Sunday, October 21, 2012

Can Retirees Base Wealth Withdrawals on The IRS' Required Minimum Distributions?

Can Retirees Base Wealth Withdrawals on The IRS' Required Minimum Distributions? 
by Wei Sun and Anthony Webb (Retirement Research at Boston)

My snarky reply to the question posed by the title of this paper is, "Of course they can, but should they?"  Apparently, they used "should" in their working paper, so they felt they couldn't use it in this follow-up paper. 

The authors compare several common withdrawal strategies with what they define as an "optimal withdrawal strategy."  Based on their comparisons and assumptions, they conclude that the IRS rules for Required Minimum Distributions (RMDs) and a modified version of RMDs outperform the other commonly used approaches (including the 4% withdrawal rule discussed in this site).

While I'm not a big fan of the 4% withdrawal rule for many of the same reasons noted by the authors, I'm not ready to buy that RMD or modified RMD approaches are either easier to implement or more "optimal" than the approach set forth in this website.  In developing their optimal strategy, the authors ignore a number of factors that may be important to retirees, including:
  • Stability of total retirement income from year to year in real dollars (or flexibility to have increasing or decreasing real income from year to year).
  • Coordination of the withdrawal strategy with other sources of retirement income, such as annuities
  • Desire to leave inheritance
Therefore, while I agree with the authors that the RMD approach has the advantage (over the 4% rule) of automatically adjusting for actual experience, there are several downsides to this approach that may not please all retirees.  Retirees should be skeptical of any withdrawal strategy (even the one suggested in this site) that claims to be "optimal."