Some Participants Using RMD as Guide for Draw Down

Researchers at TIAA-CREF set out to determine the effect on participants of the RMD waiver allowed in 2009, but as they probed the issue, it created more questions, according to David Richardson, a Charlotte, North Carolina-based senior economist for the TIAA-CREF Institute. According to the survey report, published by the Bureau of Economic Research, a key motive for the survey was to explore the reasons behind participants’ decisions to suspend or not suspend their RMDs.

More than 80% of respondents indicated that “allowing money to continue growing tax free/save on taxes” was a very important factor in their decision to suspend their RMDs. Among those that did not suspend, roughly one-third indicated that they “depend on distributions for daily spending needs,” and another 27% listed this as a somewhat important factor in their decision not to suspend. However, 39% of those who did not suspend indicated that this was not important in their decision-making. This led researchers to further explore the responses about needing RMD funds to cover spending needs, and ask whether respondents think RMDs are a guide to an appropriate draw-down rate in retirement.

Using administrative records TIAA-CREF holds for retirement plan participants who take RMDs, the researchers assigned survey respondents to quintiles by assets under management. Those in the lowest quintile have a 37% suspension rate, compared with 48% for those in the highest quintile. Researchers were surprised to find the percentage of survey respondents who say they could cover their spending needs without the RMD declines as the amount of assets at TIAA-CREF rises, from 88% (lowest quintile) to 79% (highest quintile). The researchers say this raises the possibility that some of those who are in the lowest quintile may have assets at other financial services firms that they use to support day-to-day consumption.

The survey responses also suggest that those with larger asset holdings at TIAA-CREF are more likely to assign some guidance role to the RMD amounts. The difference of more than twenty percentage points in the response to this question between the participants in the lowest (36%) and highest (58%) quintiles also may indicate that those with larger asset holdings at TIAA-CREF may not have as much assets elsewhere and rely more on income from assets from TIAA-CREF as a source of household income. Richardson admits this is a limitation of the survey and that it would be helpful to know about participants’ assets in other accounts.

A 2012 study found that using the RMD as a retirement savings withdrawal strategy does almost as well as traditional withdrawal options and outperforms the 4% rule. But, Richardson tells PLANADVISER “under a certain very restrictive set of assumptions about mortality and return, the RMD can provide a good guide for a draw down strategy, but we would think almost no one would meet that restrictive criteria.” 

He says there are a number of risks of using the RMD as a guide to spending in retirement. “It is not like longevity insurance; participants will draw down assets earlier and will have a lower level of assets generating income in later years than if they annuitized. What if there was another recession like in 2008? What if the participant has unexpected expenses? I don’t see RMDs as helping participants be prepared for these scenarios.”

Richardson adds that people using the RMD as a guide to a good spendable amount in retirement do not take into account market volatility. “That’s why the government allowed the suspension in 2009, they didn’t want people to realize capital losses on RMDs after the economy crashed,” he notes.

Richardson says it is important to remember that the RMD was designed to meet tax-policy objectives, not retirement-security objectives—it was established to help the government get back some of the tax deferral of retirement account contributions.  However, he notes that as defined contribution (DC) plans become the dominant way people receive retirement income, there is more interest in making sure RMD rules do not damage participants’ retirement security. “We don’t want a draw-down schedule that reduces the likelihood of people having financial security later in life.”

Richardson says a good first step in the trade-off between tax-policy objectives and retirement security objectives was included in the Internal Revenue Service's (IRS) proposed rules about longevity annuities—the rules would permit retirement account holders to use up to 25% of their account balance or $125,000, whichever is less, to purchase a qualifying longevity annuity without concern about noncompliance with RMD requirements.

For people really concerned about being forced to take assets out of their retirement accounts too early, Richardson suggests they can convert their assets to Roth accounts and will not have to worry about taking an RMD.

According to Richardson, the research shows there is still a lot of work retirement plan sponsors can do to provide retirement guidance and advice. “Especially as participants approach retirement, they need to be able to look at strategies for spending in retirement and making sure their assets are sustainable throughout their lifetime,” he says.

While behavioral finance has sparked changes to how plan sponsors get participants to accumulate assets for retirement—automatic enrollment, automatic investing solutions—the TIAA-CREF Institute is thinking about how to apply behavioral finance to at-retirement decisions. “We want plan sponsors to offer programs for education and advice about retirement withdrawal strategies, and incent participants to take advantage of those programs,” Richardson says.

The research report, "Do Required Minimum Distributions Matter? The Effect of the 2009 Holiday on Retirement Plan Distributions," is available for download here.