80% of retirees are getting this RMD rule wrong ‘out of fear’ – and it could cost them thousands in lost income.
Most of us have the same goal: we will spend our working years withdrawing money so that we have enough savings to have enough money to retire comfortably.
This commitment to safety means we may have to make sacrifices along the way as we look forward to future rewards. Why, then, do many retirees actually tighten their belts and reduce their retirement spending?
Based on the research done in the 1950s by Nobel Prize-win economist Franco Modigliani and his student, Richard Brumberg, many economists argue that we base our spending and saving decisions on our beliefs about life’s costs and spending – and therefore we aim to maintain our pace. constant use throughout our lives.
When we are young, we tend to have low incomes and may take out a lot of debt, such as a mortgage, believing that we can pay it off with a higher income later in life. As our income increases, we begin to save so that we can continue our spending plan by drawing on these savings when our income decreases in retirement.
In fact, people tend to reduce their consumption to keep pace with inflation when they retire, a phenomenon known as the “retirement consumption paradox.” This can happen from choice or from necessity.
For example, 32% of retirees are “sure they don’t have enough savings” and 68% are worried they’ll run out of money, according to Schroders 2024 US Retirement Survey. Whether they’ve saved enough or not, they’re worried about inflation, the cost of health care, and a declining stock market.
It’s no surprise that retirees are getting smarter about how they spend their money. But this is leading more than 80% of retirees to make the mistake of only taking their minimum distributions (RMDs) from the accounts that need them.
Doing so can cost retirees more because it may mean they are limiting their income while they are in the active part of their retirement and can enjoy it more. Then they get more money when they are down and they may not need it less.
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An RMD is an annual withdrawal from a pre-tax retirement account, required under the rules of the Internal Revenue Service (IRS). These include 401(k)s, 403(b)s, 457s, government TSPs, and traditional IRA accounts.
You must begin taking RMDs by December 31 of each year, beginning the year you turn 73. There is an early-year exception that allows you to take your first RMD by April 1 of the year following the year you turn 73. but this requires you to take two RMDs that year. If you don’t take your RMD, you could face a tax penalty of up to 25 percent of the RMD that was due.
RMDs are calculated by dividing your account balance as of December 31 of the previous year by life expectancy based on tables posted on the IRS website.
For example, if you are 77 years old, married (to someone no more than 10 years younger than you) and your balance as of December 31 of the previous year was $1,000,000, then divide $1,000,000 by 22.9 (your lifetime). care), which gives you an RMD for this year of $466.
If you’re earning even an annualized return of 4.6% on your portfolio, then you’ll still have about $1,000 at the end of the next year, only this time your life expectancy is only 22.0, so your RMD would be $45,454. .
If your returns are still reasonable, you’ll replace part or all of your withdrawals each year, leaving you with a larger account balance and larger withdrawals at a later age when you may not be able to enjoy them as much.
Of course, this can be a good thing if you want to leave something behind for your successors, but if not, you could be leaving thousands of dollars on the table – and maybe enjoying your retirement a lot more.
If you don’t want money from your RMD, you can look for options like qualified charitable giving (QCDs), which allow you to give your RMD directly to charity. Usually RMDs are taxed as income, but charitable contributions are not.
If you feel you don’t need the money now, but you may need it later — such as for increased medical expenses — you may want to consider using your IRA or retirement savings to purchase a long-term annuity contract (QLAC). Payments from a QLAC can begin up to age 85 and are generally exempt from RMD requirements until then.
If you’re concerned about RMDs, you might want to consider rolling the money into a Roth account. You will pay taxes during the rollover, but there are no RMDs for Roth accounts and, subject to certain conditions, withdrawals are tax-free.
Your optimal withdrawal amount may not be the same as your RMD – and it can change over time – so it may be a good idea to consult a financial advisor to help you determine the amount that’s right for you.
This article provides information only and should not be taken as advice. It is provided without warranty of any kind.
