(MoneyWatch) My provided simple, "just tell me what to do" advice for generating a lifetime retirement paycheck from your IRAs and 401(k) accounts, by suggesting that you equally divide your retirement savings between an inflation-adjusted immediate annuity and managed payouts. Now let's dig a little deeper into the "just tell me what to do" suggestions for the best ways to arrange for managed payouts.
To create a retirement income from managed payouts, you should invest this part of your retirement savings in a low-cost index fund that's balanced between stocks and bonds. You should keep the asset allocation to stocks between one-third and two-thirds of this portion of your savings, with the remainder in bonds or cash investments. This gives you some potential for growth without taking too much stock market risk. You should look for annual investment management expense charges well below 0.50 percent of your assets.
Vanguard's Balanced Index Fund (VBIAX) or Vanguard's Target Retirement funds are good candidates for this purpose. You could also use Vanguard's Wellesley Income Fund (VWINX), which is about 40 percent invested in stocks, or Vanguard's Wellington Fund (VWELX), which is about 65 percent invested in stocks. Other mutual fund families, such as Fidelity Investments, also have low-cost index funds. And most likely, your savings plan at work will also have index funds or target date funds that suit this purpose.
If you're in your mid-sixties or older, you should make regular monthly withdrawals equal to 0.333 percent of your account balance at the beginning of the year. For example, if you have $100,000 in savings at the beginning of the year, withdraw $333 each month. This is an annual withdrawal rate of 4 percent. If you're in your late fifties, withdraw at an annual rate of 3 percent, which works out to $250 per month with $100,000 in savings. If you're in your early sixties, use an annual withdrawal rate of 3.5 percent, or $292 per month with $100,000 in savings.
Be sure to reset the dollar amount of your monthly withdrawals every year or two, based on the value of your account at the beginning of the year and your withdrawal rate. Many IRAs and 401(k) plans will enable you to set up the automatic withdrawal programs described here.
Traditional IRA, 401(k), and 403(b) accounts are subject to the IRS required minimum distribution (RMD) rules when you reach age 70 and a half. A full description of these rules is beyond the scope of this post, but the quick summary is that the RMD rules require you to withdraw minimum amounts each year, and they apply substantial penalties if you don't comply. The RMD rules are intended to spread out payments from your tax advantaged savings over the rest of your life. However, because there are no guarantees, there's a chance you could comply with the RMD rules and still run out of money.
The minimum annual withdrawal rate starts at 3.65 percent at age 70 and increases every year. At age 73, the RMD amount is 4.05 percent of your account at the beginning of the year, and by age 80, the RMD amount is 5.35 percent of your account at the beginning of the year. Once you reach age 73 and the RMD amount exceeds a 4 percent withdrawal rate, you could simply set your annual withdrawal amount equal to the RMD amount each year and divide by 12 to calculate your monthly paycheck.
To calculate the RMD amounts, you'll want to work with a qualified tax advisor. Or, many financial institutions may also help you calculate the RMD amount.
Another possibility for managed payouts is to use Vanguard's Managed Payout funds, which provide low-cost investments and set up automatic withdrawals each month. The withdrawal amounts are reset periodically to reflect investment performance. Once again, with this type of investment, there's no guarantee that your retirement savings will last for the rest of your life. In addition, you'll need to pay attention to the RMD rules once you reach age 70 and a half.
Stay tuned for my next post, which will describe the best ways to buy an inflation-adjusted annuity and wraps up this series on using your retirement savings to generate a lifetime retirement paycheck.