Meredith Corporation (MDP), Lockheed Martin Corporation (LMT): The 4% Withdrawal Rule Versus Required Minimum Distributions, Part One

There’s been plenty of discussion over the years about the best amount to withdraw from a retirement account. It’s a tricky calculation, especially if your retirement account is fairly modest. You want to make sure your money lasts as long as you do, but you also don’t want to live more frugally than necessary.

The consequences of getting the calculation wrong can be quite dire. Take too much, and you may run out of money long before you die. Take too little, and you have been able to do less with your life than you may have wished.

Conventional wisdom suggests the 4% rule, which was initially developed in the 1990s by a California financial planner. According to his research, and subsequent refining by other researchers, an initial withdrawal of 4% of the portfolio balance, followed by an additional 4% every year (and allowing increases for inflation), and a retiree should be good for at least 30 years.

I’ve seen many articles about the 4% rule, but I’ve never seen anyone actually discuss the elephant in the room – the federal government’s Required Minimum Distribution. If your retirement savings are in a traditional IRA or a 401(k), as is quite likely, you don’t actually have a choice in the matter of how little you can withdraw each year.

If your money is in a tax-deferred account, the government wants its share of taxes that it hasn’t yet collected. So you must withdraw at least a specific amount every year, and that amount grows over time. Uncle Sam wants you to withdraw all of your savings, and pay taxes on it, before you die.

Hypothetical retirement portfolios

I ran the numbers on two hypothetical retirees, age 70, and their portfolios, each one beginning with $1 million and running under the following assumptions: the account increases in value by 5% every year, and the withdrawal is taken on December 31 every year.

The RMD portfolio withdrawals keep going up as a percentage of the balance, so that the annual withdrawal exceeds 10% of the balance by the age of 92. The great news, however, is that even at these accelerated withdrawal rates, the hypothetical RMD millionaire still has almost $500,000 by the time he turns 100.

Now, the RMD retiree must withdraw that amount every year, and pay the commensurate tax on that money to the federal government. Since the withdrawal is a higher amount, the tax due is also higher, and that will eat into the actual net amount that he receives.

Assume, however, that the RMD retiree, like the 4% retiree, can comfortably live on the 4% plus any combination of private pension and Social Security payments that he may receive. What is he to do with the “extra” money, considering that he doesn’t want to spend it all?

What to do with the “Extra” money?

I’m making the assumption that the RMD retiree actually has some “extra money” after paying taxes and deducting the amount that he requires for living expenses. Other papers published recently have questioned the 4% rule, wondering if it is actually too aggressive based on today’s stock market scenarios.

This in my opinion just underscores the fact that, when a retiree is forced to make minimum annual withdrawals that greatly exceed 4% of his balance, he is in danger of outliving his money if he does not continue to invest for both income and growth.

Unfortunately, you can’t just put the extra money back, nor can you put it into another traditional IRA. And unless you have earned income, you can’t put it into a Roth IRA, either.

One option

This is a great place for a retired person to invest in equities that offer a measure of safety against stock market downturns – in other words, dividend-paying stocks, my favorite kind.

I’ve been investigating and writing about dividend stocks for a while, so here I present three of my favorites. Please see my individual company analysis for more details.

Cracker Barrel Old Country Store, Inc. (NASDAQ:CBRL) is up 48% since I selected it in early January, yet its dividend yield has remained at 3.1% thanks to a 50% increase last week after the company reported 2Q earnings. If you’re looking for a company that is committed to growing its dividend, you can’t do much better than this. Since 2011, the dividend has doubled, while the payout ratio has remained low at 39%.

Meredith Corporation (NYSE:MDP) is up 18% since I selected it in January. It yields 4.0%. The last increase in the dividend was for 1Q 2013, Meredith Corporation (NYSE:MDP) has been paying and raising dividends for 19 years, and the 5-year dividend growth rate is 15.5%, while the payout ratio remains a reasonable 60%.

Lockheed Martin Corporation (NYSE:LMT) has not increased in share price as impressively as my other two picks, but it more than makes up for that in dividend increases. Lockheed Martin Corporation (NYSE:LMT) management has demonstrated a clear commitment to dividend growth; the dividend has doubled since 2010. The company has been paying and raising dividends for 10 years, and the 5-year dividend growth rate is 22.8%. The share price is up 10% since I selected it for my Perfect Dividend Portfolio in January.

So there are three great dividend-growth companies that offer a terrific option for a retiree: exposure to stock market price appreciation, plus the safety of a regular and growing dividend.

I do have another suggestion for retirees looking to invest “extra” money – please see Part Two, wherein I discuss some terrific recommendations for stock selections in a taxable account that offer tax-deferral on high-yielding income generators.

The article The 4% Withdrawal Rule Versus Required Minimum Distributions, Part One originally appeared on Fool.com and is written by Karin Hernandez.

Karin Hernandez is long Cracker Barrel Old Country Store, Meredith Publishing and Lockheed Martin. The Motley Fool recommends Cracker Barrel Old Country Store. The Motley Fool owns shares of Lockheed Martin. Karin is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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