Required minimum distributions (RMDs) aren’t a big deal for most people. They don’t have to make them, for one thing. If you aren’t at least 70½ — the age at which you have to start making them — the subject isn’t very high on your “need to know” list.
But if you are 70½, or have some friends who are, RMDs are a big deal. They are a major source of retiree anxiety, and may also be one of the reasons consumer spending has been persistently weak.
There is a reason for that retiree angst: The good old days are over. Today, from the day you make your first required minimum distribution, you’ll be distributing principal as well as interest and dividends. And you’ll be distributing more principal every year.
That means you’ll be watching your savings start to disappear. Worse, your savings may disappear well before you do. At age 70 today, a typical American male can expect to live another 13.6 years; a typical American woman can expect to live another 15.9 years. You can understand the rising anxiety by considering what happens as RMDs are taken from a 50/50 portfolio of stocks and bonds, such as the portfolio I use in my “Life of Riley Index” columns.
• At age 70: With the 50/50 portfolio now yielding a piddling 1.77 percent and the first required minimum distribution at 3.65 percent, the retiree is forced to withdraw (and pay taxes on) 1.88 percent of principal to complete the distribution.
• At age 75: Five years later, the distribution rate has risen to 4.37 percent, which means that 2.6 percent of principal will have to be distributed in addition to portfolio income.
• At age 80: Ten years into RMDs, the distribution rate is 5.35 percent. This means you’re distributing 3.58 percent in principal as well as all interest and dividends.
With principal withdrawals like that, it isn’t difficult to imagine a lot of people getting their final revenge on the banking industry by dying with big-time unpaid Visa and MasterCard balances. Talk about last laughs.
Yes, there is an alternative. You can pay income taxes on the principal being distributed and reinvest the remaining cash. Nice idea. Somehow I have a feeling it isn’t done very often.
It wasn’t always this way. If we look back to 1985, when the S&P 500 was yielding 4.25 percent and a five-year Treasury was yielding 10.12 percent, a 50/50 portfolio provided a yield of 7.19 percent. That’s nearly two times the first required minimum distribution. In those “good old days,” you could take the RMD and still have your account grow just from income reinvestment. The RMD didn’t exceed the portfolio dividend and interest income until you were 87 years old — older than typical life expectancies.
A year later, in 1986, a sharp drop in interest rates took the portfolio yield down to 5.4 percent. As a consequence, you reinvested only 1.75 percent of income and your RMD exceeded portfolio income six years earlier, at age 81.
After 1986, portfolio income met distribution requirements until 1998. Since both bond and stock prices were rising during the same period, being a retiree taking RMDs was a really nice experience. Your income rose each year, but your remaining principal generally rose even more.
It was the good old days, the Golden Age of Golden Years Investing.
Today, the Golden Age is long gone. In every year since 1998, a 50/50 stocks and bonds portfolio has provided a yield lower than the 3.65 percent required distribution rate at age 70½. As a consequence, everyone who turned 70½ after 1998 has had the same experience — distributions have exceeded portfolio income by ever increasing amounts.
Some readers will suggest that the portfolio could have been changed. Junk bonds could have been added. REITs could have been added. Stock investing could have been focused on high-dividend stocks, etc. The reality, however, is that yields in all portfolios were dropping during the period, so the difference wasn’t whether distributions would exceed income, but when distributions would exceed income. You could defer the event, but you couldn’t escape it.
The impact here goes well beyond angst among retirees. A good deal of the consumer spending that powers our economy has been lost as Solvent Seniors have seen their investment income plummet.
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