30 more
    years, you’ll receive over $1 million over your lifetime, assuming annual cost-of-living
    adjustments of 2.8%. That’s good news because retirees are living longer and longer. Today
    there is a 50% chance that the average 65 year old will live into his late 80s. For the average couple aged 65, there is a 50% chance that at least one spouse would live to age 92…

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Are Your Allocations Right for Social Security?

Nothing exists in a vacuum, meaning that even if you’ve determined the best time and
method of taking your Social Security benefits based on your age, objectives and lifelong
earnings, it won’t matter unless you properly coordinate your benefits with your overall
retirement income plan. Most people agree that Social Security is not enough to live on in
retirement, and needs to be supplemented with other sources of income. Therefore, it is essential
to make sure your other savings and investment vehicles are as reliable as Social Security and
capable of meeting the same financial objective: providing income that you can’t outlive.

As I noted in my white paper on required minimum distribution allocations, retirement
income for any purpose – whether it be living expenses, major purchases or satisfying RMDs –
should ideally come from interest and dividends on your savings and investment vehicles, not
from principal; just like your parents probably told you. The same concept applies when talking
about maximizing Social Security…..


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