'Hidden' Figures

This week was Valentine's Day—and, as usual, there’s been the typical seasonal promotions for flowers, candy, and even pajamas. 

I’ve been pretty good over the years remembering those type events—anniversaries (wedding AND dating), birthdays and, yes—Valentine’s Day. But sometimes the time gap between my remembering the date and actually getting around to doing something to commemorate it has been problematic. With Valentine’s Day that can be particularly painful, if only because so many others are scrambling to do the same thing—and at a time when delivery services (and costs), not to mention growing season(s) can be in short supply, relative to the need.

Several years back, I was running late in my preparations—and spotted an email touting a dozen roses for $24.99 (they’re a LOT more expensive now). Of course, for that price (even then), you could only get them in red (though it was Valentine’s Day, after all), and you actually got a glass vase included in that price (with options to “upgrade,” of course). 

So, I’m feeling pretty good about my bargain-hunting, but then the “other” charges emerged; “standard” delivery was another $12.99, and—at least at that (late) date, it cost (another) $9.99 to guarantee Valentine’s Day delivery, another $14.99 if you want it there in the morning, and there’s a “care & handling charge” of $2.99, regardless of delivery date or time. In fact, by the time you add in taxes those $24.99 roses will run you… well, quite a bit more than $24.99.

Not that you’ll see that all presented in one place—well, until the very last screen, anyway.

Surprise ‘Zing’ 

I wonder sometimes if that isn’t how those who request a hardship withdrawal feel—though, disclosures notwithstanding, it’s not like they can see what it’s actually going to cost at the point they make the request.

Oh, they know the amount they need, and presumably request. But then there’s the 20% withholding that comes off the top, but then, come tax time, they’ll find out if that 20% withholding was “enough.” At the same time, they’ll likely discover the 10% penalty (for those who aren’t yet 59½). Less obvious is the retirement savings “ground” they’ve lost to the customary six-month suspension of contributions (and match). And that’s not considering the 401(k) loan they likely had to take first because, after all, we have to make really, really sure that you absolutely have no other way to get to that money. Those “surprises” are likely to be lessened with the emergency savings and withdrawal provisions of the SECURE 2.0 Act of 2022, of course.[i] 

And then there are the surprises that come WITH retirement. That’s when you “discover” the DISadvantage of pre-tax savings, as Uncle Sam (and his state and city “cousins”) line up for their postponed “cut.” It’s also when Social Security (and Medicare) look to that as fresh income against which benefits (and the cost of benefits) is now means-tested (a.k.a. reduced/taxed).   

Now, if all that seems like a particularly depressing theme for Valentine’s Day, fear not. The impact of the “hidden” costs of retirement—like the hidden costs of that floral arrangement can be muted, if not mitigated, by not waiting until the very last minute to make preparations …

- Nevin E. Adams, JD 

---

[i] We’ll save for another day the potential impacts on future retirement savings.

"Repeat" Performance

A few months back, I was intrigued to catch several episodes of “Cosmos,” an updated version of the classic 1980 Carl Sagan series.  Along with the significantly expanded and enhanced visuals and (to me, anyway, generally annoying) animations, the series recounted the work, travails and accomplishments of Edmond Halley, who, even today, is probably best remembered for the comet whose 75-year cycle he identified and which still, as Halley’s Comet, bears his name.

Halley wasn’t the first to see the comet, of course – in fact, it had been recorded by Chinese astronomers as far back as 240 BC, noted subsequently in Babylonian records, and perhaps most famously shortly before the 1066 invasion of England by William the Conqueror (who claimed the comet’s appearance foretold his success).  Halley noted appearances by the comet in 1531, 1607 and 1682, and based on those prior observations – and the application of the work and mathematical formulas of his friend Isaac Newton – predicted the return of the comet in 1758, which it did, albeit 16 years after his death in 1742.

Of course, the importance of repeated, measured observations isn’t restricted to celestial phenomena.  Consider that individual retirement accounts (IRAs) currently represent about a quarter of the nation’s retirement assets; and yet, despite an ongoing focus on the accumulations in defined benefit (pension) and 401(k) plans that have, via rollovers, fueled a significant amount of this growth, a detailed understanding as to how these funds are actually used during retirement has, to date, not been as well understood.

To address this knowledge shortfall, the Employee Benefit Research Institute has developed the EBRI IRA Database, which includes a wealth of data on IRAs including withdrawals or distributions, both by calendar year and longitudinally, which provides a unique ability to analyze a large cross-sectional segment of this vital retirement savings component, both at a point in time and as the individual ages and either changes jobs or retires.  Indeed, as a recent EBRI publication notes, the rate of withdrawals from these IRAs is important in determining the likelihood of having sufficient funds for the duration of an individual’s life, certainly where these balances are a primary source of post-retirement income.

Previous EBRI reports[i] have explored this activity for particular points in time, but a recent EBRI analysis[ii] looked for trends in the withdrawal patterns of a longitudinal three-year sample of individual post-retirement withdrawal activity, specifically those age 70 or older (in 2010), the point at which individuals are required by law to begin withdrawing money from their IRAS.

The EBRI analysis concluded that, when looking at the withdrawal rates for those ages 70 or older, the median of the average withdrawal rates over a three-year period indicated that most individuals are withdrawing at a rate that not only approximates what they are required by law to withdraw, but at a rate that is likely to be able to sustain some level of post-retirement income from IRAs as the individual continues to age.

Furthermore, the report notes that an examination of these trends over this period suggests that, based on the resulting distribution of average withdrawal rates over time as a function of the initial-year withdrawal rate, the initial withdrawal rate for those in this age group appeared to be one that these individuals are likely to continue to make the next year.

Of course, while the median withdrawal rates suggest many individuals would be able to maintain the IRA as an ongoing source of income throughout retirement, further study is needed to see if these individuals are maintaining those withdrawal rates over longer periods of time.  Moreover, the integration of IRA data with data from employment-based defined contribution retirement accounts currently underway as part of initiatives associated with EBRI’s Center for Research on Retirement Income (CRI) will allow for an even more comprehensive picture of what those who may have multiple types of retirement accounts do as they age through retirement.

And we won’t have to wait 75 years to see how it turns out.

• Nevin E. Adams, JD

[i] See “IRA Withdrawals, 2011” online here.   See also ““Take it or Leave it? The Disposition of DC Accounts: Who Rolls Over into an IRA? Who Leaves Money in the Plan and Who Withdraws Cash?” online here. 
[ii] See “IRA Withdrawals in 2012 and Longitudinal Results, 2010–2012” online here. 

Pet "Smart"

I’ve had both cats and dogs in my family over the years, and while each of our individual pets has had a unique personality, there are some attributes that seem to apply to each species, regardless of the individual animal. One of the most obvious is their approach to food.  For example, you can leave your cat alone in an apartment for a weekend with a supply of food and water sufficient to last for a few days, and odds are when you return home, there will still be some left.  But leave your dog alone in the same apartment with the same additional allotment of food and water, chances are it won’t last 30 minutes.  And in those circumstances, if you have both a cat and a dog in that apartment, odds are the latter will eat the former’s food as well.

Animal psychologists have a variety of explanations for why dogs and cats approach food the way they do, generally citing either a confidence of its future availability, or a concern that if it’s not consumed now, it will disappear.

Experts have long been worried about how quickly individuals would spend through their savings in retirement, whether those rates of spending would too rapidly deplete savings, and if those rates would be sufficient to sustain a reasonable post-retirement lifestyle.

A recent analysis[i] of activity within the EBRI IRA database[ii] found that just over 16 percent of traditional and Roth IRA accounts had a withdrawal in 2011, including 20.5 percent of traditional accounts.  The report notes that this percentage was largely driven by activity among traditional IRAs owned by individuals ages 70½ or older where the individuals were required by law to make withdrawals from their tax qualified accounts or pay significant tax penalties.

Significantly, for those at the RMD age, the withdrawal rates at the median appeared close to the amount required by law to be withdrawn, though some were significantly more. And while the highest 25 percent did appear to be taking out amounts in excess of those required by law, the report notes that some of these accounts could be the focus of the owners’ withdrawals instead of other accounts owned by them.

A separate EBRI analysis[iii] of the University of Michigan’s Health and Retirement Study (HRS) found that at age 61, only 22.2 percent of households with an individual retirement account (IRA) said that they took a withdrawal from that account, but that the pace slowly increased to 40.5 percent by age 69 before jumping to 77 percent at age 71.  That 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, the report explains, appears to be a direct result of the required minimum distribution (RMD) rules in the Internal Revenue Code.

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.

While the median withdrawal rates evident in the proprietary EBRI IRA database suggest that many individuals are highly likely to maintain the IRA as a source of income throughout retirement, further study is needed to see if these rates hold up over time as their owners age further into retirement, and to evaluate whether those rates, in conjunction with other resources, are adequate to provide a reasonable, if not comfortable, post-retirement lifestyle. 

In the months ahead, we’ll not only be looking at this withdrawal behavior over time, but, as part of EBRI’s Center for Research on Retirement Income (CRI), we’ll be examining how IRA owners with a 401(k) plan draw down those assets across accounts, leveraging the unique ability of EBRI’s databases to link individuals’ IRAs and 401(k) accounts.

After all, it’s not just pets that consume more wisely when they have confidence in the future of that next meal.

Nevin E. Adams, JD

---

[i] See “IRA Withdrawals, 2011” online here.
 

[ii] The EBRI IRA Database, an ongoing project that collects data from IRA plan administrators, contains information for2011 on 20.5 million accounts with total assets of $1.456 trillion.  In this particular analysis, only withdrawals from the accounts identified as traditional or Roth IRAs in the database are examined, a total of 15.3 million accounts with $1.11 trillion in assets.  More information on the database, and EBRI’s research centers is online here.

[iii] See “IRA Withdrawals: How Much, When, and Other Saving Behavior” online here.

Withdrawal “Symptoms”

I was recently asked about the so-called 4 percent “rule.” That’s the rule of thumb(1) that many financial consultants rely on as a formula for how much money can be withdrawn from retirement savings every year (generally adjusted for inflation) without running out of money. Of course, like so many of the “assumptions” about retirement, certainly in the aftermath of the 2008 financial crisis, that withdrawal rule of thumb has drawn additional scrutiny.(2)

At the time, my comment was that the 4 percent guideline is just that—a guideline. What’s not as clear is whether adhering to that guideline produces an income stream in retirement that will be enough to live on.

How much are people actually withdrawing from their retirement accounts? At a recent EBRI policy forum,(3) Craig Copeland, senior research associate at the Employee Benefit Research Institute, explained that the median IRA individual withdrawal rates amounted to 5.5 percent of the account balance in 2010, though he noted that those 71 or older (when required minimum distributions kick in) were much more likely to be withdrawing at a rate of 3–5 percent (in 2008, that group’s median withdrawal rate was 7.2 percent, but in 2010, it was 5.2 percent), based on the activity among the 14.85 million accounts and $1 trillion in assets contained in the EBRI IRA Database.(4) Will these drawdown rates create a problem down the road? Will these individual run short of funds in retirement?

At its core, once you stipulate certain assumptions about the length of retirement, portfolio mix/returns, and inflation, a guideline like the 4 percent “rule” is really just a mathematical exercise.

However, trying to live on the resources you actually have available in retirement is reality—and those post-retirement withdrawal decisions are generally easier to make when you’ve made good decisions pre-retirement.

- Nevin E. Adams, JD

(1) Certified financial planner William P. Bengen is frequently credited with the concept, based on his article “Determining Withdrawal Rates Using Historical Data,” published in the October 1994 issue of the Journal of Financial Planning.

(2) It had drawn criticism before the 2008 financial crisis as well: See “The 4% Rule—At What Price?”

(3) The agenda, presentation materials, and a recording of EBRI’s May policy forum are available online here. Dr. Copeland’s presentation is online here.

(4) The results come from 2010 data in the EBRI IRA Database,TM which had 14.85 million accounts, held by 11.1 million individuals, with $1 trillion in assets—roughly one-fifth of both owners and assets in the IRA universe.