July 12, 2011
Income Source or Security Blanket?
Americans have squirreled away some $7.1 trillion in their retirement accounts. But once they actually retire, they don’t seem to know what to do with their money.
The U.S. income retirement system is in the throes of a foundational shift from guaranteed employer pensions to a system that puts most of the burden onto employees to make sure they have enough retirement income. I’ve been hearing recently about the heated debate on how Americans who are retiring are handling their finances under the new system.
Some worry that retirees are using up their personal retirement account (PRA) assets too quickly, while others believe they aren’t using the funds as retirement income, as intended when they were working and saving the money. By not spending it, they may be unnecessarily lowering their standard of living.
Findings earlier this year out of the National Bureau of Economic Research (NBER) show that individuals draw down very little of their assets, as they had intended years ago when they established their accounts.
James Poterba, NBER president, and economists Steven Venti at Dartmouth College and David Wise at Harvard University show that after age 70, retirees draw down a modest 5.2 percent annually, on average, from their IRAs, 401(k)s, Keough plans, and other PRAs. This number is particularly low, given the IRS’ requirement that they make minimum withdrawals from tax-advantaged PRAs after age 70½.
Just 7 percent of those between ages 60 and 69 withdraw more than 10 percent of their PRA balances and only 17 percent make any withdrawal at all. (One obvious thing to note is that the study looked at a relatively privileged lot – people who have been able to save.)
The drawdown rate is so low that individual retirement balances “continue to grow through at least age 85, although the rate of growth is slower at older ages than at younger ages,” the authors wrote.
How can this be explained? They speculate that individuals may be afraid to spend their monthly income in case they need it for nursing home care or big-ticket doctors’ bills that may be in their futures. Another plausible explanation: we all know a retiree who is extremely frugal or who refuses to spend money he or she wants to pass on to family or a charity.
The economists studied withdrawal patterns in 1997, 1998, 1999, 2001, 2002, 2004, and 2005. It’s also possible that the retirees in their sample don’t withdraw large amounts because this retiree cohort is still benefitting from the legacy of past employers’ defined benefit plans, which guaranteed a steady monthly income throughout their retired lives.
But I wonder about younger people who have no concept of a defined benefit plan. Will they be more rational in making decisions about using their PRAs?