The order in which you spend your money makes a difference for your taxes — and your enjoyment of life When you retire, you ideally have a couple different buckets of money to draw from — like pretax, Roth, cash and Social Security — which helps you diversify your income sources and better manage your taxes. But retirees are marking their IRAs and 401(k)s as off-limits for a decade or more, and then only taking from them sparingly, according to a new report from Vanguard, one of the biggest retirement-account custodians. This leads to people constraining their budgets early in retirement, and dying with even more money than they started with at the beginning of retirement.
It’s a reactive strategy to calm the fear of running out of money, and it ends up working far better than they expect — which is actually counter to their intentions. Why your kid’s part-time job could ultimately be worth $500K in savings Play video: Why your kid’s part-time job could ultimately be worth $500K in savings “In the savings phase, we do so much to help people auto-enroll, auto-invest — and when it comes to retirement income, we drop them in the Pacific Ocean and say, ‘swim,’” said Fiona Greig, Vanguard’s global head of investor research and policy. I would like to receive updates and special offers from Dow Jones and affiliates.
I can unsubscribe at any time. Vanguard first saw this behavior in blind administrative data from the millions of accounts it manages. It could see that most people waited until they hit the age of required minimum distributions (RMDs) — 73 now, though it will be 75 for those born 1960 and later — and then they tended to only take out the required amount.
That RMD is pegged to a government formula based on a person’s projected lifespan, and it starts out at about 4% of the account value but is larger at older ages. Following that path of withdrawals and average account growth of 7%, a person would have a greater balance at the end than when they started. Then the question becomes: What’s the point of retirement savings if you have more when you die than when you started retirement, and meanwhile you’re living on peanut butter and jelly?
Greig said this is when her team decided to delve deeper, because just looking at back-end data didn’t let them see if this was a true behavioral phenomenon, or if it was just a data artifact because Vanguard doesn’t necessarily hold each participant’s entire life savings. People regularly have accounts at several different institutions at the same time. So Vanguard surveyed retirees across the income spectrum about how they spent through their entire retirement nest eggs.
The results were shockingly the same: Only 1 in 10 retirees took consistent withdrawals from their accounts throughout retirement. Most took sporadic lump sums at times when they had large expenses, or they took one annual distribution once they hit RMD age — and took only the amount required. The risk of this, Vanguard said, is that this strategy means “backloading income into later years,” which can increase income taxes and lead to higher taxes on Social Security and possible monthly surcharges on Medicare, known as IRMAA.
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