Although retirees are only required to withdraw a certain portion of their retirement savings as distributions each year, research by JPMorgan Chase shows there are likely good reasons to withdraw more. A withdrawal approach based solely on required minimum distributions (RMDs) not only fails to meet the annual income needs of retirees, but can also leave money on the table at the end of their lives, found the financial services company.
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Using internal data and a database from the Employee Benefit Research Institute, JPMorgan Chase studied 31,000 people approaching and entering retirement between 2013 and 2018. The vast majority (84 %) of pensioners who had already reached RMD age only withdrew the minimum. Meanwhile, 80% of retirees had not yet reached RMD age and had not yet withdrawn distributions from their accounts, the study found, suggesting a desire to preserve capital for later retirement.
However, retirees’ caution about withdrawals may be misguided.
“The RMD approach has obvious shortcomings,” wrote Katherine Roy and Kelly Hahn of JPMorgan Chase. “It doesn’t generate income that supports the decline in spending by retirees 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 may even leave a large account balance 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 increased from 70.5 to 72 years. The JPMorgan Chase study looked at data from before this change.
While most employer-sponsored retirement plans and Individual Retirement Accounts (IRAs) are subject to RMDs, Roth IRA owners are exempt from the requirement to receive minimum annual distributions.
The following retirement accounts all have required minimum distributions:
An RMD is calculated by dividing a person’s account balance (as of December 31 of the previous year) by their current life expectancy factor, 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 would be required to withdraw at least $10,917 from his account that year.
RMD approach versus consumption reduction strategy
Using an RMD approach, a retiree simply sticks to the required minimum distributions each year. This strategy has several notable advantages over a more static technique, such as the 4% rule. On the one hand, by using actuarial statistics, the RMD approach takes into account the expectation of a person according to his current age; the 4% method does not. Additionally, by only withdrawing the minimum each year, the account holder will reduce their tax bill for the year and maintain maximum tax-deferred growth.
However, Roy and Hahn of JPMorgan Chase note that a more flexible withdrawal strategy linked to the actual spending behaviors of retirees is more effective in meeting income needs and reducing the possibility of dying with a considerable account balance remaining.
Assuming people are spending earlier in retirement than in their later years, a withdrawal strategy should match this declining consumption, even if it means taking more than the required minimum distribution, Roy and Hahn wrote.
“On the consumption front, we believe the most effective way to withdraw wealth is to support actual spending behaviors, as spending tends to decline in today’s dollars with age,” they wrote. “Unlike the RMD approach, reflecting actual expenses allows retirees to incur higher expenses early in retirement and get greater utility from their savings.”
Comparing the RMD approach to the consumption-declining strategy, JPMorgan Chase found that a 72-year-old with $100,000 in retirement savings could spend more money each year using the RMD approach. declining consumption strategy until age 87, when the RMD strategy would support higher spending.
Meanwhile, the same retiree would still have over $20,000 in his account by the time he turned 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 dollars left at age 100.
While the RMD approach may increase a retiree’s chances of being able to leave money to loved ones, a retiree more concerned with meeting their own needs would likely benefit from an option tied to lower consumption later on. in life.
Conclusion
According to a study by JPMorgan Chase, 84% of retirees who reached RMD age limited withdrawals from their retirement account to the minimum required. This method can leave a retiree with insufficient annual income compared to what is needed. A withdrawal approach more closely aligned with a retiree’s spending needs will provide higher retirement income and reduce the chances that retirement funds will outlive the retiree.
Tips for Retirement Savings
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