Retirement Is Coming — Are You Ready?

Dark Money

mic Listen to the podcast:

Wharton's Olivia Mitchell discusses baby-boomers’ preparedness for retirement.

The baby-boomer generation, defined as people born between 1946 and 1964, is the largest demographic in the history of the United States. Many boomers are closing in on 70 1/2, the age at which they are required by law to take disbursements from their tax-deferred retirement plans. That means billions of dollars are heading into the U.S. economy in the years to come. Wharton business economics and public policy professor Olivia Mitchell, who is executive director of the school’s Pension Research Council, says now is the time for boomers to educate themselves on what to do with their money. She recently spoke about the state of baby-boomers’ preparedness for retirement on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

An edited transcript of the conversation follows.

Knowledge@Wharton: We know how big the baby-boomer generation is, but it’s still interesting to grasp how much investment that generation has made and how much money will be put into the economy over the next couple of decades.

Olivia Mitchell: It’s absolutely true that boomers have done a good job socking away money in their tax-qualified retirement accounts. That would include individual retirement accounts (IRAs), 401(k)s, 403(b)s, the whole alphabet soup of pension lingo out there. Some baby boomers still have defined benefit plans. But the big challenge that folks are talking about now is that of this $10 trillion in tax-deferred savings accounts. Folks are now going to have to start taking out their required minimum distributions.

Knowledge@Wharton: How much do they have to take out per year?

Mitchell: The Internal Revenue Service has been willing to let you have your investment earnings tax-deferred. But they would be very happy to get some of their tax at the payout stage. The rules are specified related to your age. For example, beginning at age 70 1/2, you must take out about 3.7% of the total amount in your IRA and the same amount out of your 401K plans if you’re retired. By the time you’re 80, the percent goes up to about 5.5. And at age 100, you have to take out 15.9%. The logic is, the government wants its tax bite on those payouts.

Knowledge@Wharton: The impact that this is going to have on the economy comes at an interesting time. There are people who fall into that group of being 70 and still working because they are still trying to build back up from the recession.

Mitchell: I think there are two parts to the story. One is the financial institutions that are worried about money leaving their control. The other is workers and retirees. Many retirees may be surprised to learn that they have to start drawing down their accounts. There are ways to manage it better or worse, which we can get into. As long as you’re working, you don’t need to take the required minimum distribution from the plan that covers you in your current job. However, if you have a previous job and don’t roll that money over to your current employer, then you will have to start taking those minimum distributions.

“It’s certainly the case that Social Security is facing insolvency.”

Knowledge@Wharton: It’s surprising that some people don’t know they have to do this when they reach 70 1/2. Why is that? It’s been a well-publicized marker over the last decade or two.

Mitchell: It is publicized, and financial services companies are required to tell you that when you hit that 70 1/2 threshold, you must start taking out money at this certain percentage rate. But a lot of people don’t read their mail, quite frankly. They also may not have financial advisers. Right now, there are a number of good required minimum distribution (RMD) calculators online. I think that would be a good way to go for people that are finding this as new information.

Knowledge@Wharton: What are the things that people need to think about when they’re managing these accounts, when they get to 70 1/2? What about the idea of taking disbursements over the course of the year or taking a lump sum per year because of the tax issues?

Mitchell: If you take it in 12-month parcels, instead of one lump sum at the end of the year, that’s not going to affect your taxes. You’re still going to have to pay income tax at the end of the year. If you take it too young, however, then you also have to pay a 10% penalty. If you can avoid doing that, wait until you’re 70 1/2 to start drawing down your retirement accounts as long as you’re not working. If you have several IRAs, the law says that you can amalgamate the total and take your required minimum distribution out of just one of them, so you don’t have to dip into each individually to get to the total. However, if you have several 401(k) plans from previous employers, you have to take it out of each one separately. So, it’s a little complicated. I think this is going to be a big test for people who may potentially have cognitive aging issues and who are not financially literate.

Knowledge@Wharton: Is it common for people to not roll over the 401(k) from job to job?

Mitchell: I think it’s an absolutely great idea to consolidate your accounts. I’m one of those who never did it when I taught at a previous institution. I knew the money was being invested safely. I didn’t have any concerns. But it took me about a year to roll it over. So, sometimes it’s tricky, and you have to keep at it. However, having rolled it over into my current employer’s 401(k) account, I don’t have to take minimum distributions until I retire, which may well be never. We’ll see.

Knowledge@Wharton: What are some other things people need to consider now, especially if they’re hitting 70 1/2?

Mitchell: It’s certainly worth remembering that this required minimum distribution is the minimum, not the maximum. That is, you can roll over your entire account. You can cash out your entire account. Of course, you’ll pay income tax on it if you’re over the age of 70 1/2. But if it’s just a small 401(k) plan, it may well behoove you to do that and put it into the bank or a brokerage account or whatever it is that you would be doing with it anyway. This gets back to the point that a lot of the financial institutions are now thinking that it might behoove the retiree, as well as them, to let you keep your money in the 401(k) plan that you’ve been investing all the way along. Typically, those would be lower cost, more professionally managed, and they can help you by paying out the required minimum without you having to do the arithmetic ever year at tax time.

Another thing you can do is purchase a payout annuity with up to $250,000 in your 401(k) account. Then that amount will start paying you when you tell it to, when you tell the annuity provider to do so. But that is withheld from the required minimum distribution amount. In other words, it reduces the amount you have to take as a required minimum distribution. That may behoove people that want to protect their assets over the longer term and don’t want to pay so much tax on it right away.

Knowledge@Wharton: What’s the best reason for going the annuity route?

“It would help if people tried to do everything possible to continue working.”

Mitchell: There are two reasons. One is that an annuity is an excellent product to help you avoid running out of money in old age. The second reason is that portion that you’ve used to buy the annuity is exempt from the required minimum distribution. So, it can lower your tax as well.

Knowledge@Wharton: I saw an article that talked about people who are starting to pull from their 401(k)s and reinvesting the money. It seems they don’t have the need for all of that money, but they want to put it in something that could still earn them value as they go forward.

Mitchell: It’s been observed that many older people take the required minimum distribution percentages as financial guidance or advice, so they imagine that this might be the right way to spend down their accounts. That’s not necessarily true because you could run out under those circumstances. If you can afford to, maybe one option is to put it in a brokerage account or save it in a bank. There are also strategies that are worth mentioning in terms of how you invest the brokerage account versus what’s in your IRA or 401(k). For example, you might want to put bonds in the IRA. They’ll pay off a little bit less, therefore lowering your tax burden when you take out the RMD. And put more of your stocks, say, in your brokerage account.

Knowledge@Wharton: The bond move is an interesting one to discuss because of what we’ve seen with bonds, especially over the last year or so. The tenure has really been jumping the last few months.

Mitchell: That’s in part a reflection of the increases in inflation that are expected down the road. For retirees, my usual thought is, start thinking about inflation-protected bonds because you may well need them if inflation starts ramping up again.

Knowledge@Wharton: We’ve talked with you before about the potential issues involving Social Security down the road. The word “insolvency” still is played in there. With a lot of questions about Social Security out there, does that affect how people need to think about their retirement money? Maybe not now, but maybe in 10 years when we get closer to that projected 2034 date?

Mitchell: Well, it’s certainly the case that Social Security is facing insolvency. They’re not going to pay zero benefits, but there may well be a 25% cut or 30% cut in benefits down the road. Another factor to point out, vis a vis this required minimum distribution discussion, is that if you take larger distributions from your retirement accounts, then that subjects more of your Social Security benefit to income tax. One strategy might be to delay taking Social Security. Draw down more from your retirement accounts so that you’re in a lower tax bracket and pay less. When you finally hit age 70 or beyond, then take the Social Security benefit. It’s a complicated little ball of wax that we have here. And I think it really pays for folks that have some money in their 401(k)s and IRAs to start talking to an adviser.

Knowledge@Wharton: With that 3.7% as the minimum amount, a lot of people have to get a feel for whether that number is right for them. Correct?

Mitchell: That will depend a lot on how much you had. I had a calculation of what the typical 401(k) levels are for people close to retirement, say around 65, 66 years old. The median 401(k) balance is only about $44,000. If you took 3.7% of that, it’d be about $1,600 a year. However, if you look at the 90th percentile, those folks have about $370,000. They’re going to be pulling down $13,000, $14,000 a year. Now again, that’s probably not enough for anybody to live on, but it can definitely influence your standard of living. It suggests that some folks are going to have to draw down more than their retired minimum, and others might just tend to keep saving it and store it away for their future.

Knowledge@Wharton: For people in that range of $44,000, that’s a tough spot to be in. The fact that it’s the median is a little bit scary.

Mitchell:  It’s absolutely the case that the typical American is relying very heavily on Social Security for retirement sustenance. And, of course, Medicare. So this may make a little bit of a difference at the margin. But what could make a much bigger difference to their retirement well-being would be delaying claiming Social Security at age 70. Your benefits could well be 75% bigger than if you claimed them at 62 years old.

Knowledge@Wharton: What other things do people need to consider when they’re getting to that 70 1/2 age?

“If you look at the surveys of baby boomers, many of them don’t want to sit in the rocking chair on the front porch or play golf full time.”

Mitchell: What I would say is that it would help if people tried to do everything possible to continue working. The longer you delay retirement, it benefits you on a number of fronts. Obviously, your Social Security benefits are higher when you get there. You’re not drawing down your nest egg. And there’s a lot of research that suggests that people who can continue to work and do so are much healthier. That’s not true of everyone, of course. We know that there are disability problems among the older population. But remaining engaged and employed and involved in the workplace and in a social circle can really help along many fronts. Not just physical health, but mental health as well.

Knowledge@Wharton: Getting away from the financial part of it for a second, the experience and knowledge of older workers ends up being an incredible benefit to the company.

Mitchell: Absolutely. One of the things that we’re facing in the United States, as well as much of the developed world, is that the long-term decline in fertility has meant there’s simply not a lot of younger workers coming into the labor force with the training and the skills that are needed. Employers are starting to pay attention to the fact that they need to keep older workers on. I believe there will be a demand for older workers, as long as the older workers invest in their skills, learn the new technology and make an effort to stay up with things.

Knowledge@Wharton: Are we going to see the retirement age here in the United States bumped up in the next decade or so?

Mitchell: I suspect that we’re going to see it along a couple fronts. First, to restore Social Security solvency, we’re going to have to raise the retirement age. There’s no question about that. I think at the same time, people want to continue working. If you look at the surveys of baby boomers, many of them don’t want to sit in the rocking chair on the front porch or play golf full time. Many baby boomers are talking about un-retirement jobs. Sometimes they’re volunteer, sometimes they’re paid, sometimes they’re part-time jobs, mentoring jobs and so forth. I think that we really are at a crossroads where we are having to remake the definition of retirement.

Knowledge@Wharton: Is there a target number for the new retirement age?

Mitchell: Every country in the world that has tried to move the retirement age precipitously has faced some problems politically. In the U.S., we raised the retirement age back in 1983. But it was done gradually so that people had some advance warning. But if we step back and recall that when Roosevelt put in the Social Security system, age 65 was a retirement age. That was also the life expectancy. So, half of the people never even made it. If we did that, we’d probably have to have a retirement age of at least 85 or 86.

Knowledge@Wharton: This is also going to be a unique challenge for the money managers, with all of this money that’s going to be coming out over the next few years and having to replace it with money from millennials, who are of a different mindset. It’s going to be an interesting dynamic for the investment community.

Mitchell: It absolutely is. The good news is the millennials do seem to be saving. In fact, all of us should probably be saving a lot more, given the low-interest environment that many economists believe we’re facing for the next 20 or 30 years. I think the general perspective is that we’re going to be dealing with a younger generation that’s much more computer-friendly. This is why a lot of the money managers are putting in robo-advisers and replacing some of the call centers with interaction online. The industry is having to retool, if you will.

Citing Knowledge@Wharton

Close


For Personal use:

Please use the following citations to quote for personal use:

MLA

"Retirement Is Coming — Are You Ready?." Knowledge@Wharton. The Wharton School, University of Pennsylvania, 04 April, 2017. Web. 18 August, 2017 <http://knowledge.wharton.upenn.edu/article/are-you-ready-for-retirement/>

APA

Retirement Is Coming — Are You Ready?. Knowledge@Wharton (2017, April 04). Retrieved from http://knowledge.wharton.upenn.edu/article/are-you-ready-for-retirement/

Chicago

"Retirement Is Coming — Are You Ready?" Knowledge@Wharton, April 04, 2017,
accessed August 18, 2017. http://knowledge.wharton.upenn.edu/article/are-you-ready-for-retirement/


For Educational/Business use:

Please contact us for repurposing articles, podcasts, or videos using our content licensing contact form.