Lots of research has been done on the best way to generate retirement income. It’s one of the most popular financial topics. I think this popularity is driven by two things: its obvious importance—and the fact that there’s no one right answer.
By contrast, figuring out how much we need to save for retirement is relatively easy. It isn’t hard to pick a future retirement date, or at least a range of years during which we’ll likely retire, and then figure out how much we ought to be saving. But when it comes to generating retirement income, none of us knows how long we will live, what markets will do or what our healthcare needs will be. There are also subjective questions, like how much do we want to leave to our heirs?
Read: Saving for retirement is easy enough — spending it is more complicated
Last November, Morningstar released a report analyzing a variety of methods to determine a retiree’s safe portfolio withdrawal rate. At 59 pages, it’s quite extensive, but well worth the read. It analyzes several withdrawal strategies, provides pros and cons for each, and ends with a process to develop an individual retirement income plan.
One of the options it considered is the so-called RMD withdrawal strategy. Under this plan, annual withdrawals are based on your portfolio’s previous year-end balance. You withdraw a percentage of your portfolio consistent with the required minimum distribution (RMD) guidelines provided by the IRS life expectancy tables. Under this scheme, your income would rise or fall as your portfolio’s value changes.
The online financial planning magazine ThinkAdvisor recently asked three retirement planning experts for their views of the RMD withdrawal strategy versus the better-known 4% rule. Under the 4% rule, you withdraw 4% of your portfolio in year one, and then increase that amount by inflation in year two and subsequent years. The 4% rule has been criticized for a host of reasons. Some say 4% is too high given today’s low bond yields and high stock valuations. Others say the strategy is too robotic in the face of plunging financial markets.
Michael Finke, a professor at the American College of Financial Services, doesn’t like the possible income shock of the RMD approach. If a retiree is heavily invested in stocks, a serious down year could slash her income the following year.
“A better retirement plan evaluates how much of the budget is flexible and how much is inflexible,” Finke said. “Then build an investment plan that doesn’t expose inflexible spending to either market or longevity risk.” Finke said his experience shows that about two-thirds of retirees’ expenses are fixed. The RMD strategy might work for …….