How to create an automatic retirement paycheck

One of the most critical retirement planning challenges is generating regular paychecks from your 401(k) or IRA -- and making them last the rest of your life. It turns out there's one straightforward method for generating retirement income that just about anybody can use. 

The basic idea

With the part of your retirement savings that's invested in an IRA or 401(k) plan, use the IRS required minimum distribution (RMD) to calculate the amount of your retirement paycheck that you would receive during a calendar year. The IRS requires you to make minimum withdrawals from your retirement savings at age 70-1/2 to be included in your taxable income. (By the way, the RMD doesn't apply to Roth IRAs.)

The IRS also specifies the method for calculating the RMD for a specific calendar year: You divide the value of your account balance on Dec. 31 of the previous year by your life expectancy at your current age, as determined by an IRS table. This life expectancy table can be converted to a series of withdrawal percentages.

For example, suppose you attain age 70-1/2 in 2017. Based on the IRS table, your life expectancy would be 27.4 years. So during 2017, the RMD would require you to withdraw 3.65 percent of your account balance as of Dec. 31, 2016. You can withdraw this amount at any time during 2017 and in any frequency -- monthly, quarterly or in one payment. 

This required withdrawal percentage also increases at every age. For example, you would need to withdraw 4.37 percent at age 75, 5.35 percent at age 80, 6.76 percent at age 85, and so on. (This table shows the percentages that apply at each age.)

If you're younger than age 70, the IRS tables don't specify a withdrawal percentage. In this case, you could use 3.5 percent for your withdrawal percentage each year until age 70.

For each future calendar year, you recalculate your retirement paycheck using the RMD for the coming year, based on the prior year-end asset value. This way, the amount of your retirement paycheck is adjusted up or down, reflecting whether your assets had positive or negative returns during the previous year. This recalculation method results in spreading of the payment of your remaining account balance over the rest your life.

Recent research conducted by the Stanford Center on Longevity (SCL), in collaboration with the Society of Actuaries (SOA), demonstrates that the RMD method is a reasonable way to calculate a lifetime retirement paycheck. It works best when used in combination with Social Security, pensions if you have one and guaranteed lifetime payout annuities.

What investments should you use to generate the RMD income?

If you have guaranteed lifetime paychecks through Social Security, pensions and annuities that cover your basic living expenses, then the SCL/SOA research supports investing the savings in your RMD paycheck generator in a low-cost, target-date fund that's appropriate for retirees. Such a fund typically is about 50 percent invested in stocks. The SCL/SOA research also justifies a higher allocation to stocks for the RMS paycheck generator, if you can tolerate the volatility.

If you're a risk-averse retiree, you might want to invest lower amounts in stocks.

Implementing the RMD paycheck generator 

Virtually all IRA and 401(k) administrators can calculate the RMD for you, so that you'll know your spending budget for the coming year. Many IRA administrators, such as Fidelity Investments, Schwab and Vanguard, will make automatic payments to you in the frequency you specify (monthly, quarterly or annually). Your check can either be automatically deposited in your bank account or mailed to you.

In addition, Fidelity recently said it's creating mutual funds that are designed specifically to be used with its automatic RMD payment service. This further simplifies the process, so you can put your investments on autopilot.

Advantages and disadvantages of the RMD

An RMD paycheck generator is simple to set up so that it automatically pays you a periodic retirement paycheck. You don't need to remember to make withdrawals from your savings or even change your investments if you invest in funds that are appropriate to be used with the RMD. 

You might really appreciate this feature when you get older and are less interested in managing your savings. In addition, the RMD paycheck generator has a very good chance of making your money last for your life.

The potential disadvantage of the RMD distribution is that your retirement paycheck isn't guaranteed, like Social Security, a pension or an annuity. For instance, your RMD paycheck might decrease if your investments fare poorly or if you live a very long time. That's why you might want to use the RMD paycheck generator to cover your discretionary living expenses, like travel, hobbies and spoiling your grandchildren.

No matter what, you'll be glad you set up a thoughtful retirement paycheck strategy when you reach your 70s, 80s or 90s, and you still have enough money to live the life you want.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.