Although retirees only pay a certain portion of their retirement savings out as benefits per year, a study by JPMorgan Chase turns out there’s probably a good reason to take out more. A withdrawal approach based solely on: required minimum distributions (RMDs) not only fail to meet retirees’ annual income needs, but can also leave money on the table at the end of life, the financial services firm found.
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Using internal data and an Employee Benefit Research Institute database, JPMorgan Chase studied 31,000 people as they approached and entered retirement between 2013 and 2018. The vast majority (84%) of retirees who had already reached RMD age only withdrew the minimum. Meanwhile, 80% of retirees who had not yet reached RMD age had no payments from their accounts, the study found, suggesting there is a desire to preserve capital for later retirement.
However, retirees’ caution around withdrawals can be misleading.
“The RMD approach has some obvious shortcomings,” wrote Katherine Roy and Kelly Hahn of JPMorgan Chase. “It does not generate income to support the declining spending of retirees in today’s dollars, a behavior we see occurring with age. In fact, the RMD approach tends to generate more income later in retirement and can leave a significant balance even at age 100.”
What are RMDs?
An RMD is the minimum amount the government requires most retirees to withdraw from their tax-advantaged retirement accounts at a certain age. In 2020, the RMD age was raised from 70.5 to 72 years. The JPMorgan Chase study examined data that predated this change.
The following retirement accounts all have the required minimum benefits:
A RMD is calculated by dividing a person’s account balance (as of December 31 of the previous year) by their current life expectancy, a figure set by the IRS. For example, a 75-year-old has a life expectancy factor of 22.9. If a 75-year-old retiree has $250,000 in a retirement account, he must withdraw at least $10,917 from his account that year.
RMD approach versus declining consumption strategy
Using an RMD approach, a retiree simply adheres to the minimum required benefits per year. This strategy has some notable advantages over a more static technique, such as the 4% rule. First, using actuarial statistics, the RMD approach takes into account one’s expectation based on one’s current age; the 4% method does not. By withdrawing only the minimum each year, the account owner will: reduce his tax bill for the year and to maintain maximum deferred tax growth.
However, Roy and Hahn of JPMorgan Chase note that a more flexible withdrawal strategy, coupled with the actual spending behavior of retirees, is more effective at meeting income needs and reducing the likelihood of dying with a significant balance in the account.
Assuming that people spend more in retirement than in their senior years, a withdrawal strategy should fit this declining consumption, even if it means taking more than the required minimum distribution, Roy and Hahn wrote.
“In terms of consumption, we believe that the most effective way to absorb wealth is to support actual spending behavior as spending in current dollars tends to decline with age,” they wrote. “Contrary to the RMD approach, by displaying actual expenses, retirees can support higher early retirement spending and achieve greater utility from their savings.”
Comparing the RMD approach to the declining consumption strategy, JPMorgan Chase found that a 72-year-old with $100,000 in retirement savings could spend more money each year using the declining consumption strategy approach until age 87, when the RMD strategy would support higher spending.
Meanwhile, the same retiree would still have more than $20,000 in his account by the time he turns 100 if he cut his benefits to the minimum amount. A 72-year-old using the declining consumption approach would only have a few thousand left at age 100.
While the RMD approach may increase a retiree’s chance of bequeathing money to loved ones, a retiree more concerned with meeting their own needs would likely benefit from an option related to their declining consumption in later life.
A whopping 84% of retirees who reached RMD age limited their retirement account withdrawals to the minimum required, according to a study by JPMorgan Chase. This method can leave a retiree with not enough annual income than necessary. A withdrawal approach that more closely matches a retiree’s spending needs will yield more retirement income and decrease the likelihood that pension funds will outlast the retiree.
Tips for retirement savings
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If you’re still years or decades away from retirement, it’s still important to know where you stand on the path to retirement. SmartAsset is free 401(k) calculator can help you determine how much you can expect your savings to grow over time and how much you can have when it comes time to retire.
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