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?

3 Responses to Income Source or Security Blanket?

  1. mike dalton says:

    The average withdrawal of 5.2% implies an average age of those taking the minimum distribution of between 79 and 80. The first line of suggesting that they don’t know what to do with their money is simply unfounded – I am 68, am still working and expect to live on Social Security at 70 and non-exempt assets — my IRAs and 401 ks have all been converted to Roths for which there is no mandatory withdrawal at 70.5. I have many similarly situated friends and we frequently discuss what to do with our money– leave to the undeserving heirs, the undeserving charities, the undeserving government, or the undeserving hospitals (get an advance medical directive)????? The last line suggests we are not rational– we are we just grew up frugal (heresy i know).

  2. Perhaps retirees are wiser than they are being given credit for. Most financial advisors recommend that retirees withdraw about 4% of their portfolio in the 1st year of retirement – and then adjust that amount for inflation in subsequent years. This is to have a pretty good shot at not running out of money. I read a recent article in the Journal of Financial Planning that suggests the “safe” percentage may be even lower. Also, the Uniform Life Table for calculating Required Minimum Distributions only requires retirees to withdraw 3.6% at age 70.5 to 8.8% at age 90. It pays to be conservative. We are all charting new waters, relying so much on our own investments, and not pensions, to last through retirement.

  3. Murray Gendell says:

    Our poor health system does not protect us against the catastrophic costs of serious illness requiring hospitalization, the likelihood of which inreases with age. This concern is the main reason for the caution my wife and I exercise in spending our income. In addition, we have been, and probably will continue to be, in a very low interest environment that makes it difficult to get more than a pittance on capital-conserving investments. One of the few things we have some control of is our expenditures. We look for opportunities to reduce expenses, without eliminating all pleasures. Also, we try to keep from spending all of our required tax distributions. One way we have been doing this is to have my wife. who is still earning, add to her Roth account. We think our Roth accounts might be the best legacy we can leave to our children, so they are the last accounts we will draw on, if necessary.