# Expert analysis using tax facts online.

Determining the withdrawal rate that will allow a client to live from their retirement savings without running out of money or unduly restricting lifestyle choices can prove to be a guessing game for even the most sophisticated clients. No client wants to be forced to rely on a small Social Security income alone in the later years of retirement, yet these clients want to enjoy their retirement to the fullest degree.

There are several workable strategies that your clients can use for determining their ideal withdrawal rate. The traditional approach for determining the appropriate withdrawal rate is the 4 percent rule, which, as the name suggests, limits the client to a withdrawal rate of 4 percent per year. A recent study examined the IRS required minimum distribution ("RMD") rules for determining an annual withdrawal rate and found that this strategy can also prove effective. The pros and cons of these strategies are discussed below.

Tax Facts Online provides a helpful explanation of the RMD rules. Question 3585 outlines the general RMD requirements, and tells us that clients must generally begin taking distributions from their individual retirement accounts six months after reaching age 70 Vi. Question 3586 tells us that these required distributions are determined using the IRS RMD Uniform Lifetime Table, which can be found in Tax Facts Online Appendix F. The RMD amount is determined by dividing the client's account balance by the applicable distribution period provided in the RMD Uniform Lifetime Table, which is based upon the client's age.

To use the RMD strategy to determine the optimal amount that should be withdrawn from retirement savings in their first year of retirement, Tom and Sophie would divide the account balance in the current year by thirty-two--the applicable distribution period for a sixty-five year old, as specified in the Uniform Lifetime Table. This would result in a first year withdrawal of about \$7,800, which is approximately 3.13 percent of their initial balance.

In their second year of retirement, if we assume a 5 percent average growth rate on their account assets, their beginning balance will have increased slightly to \$254,100 (after factoring in their first year withdrawal). The applicable distribution period for a sixty-six year old is 31.1, so their second year withdrawal increases to \$8,170, or 3.23 percent. Their withdrawal rate would gradually increase in this manner each year--by the time they reach age seventy, Tom and Sophie will withdraw about \$9,827 each year, or about 3.65 percent. By age seventy-five, they will withdraw approximately \$12,289 annually (4.36 percent) and their account balance would have grown to about \$281,500, again assuming 5 percent annual growth.

Of course, these calculations assume that the account assets continue to grow at a constant rate of 5 percent annually. If the assets performed poorly or unexpectedly well in any given year, this strategy would adjust the withdrawal percentage each year to take that performance into account.

If Tom and Sophie decide to use the 4 percent rule, they will withdraw \$10,000 (4 percent of their initial balance) each year from their account. By the time they reach seventy-five, if we assume the same annual 5 percent growth rate, their account balance will have grown to about \$275,000.

By age eighty, Tom and Sophie would be withdrawing approximately \$15,000 from their account under the RMD strategy, while they'd still be withdrawing only \$10,000 annually under strict application of the 4 percent rule.

Assuming constant annual growth, either of these strategies will ensure that Tom and Sophie never run out of retirement savings. However, we all know that we can't assume constant growth. The primary difference between the two strategies is their baseline account balance measurement. The RMD strategy looks at the account balance every year to determine the withdrawal percentage, while the 4 percent rule simply takes a constant 4 percent out of the initial account balance.

While the RMD approach may be slightly more complicated than the 4 percent rule, it tends to offer a more realistic approach because it takes actual account performance into consideration each year. If the accounts have performed very well, using the 4 percent approach may unduly restrict Tom and Sophie's withdrawals each year. Conversely, in a down market, the 4 percent rule will overestimate what they should be withdrawing.

In general, the analysis should be undertaken for each client and will depend heavily on their initial account balances, projected market conditions, and the client's lifestyle preferences. Would they prefer a slightly lower withdrawal rate in early years and a larger one in later years, or are they more comfortable with a constant income stream each year? Are their assets allocated in such a manner that account performance is predictable from year to year, or are their investment returns likely to fluctuate greatly? In the end, the decision must be made by the client. Presenting projected outcomes under several different scenarios to each client can help provide a more realistic picture of retirement income options to help the client determine his or her preferred strategy.
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