While retirees only need to take out a certain portion of their retirement savings each year, a JPMorgan Chase study shows there’s likely good reason to take out more. A withdrawal approach based solely on required minimum benefits (RMDs) not only fails to meet retirees’ annual income needs, but can also leave money on the table at the end of their lives, the financial services company found.
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Using internal data and a database from the Employee Benefit Research Institute, JPMorgan Chase studied 31,000 people as they retired between 2013 and 2018. The vast majority (84%) of retirees who had already reached RMD age took up only the minimum. Meanwhile, 80% of retirees had not yet reached RMD age and had yet to withdraw distributions from their accounts, the study found, suggesting a desire to preserve capital for later in retirement.
However, retirees’ caution regarding withdrawals may be misplaced.
“The RMD approach has some obvious shortcomings,” wrote JPMorgan Chase’s Katherine Roy and Kelly Hahn. “It doesn’t generate income that supports today’s declining dollar spending by retirees, 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 account 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 increased from 70.5 to 72. The JPMorgan Chase study examined data predating this change.
While most employer-sponsored retirement plans and individual retirement accounts (IRAs) are subject to RMDs, owners of Roth IRAs are exempt from taking minimum annual distributions.
The following retirement accounts all have the required minimum benefits:
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 need to 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 distributions each 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 a person’s expectation based on their current age; the 4% method does not. By withdrawing only the minimum each year, the account owner reduces his tax bill for the year and maintains the maximum tax-deferred 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 death with a significant balance in the account.
Assuming people retire earlier than during their senior years, a withdrawal strategy should suit this declining consumption, even if it means taking more than the required minimum distribution, Roy and Hahn wrote.
“With regard to consumption, we believe 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. “Unlike the RMD approach, reflecting actual expenses allows retirees to sustain higher spending before retirement 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 until age 87, when the RMD strategy 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 limited his distributions 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 the likelihood that a retiree will be able to leave money to loved ones, a retiree who is more concerned with meeting his own needs will likely benefit from an option related to his declining consumption later in life.
It boils down
A whopping 84% of retirees who reached RMD age limited their retirement account withdrawals to the minimum required, a study by JPMorgan Chase found. This method can leave a retiree with not enough annual income than necessary. A withdrawal approach that is more closely aligned with a retiree’s spending needs will provide more retirement income and reduce the likelihood that pension funds will outlast the retiree.
Tips for retirement savings
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