Making Your Money Last

Don't Run Out of Money in Retirement

This spend-down strategy based on RMD rules will help you cover retirement expenses with less risk.

Most retirees face the same conundrum: how to spend down assets without completely depleting them. One popular strategy is to apply the 4% rule -- withdraw 4% of your initial retirement balance and adjust the dollar amount annually to keep pace with inflation. Another rule of thumb is to spend only your portfolio's interest and dividends.

Some academics aren't fans of either strategy. A retiree who spends only his interest and dividends may load up on, say, bank stocks -- and that's "the tail wagging the dog," says Anthony Webb, research economist at the Center for Retirement Research at Boston College. Leaving the principal untouched may fit with a desire to leave money to heirs, but it could put a crimp in your lifestyle.

As for the popular 4% rule, it doesn't respond to actual investment returns, Webb says. Retirees drawing fixed dollar amounts from a sinking portfolio will soon run into trouble.

The RMD strategy. A third option may work better for many retirees: Base annual spending on the required minimum distribution rules that apply to traditional IRAs after you turn 70 1/2. Retirees of any age can use RMD calculations as a spending guidepost by simply dividing their total year-end portfolio balance by the life-expectancy factor listed for their age in IRS Publication 590.

In a recent study, Webb and coauthor Wei Sun, of China's Renmin University, found that the RMD strategy outperformed the spend-the-interest strategy and the 4% rule, given a typical retiree's asset allocation. Because the RMD approach calculates the annual withdrawal as a percentage of the remaining portfolio, it is calibrated to investment returns. And the withdrawal percentage increases with age.

The strategy isn't perfect. It may result in withdrawal rates that are too low, particularly early in retirement, causing retirees to leave behind money that they might have preferred to spend. But if we're entering an extended period of low returns, as many advisers predict, you may want to err on the side of conservative spending rates.

A hybrid approach. Although no simple rule is ideal, retirees may incorporate an RMD-inspired strategy into a broader plan for covering expenses. A 2010 Vanguard Group paper, for example, found benefits from combining an inflation-adjusted immediate annuity with an RMD approach. This strategy produced stable cash flows that grew at a faster rate than those produced by other rules of thumb.

Given the surprises that can crop up in retirement, any rules of thumb that appear to put spending plans on autopilot may be dangerous. The key is to reassess spending constantly and make adjustments as necessary, says Vanguard principal John Ameriks.

Eleanor Laise is Associate Editor for Kiplinger's Retirement Report.

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