Marking Time — When Retirement Milestones Become Personal

  There’s something about a birthday that ends in zero that hits differently. And I have one of those this week.

I’ve spent more than half my professional life thinking, writing, and talking about retirement — how people get there, how they prepare (or don’t), and what it all means when work finally loosens its grip.

And yet, when you hit a milestone like this, “theory” gets very personal very fast.

Truthfully, this isn’t what I thought “this” would feel like. Not dread. Not triumph. Just … different. Though lately, I’ve been thinking about it more than I expected.

See, it’s not just another candle (you’d have to forewarn the local fire department). It’s a checkpoint. A round number that invites reflection whether you ask for it or not. Sure, it’s just another year. But it’s a whole other category of living.

That said — and I’m happy to be able to say this — I don’t “feel” my age.[i] Or what I thought it would be like to be this age.

What I am starting to feel — though only recently, and doubtless due to the approaching anniversary of my birth — is an appreciation of how I spend my time. 

No longer bound by office start and stop times, the “rigor” of commutes, the (seemingly) endless pattern of meetings and conference calls — time, and the opportunity to see and do “other” things beckons. 

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You start to notice how you spend time, and who you spend it with. You’re more aware of what drains you — and what gives energy back. You get better (though it’s still a work in progress) at saying “no,” not because you’re tired, but because you’ve learned that every “yes” displaces something else.

There are a fair number of age markers in our business; age 50 for catch-ups, 59 ½ for penalty-free withdrawals,[ii] 62 for early Social Security withdrawals, 65 (as adjusted) for retirement/Social Security, and age 73 or 75 for RMDs (depending on your age). We’ve even recently added some others (ages 60-63) for “super” catchups. And let’s not forget the implicit retirement age “marker” associated with target-date fund selection. 

These markers give us an opportunity — an “excuse,” if you will, to engage with individuals along the way to help them consider different, and perhaps better, ways of financial preparation. Their advantage is you don’t need anything more than a calendar to anticipate and track them. Their limitation is that many arrive too late for truly meaningful course corrections — when time, compounding, and flexibility are already constrained.

If there’s a lesson in those age-based milestones, it’s this: milestones matter, but they don’t have to define you. They’re prompts, not verdicts. Invitations to take stock, adjust course, and — if you’re lucky — keep doing meaningful work with people you respect — and for people that need your support.

Because if you’ve learned nothing else by the time you reach a birthday that ends in zero, remember that the future is never guaranteed — and the time to make change — is finite.

• Nevin E. Adams, JD

 

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[i] Some of you, surely, are thinking to yourself “and you sure don’t act it, either!”

[ii] I’m cognizant of the rule of 55, though I suspect many aren’t.

Do Roth and 401(k) Pre-Tax Holders Really Spend Differently?

An interesting—and somewhat counterintuitive—report came out last week, one that cast doubt on the “common wisdom” regarding Roth versus traditional pre-tax savings.

The assumption underlying the research[i] was that those who had not yet paid taxes on their savings (the traditional pre-tax savings) would be hesitant to tap into those savings and trigger taxes, certainly more so that individuals that had already paid those taxes. Instead, the research suggested that the opposite occurred; that individuals who had saved on a pre-tax basis actually withdrew more/sooner—but with a twist. 

This they hailed as good news. They noted that the research suggests investing in a CT (current-taxed, or Roth) plan could help ease concerns about outliving funds—because they spend at a lower rate (though they saw this as a negative for those who saved on a deferred tax (DT) basis).  They even managed to find a silver lining in the “cloud” of faster spending by the pre-tax crowd because those individuals appeared to be trying to adjust for the effect of taxes (with the caveat “despite our findings that they do not appear to adjust sufficiently, if at all”). And they saw as a positive this report’s contribution to the “accounting literature exploring the effectiveness and consequences of incentivizing behaviors through tax policy, by highlighting how past decisions motivated by taxes (e.g., retirement plan type) may continue to affect one’s quality of life long into the future.”

A few words of caution would seem to be in order, however. This wasn’t based on the patterns of actual people spending their actual money in the real world. Rather, and to their credit, they constructed a laboratory environment of sorts; they selected a group of volunteers, gave them certain criteria—basically a role they would “play” in the experiment—and set out a spending scenario. They then had them read about various spending choices—and, well—recorded how the individuals chose.

As for their conclusions, when you probe into the results more carefully, what you see is that even though those who had pre-tax accounts ostensibly feel the “pain” of taxes due on their retirement withdrawals—and that appeared to restrict their spending—it seemed to be offset by another reality. That, for reasons not understood/explained, those same individuals appeared to relish the expected benefits of consumption more than Roth holders. Said another way, their “reservations”— the cognizance of taxes—didn’t seem to constrain their spending because they were (more) enamored of the benefits of spending. Indeed, the researchers commented that those with “equivalent nominal balances” actually spent at the same rate.

I’ll just comment that it’s an interesting premise—and that the test environment created struck me as detailed and complex to map out, establish and execute. That said, I would be hesitant to draw any substantive conclusions on actual human behavior from this analysis. To me, all it seemed to “prove” is that people selected for an experiment tend to spend to the perceived “limits” of their hypothetical account, regardless of taxation. It didn’t strike me that Roth holders spent less (as many headlines covering the report suggested), but rather that pre-tax holders spent the same, even though they were going to have to deal with a tax bill at some point (hypothetically, of course).

And that, to me, isn’t a positive thing for Roths so much as it is a cautionary note for pre-tax savers—who may have forgotten that tax deferral is just that.

 - Nevin E. Adams, JD

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[i] How Does Tax Timing Affect Spending in Retirement?  

'Tacts' Treatment?

Roth 401(k)s are more prevalent—and popular—than ever. But is that good—or bad—for retirement?

A recent op-ed[i] in The Wall Street Journal explored the potential implications—“What ‘Rothifying’ 401(k)s Would Mean for Retirees”— (subscription required), though the focus is on tax policy as well.

You’ll remember that so-called “Rothification”—essentially the elimination of the pre-tax treatment currently accorded 401(k) contributions—was quite the controversial issue back in 2017 when the Republican-controlled House of Representatives was looking for ways to raise revenue to help pay for tax cuts.[ii] And while it’s not been an active focus of late, it seems likely to resurface as the nation’s budget deficit widens, and the field of 2020 presidential aspirants seem determined to find ways to spend more or, in the case of the incumbent, collect less in taxes.

‘Out’ Comes 

As for the WSJ treatment, I’ll spare you the short read (longer if you actually check out the 36-page paper it was based upon), and summarize it thusly: later retirements (not by choice, but of necessity), less retirement income, and more wealth inequality. Though, at least in the short run, more tax revenue for Uncle Sam.[iii]

Now most of this comes from a key assumption; as the WSJ piece puts it, “Over their lifetimes, workers would accumulate one-third less in their 401(k)s under a Roth system. This is because, with no tax advantage from contributing to a 401(k), workers would save less and those lower contributions would earn less over the years.”

Said another way, without the tax break, the authors conclude that workers won’t save as much, and saving less means that they’ll have less invested, and that  means that they’ll have less retirement income. They also argue that, with Rothified savings, workers would tap into Social Security later—a year later, on average, they claim. They note that with their retirement savings already taxed, wealthier individuals would be inclined to defer taking Social Security (increasing their benefit), widening income inequality.[iv]

‘Less’ on Plan?

The concern about mandatory Rothification was always that workers would, in fact, save less—and this is a concern that employers have expressed, though this was in the context of the ability to save on a pre-tax basis being taken away. That, in turn, seems to be predicated on the notion that workers have a specific dollar amount in mind that they can afford to save, and that if some of that certain dollar amount goes to taxes, there is a dollar-for-dollar offset. Doubtless that’s true for some, particularly among lower-income workers. However, when I have seen savings data, what seems to be the norm is that individuals save a specific percentage of pay, one generally driven either by what’s necessary to earn the employer match, or perhaps that rate at which default contributions are set. In other words, people choose to save 3% of pay, not $50/paycheck.

Now, if that  perception is accurate (feel free to disagree in the comments below if you see things differently), then it seems to me that most individuals might actually save the same amount, regardless of whether it’s pre- or post-tax. And if they were to same at the same rate (and admittedly that’s a big “if”), their retirement outcome might actually be more  secure—because withdrawals (and taxation) wouldn’t be forced on them by RMD calculations, because they wouldn’t have to worry about those contributions—and the earnings that have accumulated on those contributions—being taxed, and, significantly, because the reduction in taxable income wouldn’t undermine (through “means testing”) Social Security benefits.

But key to the analysis is how participants would respond, and the study cited in the WSJ isn’t the only academic consideration on the subject; one in 2015 found no change in savings rates with a voluntary addition of a Roth feature, and in 2017, the non-partisan Employee Benefit Research Institute (EBRI) found that it might help—or hurt—retirement security—and this is key—depending on the response of participants.

It appears that more participants are being presented with that option. Nearly 70% of plans now provide a Roth 401(k) option, according to the most recent survey by the Plan Sponsor Council of America. Perhaps more significantly, that survey, reporting 2018 plan activity, finds that nearly a quarter of participants (23%) elected to contribute to a Roth when given the opportunity, up from 19.5% in 2017 and 18.1% in 2016—an increase of nearly 30% in just three years.

Academic studies notwithstanding, it’s worth remembering that retirement security isn’t just a matter of how much you have saved at  retirement; it’s how much you have available to spend throughout retirement.

- Nevin E. Adams, JD

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[i]The authors of the WSJ article, Olivia S. Mitchell and Raimond Maurer, previously authored a research paper upon which the WSJ piece was based (albeit with a slightly different title, “How Would 401(k) ‘Rothification’ Alter Saving, Retirement Security, and Inequality?”). 

[ii]They weren’t, however, the first to propose such a shift. President Obama did so in 2015.

[iii]However, the authors state that the taxes collected on withdrawals of that money exceed the amount of additional income taxes that would be collected during people’s working lives under Rothification.

[iv]As a side note, the authors in the WSJ article note that not only would this be bad for Social Security funding, but they also conclude that the taxes collected on withdrawals would exceed the amount of additional income taxes that would be collected during people’s working lives under Rothification—ostensibly because of their previous assumption that it would be a larger accumulation of money to be taxed. 

“Drawing” Board?

While drawing boards have been used by engineers and architects for more than two centuries, the phrase “back to the drawing board” is of much more recent origin, coined by the Peter Arno in a cartoon first published in the March 1, 1941 issue of New Yorker magazine.(1) The cartoon features a crashed plane in the background, a parachute in the distance, several military officials and rescue workers rushing to help/investigate—and one remarkably nonchalant individual, walking in the opposite direction with a rolled up document tucked under his arm as he comments, “Well, back to the old drawing board.”

For all the much-deserved focus on retirement savings accumulations, a growing amount of attention is now directed to how those already in (and fast-approaching) retirement are actually investing and drawing down those savings.

A recent EBRI analysis(2) found that at age 61, only 22.2 percent of households with an individual retirement account (IRA) took a withdrawal from that account. That pace slowly increases to 40.5 percent by age 69 before jumping to 54.1 percent at age 70, and by the age of 79, almost 85 percent of households with an IRA took a distribution.

IRAs are, of course, a vital component of U.S. retirement savings, holding more than 25 percent of all retirement assets in the nation, according a recent EBRI report. A substantial and growing portion of these IRA assets originated in other employment-based tax-qualified retirement plans, such as defined benefit (pension) and 401(k) plans.

The EBRI analysis also found that the percentage of households with an IRA making a withdrawal from that account not only increased with age, but also spiked around ages 70 and 71, a trend that appears to be a direct result of the required minimum distribution (RMD) rules in the Internal Revenue Code.(3) Those rules require that traditional IRA account holders begin to take at least a specific amount from their IRA no later than April 1 of the year following the year in which they reach age 70-½, or else suffer a fairly harsh tax penalty.

In fact, at age 71, 71.1 percent of households owning an IRA that took a withdrawal reported that they took only the RMD amount, increasing to 77.4 percent at age 75, 83.2 percent at age 80, and 91.1 percent by age 86.

However, the EBRI report noted that IRA-owning households not yet subject to the RMD—those headed by individuals between the ages of 61 and 70—made larger withdrawals than older households, both in absolute dollar amounts as well as a percentage of IRA account balance. Indeed, the bottom-income quartile of this age group had a very high percentage (48 percent) of households that made an IRA withdrawal—and their average annual percentage of account balance withdrawn (17.4 percent) was higher than the rest of the income distribution. Moreover, those younger households that made IRA withdrawals spent most of it.

While a significant percentage of those in the sample are drawing out only what the law mandates, the data indicate that more of those in the lower-income groups not only draw money out sooner, but also draw out a higher percentage of their savings—perhaps too early to sustain them throughout retirement.(4)

Planning and preparation matters—not only for retirement savings, but in retirement withdrawals. Because for those whose retirement resources run short too soon, it’s generally also too late to go “back to the drawing board.”

Nevin E. Adams, JD

(1) You can see the original cartoon online here.

(2) The data for this study come from the University of Michigan’s Health and Retirement Study (HRS), which is sponsored by the National Institute on Aging. See “IRA Withdrawals: How Much, When, and Other Saving Behavior,” online here.

(3) As noted in a previous post (see “Means Tested”), there are advantages to a drawdown strategy based on the schedule provided by the Internal Revenue Service (IRS) for required minimum distributions, or RMDs. See also Withdrawal “Symptoms.”

(4) The EBRI Retirement Readiness Ratings™ indicate that approximately 44 percent of the Baby Boomer and Gen-Xer households are simulated to be at-risk of running short of money in retirement, assuming they retire at age 65 and retain any net housing equity in retirement until other financial resources are depleted. Those individuals may well become part of the significant percentage of retirees who eventually must depend on Social Security for all of their retirement income. See “All or Nothing? An Expanded Perspective on Retirement Readiness.”

Means, Tested

Recently the Center for Retirement Research at Boston College released a paper titled “Can Retirees Base Wealth Withdrawals On the IRS’ Required Minimum Distributions?”¹ The answer to that question, according to CRR, is “yes.” A more complete response might be, “yes, or any number of other random withdrawal methodologies.”

There are some advantages to a drawdown strategy based on the schedule provided by the Internal Revenue Service (IRS) for required minimum distributions, or RMDs.² First off, and as the CRR paper notes, it’s relatively straightforward. Secondly, it effectively defers initiating withdrawals until age 70-½, which also provides some additional accumulation opportunity. Perhaps most importantly, it helps avoid the stiff penalties the IRS imposes on those who don’t withdraw funds from these accounts at least as rapidly as the RMD schedule provides. The CRR paper cites as an advantage the reality that those drawdowns are based on the portfolio’s current market value, though surely some people remember how the impact of the 2008 financial crisis on those accounts triggered a more aggressive withdrawal schedule than many found optimal or necessary.

A previous post dealt with another popular drawdown method: the so-called 4 percent rule (see “Withdrawal ‘Symptoms”). As with that 4 percent “rule,” once you stipulate certain assumptions about the length of retirement, portfolio mix/returns, and inflation, those type guidelines are really “just” a mathematical exercise that involves stretching a finite pool of resources over an estimated period of time.

The CRR paper outlines a series of reasons as to why the RMD approach might be superior to alternatives such as the 4 percent rule, but ultimately the biggest shortcoming of the RMD schedule as a basis for withdrawal may be that it fails to take into account how much income is needed, much less when it is needed—and it’s based on a series of assumptions that may or may not apply to an individual’s real-life circumstance.

Of course, in a very real sense, relying on any arbitrary systematic calculation to determine how much, and how fast, to drawdown savings can be seen as a way of living within your means—an approach that can work just fine if you have first made preparations to have adequate means upon which to live.

- Nevin E. Adams, JD

¹ The CRR report is online here.

² Information about required minimum distributions is available at the IRS website, online here. IRS worksheets to calculate the amount of the RMD are online here.

For some interesting data on actual withdrawal rates from individual retirement accounts, see “Withdrawal Symptoms.”

Road "Construction"

The Senate Finance Committee is positioned to pass a highway bill, funded at least in part by changing the tax treatment on retirement accounts.

Specifically, the modified chairman’s mark of the proposed Highway Investment, Job Creation and Economic Growth bill would require that age 70-1/2 account distributions be treated, for tax purposes, as distributed within five years of the death of the account holder (unless the beneficiary is the account holder’s age, a child with special needs, or older than 70).

Under current law, holders of IRAs and 401(k)-type accounts are required to begin taking taxable distributions from those accounts once they reach age 70-1/2, though if the account holder dies, the taxation of the account is spread over the life of the beneficiary. According to a Senate Finance Committee press release, this particular provision is estimated to raise $4.648 billion over 10 years.

The bill’s prospects in the Senate remain unclear, and the Wall Street Journal notes that the House version does not contain the retirement account tax change. However, the Senate provision demonstrates how the current budgetary and economic pressures in Congress—particularly in an election year—make the tax treatment of retirement savings a major target for any number of legislative initiatives, including those that have little or nothing to do with retirement.

The Employee Benefit Research Institute (EBRI) has long provided a credible and objective source of information for both policymakers and regulators, including recent testimony provided to:

• The Senate Finance Committee on “Tax Reform Options: Promoting Retirement Security”, and “The Impact of Modifying the Exclusion of Employee Contributions for Retirement Savings Plans From Taxable Income: Results From the 2011 Retirement Confidence Survey.”

• The Senate Committee on Health, Education, Labor, and Pensions on “The Power of Pensions: Building a Strong Middle Class and a Strong Economy,” and

• The House Committee on Education and the Workforce, Subcommittee on Health, Employment, Labor, and Pensions, regarding “Retirement Security: Challenges Confronting Pension Plan Sponsors, Workers, and Retirees.”

The impact of certain tax reform proposals was evaluated in the November 2011 EBRI Issue Brief, and will be updated to include input from the 2012 Retirement Confidence Survey next month.

- Nevin E. Adams, JD


The Employee Benefit Research Institute is a private, nonprofit research institute based in Washington, DC, that focuses on health, savings, retirement, and economic security issues. EBRI offers a unique perspective in that we do not lobby nor take policy positions. The work of EBRI is made possible by funding from its members and sponsors, which includes a broad range of organizations involved in benefits issues. For a full list see EBRI’s Members.