Although pensioners are required to take only a certain part of theirs retirement savings as distributions each year, JPMorgan Chase research indicates that there is probably a good reason to take more. A withdrawal approach based solely on minimum distributions required (RMD) not only fails to meet the annual income needs of retirees, it can also leave money on the table at the end of their lives, the financial services firm found.
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Using internal data and the Employee Benefit Research Institute database, JPMorgan Chase surveyed 31,000 people as they approached and entered retirement between 2013 and 2018. The majority (84%) of retirees who had already reached RMD age , only drew the minimum. Meanwhile, 80% of retirees who have not yet reached the RMD age have yet to take distributions from their accounts, the survey found, suggesting a desire to preserve capital for later retirement.
Retirees’ prudence about withdrawals can be misguided, however.
“The RMD approach has some clear flaws,” wrote Kathryn Roy and Kelly Hahn of JPMorgan Chase. “It doesn’t generate the income to support retirees’ declining spending in today’s dollars, a behavior we see happening with age. In fact, the RMD approach tends to generate more income later in retirement and can even leave a significant account balance at age 100.
What are RMDs?
The 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. The JPMorgan Chase study examines data that predates this shift.
All of the following retirement accounts come with required minimum distributions:
Ann The RMD is calculated by dividing a person’s account balance (as of December 31 of the previous year) by the current life expectancy factor, a figure determined 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 would need to withdraw at least $10,917 from his account that year.
RMD approach versus drawdown strategy
Using the RMD approach, the retiree simply sticks to the minimum required distributions each year. This strategy has several notable advantages over a more static technique, such as 4% rule. On the one hand, using actuarial statistics, the RMD approach takes into account a person’s life expectancy based on their current age; the 4% method does not. Also, by withdrawing only the minimum each year, the account owner will reduce your tax bill for the year and maintaining maximum deferred tax growth.
However, JPMorgan Chase’s Roy and Hahn note that a more flexible withdrawal strategy tied to retirees’ actual spending behavior is more effective at meeting income needs and reducing the chance of dying with a significant account balance.
Assuming people spend more early in retirement than in their later years, the withdrawal strategy should match this declining consumption, even if it means taking more than the required minimum distribution, Roy and Hahn write.
“On the consumption front, we believe the most effective way to withdraw wealth is to maintain actual spending behavior, as spending tends to decline in today’s dollars with age,” they wrote. “Unlike the RMD approach, reflecting actual spending allows retirees to maintain higher spending early in retirement and achieve greater utility from their savings.”
In comparing the RMD approach with the drawdown strategy, JPMorgan Chase found that a 72-year-old with $100,000 in retirement savings could spend more money each year using the drawdown strategy approach until age 87, when the RMD strategy would support higher costs.
Meanwhile, that same retiree would still have more than $20,000 in his account by the time he turns 100 if he limited his distributions to the minimum amount. A 72-year-old using the declining consumption approach would only have a few thousand left by age 100.
Although the RMD approach can increase a retiree’s chances of leaving money to loved ones, a retiree who is more concerned about meeting their own needs will likely benefit from a taper option later in life.
A whopping 84% of retirees who have reached RMD age limit withdrawals from their retirement accounts to the bare minimum, a JPMorgan Chase study found. This method can leave a retiree with an annual income short of what is needed. A withdrawal approach that is more closely aligned with the retiree’s expenses will provide more income in retirement and reduce the chances that the pension funds will outlast the retiree.
Tips for saving in retirement
Do you have a financial plan for retirement? It’s never too late to start planning and a financial advisor can help you do just that. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool connects you with up to three financial advisors who serve your area, and you can interview your advisor matches for free to decide who is the best fit for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.
If you’re still years or decades away from retirement, it’s still important to know where you are on the road 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 might have when it’s time to retire.
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