Required Minimum Distribution vs annuitization

IRS rules require that a certain amount of a traditional IRA be withdrawn each year after the IRA owner reaches the age of 70 ½ years.


 * RMD Suspended for 2009
 * "If you're over age 70½, you won't have to take required minimum distributions (RMDs) in 2009 from your tax-deferred retirement accounts under new legislation signed by President Bush.
 * The 2009 RMD suspension applies to traditional IRAs,  401(k)s,  403(b)s, and other defined contribution plans. The suspension also applies to investors under age 70½ with  inherited IRAs or inherited retirement plan accounts that would otherwise be subject to RMDs."--Vanguard News release, December 23, 2008

The distribution rules were made more generous in recent years and appear to work better than many annuities. If only the IRS Required Minimum Distribution (RMDS) percentage (See IRA Distribution Tables) is taken in bull or bear market years, the amount of money withdrawn will be increased some years and reduced some years but will theoretically never run out. Of course a severe long term decline like the Japanese scenario might make the amount of money insufficient to support required retirement expenses. Portfolio allocations for retirees dependent upon investments for a significant portion of their living expenses should be conservative anyway (higher percentage of fixed income reducing the equity risk).

Assuming the portfolio grows in value 6%/year (The default value in the Vanguard planner), the portfolio grows 19.5% in value after the distributions for the first 13 years. If the recipient is lucky enough to live to 100 years, the portfolio would have lost 37% of its initial value.

Since the distribution is based upon the recipient’s life expectancy, it increases each year as the life expectancy decreases. For example the distribution for the first year is based upon a life expectancy of 27.4 years. If one makes it to 100 years old the distribution is based upon a life expectancy of 6.3 years. This means the distribution income doubles after 13 years and peaks at 288% of the initial distribution value when one reaches 96 years of age. It is still 270% of the initial distribution value if one reaches 100 years of age.

Distribution from the IRA only means that taxes are due. After taxes are paid, if some portion of the distribution is not required for living expenses, it can be reinvested outside the IRA.

A final important consideration is that a surviving spouse can roll an IRA account from a deceased spouse directly into his or her own IRA account. Of course any amount remaining after both spouses are dead goes into the estate unless the spousal IRA has designated beneficiaries and is timely rolled over into inherited IRAs for the beneficiaries or distributed to a charitable beneficiary. Many forms of annuity only guarantee payment while the recipient is living.

Links

 * Publication 590 (2007), Individual Retirement Arrangements (IRAs)
 * Retirement Plans FAQs regarding the Required Minimum Distributions
 * Required Minimum Distribution (RMD) Calculator