The Geneva Papers on Risk and Insurance Issues and Practice, 2013, Vol.38(4), p.729
Retired households must trade off the risk of outliving their wealth against the cost of unnecessarily restricting their consumption. Using numerical optimisation techniques, we compare two innovative rules of thumb: (1) consuming the age-related percentage of remaining wealth specified in the Internal Revenue Service (IRS) Required Minimum Distribution (RMD) tables, and (2) consuming the age-related percentage of remaining wealth specified in the IRS RMD tables PLUS interest and dividends, with alternative rules of thumb and with the theoretical optimal. We show that in models that incorporate uncertain investment returns, the second RMD strategy (spending age-related percentages of remaining wealth PLUS interest and dividends) performs better than plausible alternatives, such as spending the interest and dividends, consuming an inflation-indexed 4 per cent of initial wealth, or decumulating over the household’s life expectancy. Importantly, except for more risk-averse single males, it also performs better than the purchase of a market-load inflation-indexed annuity, and approaches the theoretical optimum.
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