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Edna Plans Ahead - Planning For RMDs

|Includes:iShares Core Total U.S. Bond Market ETF (AGG), VTI

The last post introduced Edna, who made her first-ever distribution from her IRA on January 1, 2013. Her IRA started out at $1 million on January 1, 2012. It's invested in a 50/50 mix of VTI and AGG.

Now that Edna is faced with annual distributions, she decides to forecast what her future withdrawal requirements will be. Using historical averages, she feels that she can expect an average dividend yield of 2% and an average price appreciation of 3.5% on her VTI/AGG combination. Edna knows that averages can be a dangerous planning basis, but she has to start somewhere. Under these assumptions, the next ten years will look something like this:

  • RMDs rise gradually from 3.77% in 2014 to 5.35% in 2023.
  • The dollar amount of the distribution rises from $44,397 to $57,179 over the same period.
  • At the same time, the dividend payments on Edna's ETFs fall from $21,519 to $20,662 as the balance in the account falls.
  • Total distributions for the time period will be $508,182.
  • At 28%, Federal income tax on this amount will be $142,291. This is about 12% of the year-end 2013 account balance.

At this point Edna realizes three things:

  • Even under favorable assumptions, if she keeps the same asset allocation, she will be selling investments at an increasing pace, since required distributions will rise as dividend income falls.
  • Her assumptions are bound to be wrong. Markets cycle. If she is taking distributions in a bear market, she will have to sell ETFs that have already declined in value.
  • If she doesn't spend all of her RMDs, she will gradually build up a decent sized after-tax investment account, and she should have a plan for this account.

Like most of us, Edna is probably also wondering, "Why didn't I think of this earlier?" The answer, of course, is that she didn't think it was important until now!

Edna has a lot to think about. The next few posts will discuss what her response might be to these concerns.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Stocks: AGG, VTI