4% Rule for RMD
When planning for retirement withdrawals, you may come across two important concepts: Required Minimum Distributions (RMDs) and the 4% rule. While both relate to drawing income from your retirement savings, they serve different purposes and are often misunderstood as being interchangeable. So, what exactly is the 4% rule, and how does it compare to RMDs?
The 4% Rule Explained
The 4% rule is a general retirement income strategy, not an IRS requirement. It was popularized in the 1990s as a guideline to help retirees determine how much they can safely withdraw each year from their retirement savings without running out of money.
According to this rule, you withdraw 4% of your total retirement savings in the first year of retirement, then adjust that amount annually for inflation. For example, if you retire with $1 million, you would withdraw $40,000 in the first year. This strategy assumes a 30-year retirement horizon and aims to balance income needs with portfolio longevity.
How It Differs from RMDs
Required Minimum Distributions (RMDs), on the other hand, are mandatory withdrawals set by the IRS, starting at age 73 (or age 75 for those born in 1960 or later). The RMD percentage increases each year as you age, based on your life expectancy as defined by the IRS Uniform Lifetime Table.
For example:
- At age 73, your RMD is about 3.77% of your account balance
- By age 85, the percentage jumps to nearly 6.25%
- Eventually, RMD percentages can exceed 10% in later retirement years
Unlike the 4% rule, RMDs are not optional—failing to take them can result in steep IRS penalties of up to 25% of the amount not withdrawn.
Should You Use the 4% Rule?
The 4% rule can be useful for early retirement planning, especially before RMDs begin. It offers a conservative estimate for annual withdrawals, helping you avoid depleting your savings too quickly. However, once RMDs kick in, they may exceed 4%, especially as you get older—so your withdrawal strategy may need to adjust accordingly.
Final Thought
The 4% rule is a helpful planning tool, while RMDs are a legal requirement. Understanding both allows you to build a smarter, more tax-efficient retirement income strategy that evolves over time.
If you are unsure about the application of this rule, Dimov Tax is ready to offer expert assistance. Contact us today for a professional approach to RMDs.