84% of retirees make this RMD mistake

Retirees who limit retirement account withdrawals to RMDs may be making a mistake, according to JPMorgan Chase.

Although retirees are only required to take out a certain portion of their retirement savings as distributions each year, a study from JPMorgan Chase suggests there’s probably good reason to take more. A retirement 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 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 retired between 2013 and 2018. The vast majority (84%) of retirees who had already reached RMD age withdrew only the minimum. Meanwhile, 80% of retirees who had not yet reached RMD age had not yet taken distributions from their accounts, the study found, suggesting a desire to preserve capital for later in retirement.

However, retirees’ prudence about withdrawals can be misplaced.

“The RMD approach has some clear shortcomings,” wrote Katherine Roy and Kelly Hahn of JPMorgan Chase. “It doesn’t generate income to support reducing retirees’ spending 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 even leave a sizable account balance at age 100.”

What are RMDs?

Retirees who limit retirement account withdrawals to RMDs may be making a mistake, according to JPMorgan Chase.

Retirees who limit retirement account withdrawals to RMDs may be making a mistake, according to JPMorgan Chase.

The RMD is the minimum amount the government requires most retirees to withdraw from tax-advantaged retirement accounts at a certain age. In 2020, the RMD age increased from 70.5 to 72. The JPMorgan Chase study looked at data that predates 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.

All of the following retirement accounts come with required minimum distributions:

The 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 number 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, they should withdraw at least $10,917 from their account that year.

RMD Approach vs Declining Consumption Strategy

Retirees who limit retirement account withdrawals to RMDs may be making a mistake, according to JPMorgan Chase.

Retirees who limit retirement account withdrawals to RMDs may be making a mistake, according to JPMorgan Chase.

Using an RMD approach, a retiree simply sticks to the minimum required distributions each year. This strategy has several notable advantages over a more static technique such as the 4% rule. For one, using actuarial statistics, the RMD approach factors 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 holder will reduce their tax bill for the year and retain the maximum tax-deferred growth.

However, JPMorgan Chase’s Roy and Hahn note that a more flexible withdrawal strategy tied to retirees’ actual spending behaviors is more effective at meeting income needs and reducing the chance of dying with a significant account balance.

Assuming people spend more earlier in retirement than in their later years, a retirement strategy would have to match this reduction in consumption, even if it means taking more than the required minimum distribution, wrote the Roy and Hahn.

“On the consumption front, we believe the most effective way to withdraw wealth is to support real spending behaviors, as spending tends to decline in today’s dollars with age,” they wrote. “Unlike the RMD approach, reflecting actual spending allows retirees to support higher spending early in retirement and achieve greater utility from their savings.”

Comparing the RMD approach with the taper strategy, JPMorgan Chase found that a 72-year-old with $100,000 in retirement savings could spend more money each year using the taper strategy approach until age 87, when the RMD strategy would supported higher spending.

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.

While the RMD approach may increase a retiree’s chances of being able to leave money to loved ones, a retiree who is more concerned with meeting their own needs will likely benefit from an option tied to declining consumption later in life of.

Conclusion

A whopping 84% of retirees who reached RMD age were limiting their retirement account withdrawals to the minimum required, according to a JPMorgan Chase study. This method can leave a retiree with not enough annual income than they need. A retirement approach more closely aligned with a retiree’s spending needs will provide more retirement income and reduce the chances that retirement funds will outlive the retiree.

Tips for saving for 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 matches you with up to three financial advisors serving your area, and you can interview your advisors at no cost to decide who is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

  • Whether you’re still years or decades away from retirement, knowing where you are on the road to retirement is still important. 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 might have when it’s time to retire.

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