The Modified Common Rule is an evolving algorithm that is loosely based on the Common Rule. However, the following changes are made to it to increase portfolio longevity or increase wealth transferred to an heir.
- Tax deferred accounts are used earlier to reduce the larger taxes paid in the future due to Required Minimum Distributions (RMDs)
- Consequently, taxable brokerage accounts withdrawals occur at a slower rate or are delayed entirely to later years.
The Modified Common Rule is used in our retirement income calculator when a retiree’s income needs do not require any account withdrawals after RMDs are made. In our model, these other sources of retirement income include:
- taxable social security benefits
- taxable pension benefits
- taxable bond interest from the bond allocation in the taxable brokerage account
- taxable stock dividends from the stock allocation in the taxable brokerage account
- tax-free social security
Like the Common Rule, this rule also follows a zero-dividend taxable stock account strategy when these other sources of income plus RMDs exceed a retiree’s income need. So, all additional retirement income generated by these sources that exceed the retiree’s needed income are re-invested in a zero-dividend taxable stock ETF, like the First Trust Dow Jones Internet Index Fund (ticker: FDN). This approach is advocated by DeMuth (2019) and DiLellio and Ostrov (2020), since these funds will all be eventually passed to the retiree’s heirs tax-free since they will receive a step-up in costs basis.