Michael on April 4th, 2008
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It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.

Is the intention of the minimum requirement distribution of your IRAs to deplete them, little by little? Somewhere down the line my monthly interest will be less and less as the balance goes down. What else can I do?
–Frustrated investor

STRAIGHTFORWARD ANSWER: The intention of the Minimum Required Distribution (MRD) rule is to ensure that you withdraw a certain amount of your IRA assets each year in retirement. But the law doesn’t say anything about what you must do with that money.

More detailed explanation:

Minimum required distributions (MRD) are required from traditional IRAs and workplace retirement programs (like your 401(k)). With rare exception, the law requires that a certain amount of these accounts be distributed to you each year, starting with the year after you turn 70 1/2 years old. Since these accounts are tax-deferred, you will pay tax on the distributed amount.

You: How much must I take as a distribution?

The amount is based on your life expectancy.

You: Now how would I know that?

You wouldn’t. But the IRS does.

You: They know when I am going to die? This is sick.

I’d like to think that they don’t know when you’ll kick, but I can’t be certain. However, for purposes of calculating the MRD, your life expectancy is not specific to you, any Chinese food addition, or your propensity to jump out of airplanes. There’s a table out there that they use (here’s the simplest one); your life expectancy is based on your age alone. (unless you have a certain kind of designated beneficiary or are dealing with an inherited IRA, both of which, along with a few other fun exceptions, are way beyond the scope of this post).

So, if you’re 75 years old, the IRS says you have 13.4 years left to live and so you will have to withdraw about 7.46% (1/13.4) of your IRA this year.

You: But doesn’t this mean that my account will decrease every year?

It very well could and often will. Of course, it’s possible that your account could grow by more than your MRD. For example, between the time you turn 75 and 76, the market could perform well and overcome the MRD. But most of the time it won’t.

Frustrated Investor’s concern that she is destined to have significantly less money as a result of the MRD is misplaced. Sure, she is nearly assured to have less money in her IRA over time, but there’s no law that says she has to spend 100% of the money she distributes. She can choose to distribute the required amount (MRD) each year, spend what she needs to, and keep the rest in an ordinary savings account. If she runs out of money in retirement, it won’t be because of the MRD; it will be because she hasn’t saved enough before retirement or spent too much during it. Here’s to that not being the case.

Quick side note: Roth IRAs are not subject to MRD, another key advantage of the Roth.

Got questions? Every Friday is Q & A day. Send one in! To do so, click here for more information or just email me a question.

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