Accumulation’s Done. Now What?

More Baby Boomers are entering retirement with large portions of their retirement savings in individual retirement accounts (IRAs), EBRI pointed out in “IRA Withdrawals: How Much, When, and Other Saving Behavior.” In other words, people’s financial security in retirement may depend on how they manage these accounts post-retirement.

Some could be sacrificing a more enjoyable retirement by exercising too much caution in drawing down IRA balances. Others may jeopardize retirement security by spending too much, too soon.

EBRI examined different withdrawal patterns with households not yet subject to the requirement minimum distribution rules (RMD). Those households with members between the ages of 61 and 70 that made withdrawals even though they were not yet required to take IRA distributions made larger withdrawals than older households, both in absolute dollar amounts as well as a percentage of IRA account balance.

The bottom-income quartile of this age group had a very high percentage (48%) of households that made an IRA withdrawal. Their average annual percentage of account balance withdrawn (17.4%) was higher than the rest of the income distribution.

Among households with members between the ages of 71 and 80 that are subject to RMDs, those that have a withdrawal exceeding the RMD amount had average withdrawal amounts that were more than double the amounts taken by those that withdrew only the RMD amount. The percentage of account balance withdrawn was also much larger for households that withdrew more than the RMD amount.

Younger households (61 to 70) that made IRA withdrawals spent most of it, while for those between 71 and 80 there was some increase in savings (in CDs and similar holdings) associated with an IRA withdrawal.

Different Ages, Different Withdrawals

The percentage of households making an IRA withdrawal increased with age, and spiked around ages 70 and 71. This is likely a direct result of the RMD rules in the Internal Revenue Code. These rules require that traditional IRA account holders begin to take at least the minimum withdrawal specified from their IRA no later than April 1 of the year following the year in which they reach age 70-1/2. (Otherwise they incur a tax penalty.)

At age 61, only 22% of households made an IRA withdrawal, which slowly increased to 40.5% by age 69 before jumping to 54% at age 70, and to 77% at age 71. By the age of 79, almost 85% of households with an IRA took a distribution.

Although the RMD rules require households to start taking distributions after age 70-1/2, not everyone with an IRA who reached that age made a withdrawal.

Reasons for this can vary. The account could be a Roth IRA, which is not subject to the RMD rules, or the account belonged to a spouse who was still under the age of 70-1/2.

Some households reporting taking the RMD only in order to avoid a tax penalty, and the percentage of these households also rose with age. At age 71, 71% of households took the RMD. This increased to 77% at age 75; 83% at age 80; and 91% by age 86.

Age, Income and Withdrawal Behavior

One of the important advantages of traditional defined benefit (DB) pensions is that when an annuity option is chosen, the benefit amounts are generally adjusted for mortality risk and protect the beneficiaries from longevity risk. There is no need for beneficiaries to calculate the complex withdrawal rates. But as individual accounts such as IRAs and 401(k)s become more prevalent, withdrawal rates and strategies are becoming more complicated and more important. 

EBRI’s report showed that IRA withdrawal rates clearly decrease as income increases. In the bottom-income quartile of households with members between the ages of 61 and 70 that made an IRA withdrawal, nearly half (48%) of the households made an IRA withdrawal, as did those in the second-income quartile (48%). But the next two quartiles showed significant drops in IRA-withdrawal rates: 43% of retired households in the third quartile and only 29% of retired households in the top-income quartile made an IRA withdrawal.

This highlights the first area of potential concern: More people in the lower-income groups withdraw money early, i.e., before the RMD kicks in. This should not be surprising, since lower-income households could be expected to be in greater need of money. But are these low-income households withdrawing too much too soon?

The percentage of households making an IRA withdrawal before the RMD kicks in is very high in the bottom-income quartile, EBRI found, and these households are withdrawing money at a much faster rate than the higher-income households. While households in the bottom-income quartile have the majority of their total assets outside of IRAs, this pattern of withdrawal could be another area of concern.

Among households between ages 71 and 80 that are subject to RMDs, there are also some important patterns. Households that have a withdrawal exceeding the RMD amount had average withdrawal amounts that were more than double the amounts taken by those that withdrew only the RMD amount. The percentage of account balance withdrawn was also much larger for households that withdrew more than the RMD amount. Finally, younger households (ages 61 to 70) that made IRA withdrawals spent most of it. For these households, an IRA withdrawal was not associated with an increase in any other type of savings. On the other hand, for those between 71 and 80, there was some increase in savings (in CDs and similar holdings) associated with an IRA withdrawal.

The University of Michigan’s Health and Retirement Study (HRS), which is sponsored by the National Institute on Aging, supplied the data for this study. HRS is a biennial national survey of older Americans, with primary respondents who are at least 50 years old, along with their spouses.

“IRA Withdrawals: How Much, When, and Other Saving Behavior” can be downloaded here.