Retirees who limit withdrawals from retirement accounts to RMDs could be making a mistake, according to JPMorgan Chase.
Although retirees only need to take out a certain portion of their retirement savings as distributions each year, a JPMorgan Chase study shows that there are likely good reasons to take out more. A withdrawal approach based solely on required minimum distributions (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 firm found.
Using internal data and an Employee Benefit Research Institute database, JPMorgan Chase studied 31,000 people as they retired between 2013 and 2018. The vast majority (84%) of retirees who had already reached the RMD age only raised the minimum age. Meanwhile, 80% of retirees who had not yet reached RMD age had yet to withdraw distributions from their accounts, the survey found, suggesting they want to preserve capital for later in retirement.
However, retirees’ caution about withdrawals can be misleading.
“The RMD approach has some obvious shortcomings,” wrote JPMorgan Chase’s Katherine Roy and Kelly Hahn. “It doesn’t generate income that supports retirees’ declining spending in today’s dollars, a behavior we see occurring as we 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.”
If you’re interested in professional guidance as you navigate RMDs, consider using this free tool to match with a fiduciary financial advisor.
What are RMDs?
Retirees who limit withdrawals from retirement accounts to RMDs could be making a mistake, according to JPMorgan Chase.
An RMD is the minimum amount the government requires most retirees to withdraw from their tax benefits at a certain age. In 2020, the RMD age was increased from 70.5 to 72. The JPMorgan Chase study examined data that predated this change.
Although 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 come with 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, 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 must withdraw at least $10,917 from his account that year.
A financial advisor can help you navigate the rules of RMDs.
RMD approach versus decreasing consumption strategy
Retirees who limit withdrawals from retirement accounts to RMDs could be making a mistake, according to JPMorgan Chase.
Using an RMD approach, a retiree simply adheres to the minimum required annual distributions. 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 expectations based on their current age; the 4% method does not. In addition, by withdrawing only the minimum each year, the account owner reduces their tax bill for the year and retains the maximum tax-deferred 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 possibility of dying with a significant account balance.
Assuming people spend more early in retirement than in their senior years, a withdrawal strategy should match this declining consumption, even if it means taking more than the required minimum benefit, Roy and Hahn wrote.
“On the consumption front, we believe the most effective way to retire wealth is to support actual spending behavior, as spending in today’s dollars tends to decline over the years,” they wrote. “Unlike the RMD approach, reflecting actual spending allows retirees to support higher spending during 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 has higher would support expenditure.
Meanwhile, the same retiree would still have more than $20,000 in his account by the time he turns 100 if he limits his benefits to the minimum amount. A 72-year-old using the declining consumption approach would have only a few thousand left at the age of 100.
While the RMD approach may increase a retiree’s chances of leaving money to loved ones, a retiree who is more concerned with meeting his own needs would likely benefit from an option related to his declining consumption in later life. Consider matching with a financial advisor if you need help with an RMD strategy.
In short
As many as 84% of retirees who reached RMD age limited withdrawals from their retirement accounts to the minimum amounts required, according to a JPMorgan Chase survey. This method may result in a retiree not having enough annual income than necessary. A withdrawal approach that more closely matches a retiree’s spending needs will provide more retirement income and reduce the chance that the pension funds will outlast the retiree.
Do you have a financial plan for your retirement? It’s never too late to start planning and a financial advisor can help you do that. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors serving your area, and you can interview your advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’re still years or decades away from retirement, it’s still important to know where you stand on the road to retirement. SmartAsset’s free 401(k) calculator can help you determine how much you can expect your savings to grow over time and how much you will have left when the time comes to retire.
Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with leads and provides marketing automation solutions so you can spend more time making conversions. Learn more about SmartAsset AMP.
