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Retired Investor The Big Question

Many Retirees Limit Withdrawals to the RMD Amount

Our Big Question survey gives insights into what types of accounts are favored by AAII retirees, and how they make withdrawal decisions.

by Charles Rotblut, Ryan Reeh, Lucy Manning | November 2020

Charles Rotblut leads a class in AAII's new Essential Investing Video Course. Go to https://www.aaii.com/ves for more information and to subscribe.

Many retired AAII members use the tax code as their withdrawal strategy. Close to half told us that they limit their withdrawals to the amount required to be taken each year.

This insight came from our latest “big question” survey. The survey focused on strategies for taking retirement withdrawals. Among the subjects we asked AAII members about were what guides their withdrawal decisions, what causes them to adjust their withdrawals and the role taxes play.

The survey is part of a periodic initiative to give individual investors a chance to talk about their investment decisions and challenges. Each survey asks what we’re describing as a “big question” about a subject affecting many investors. A randomly selected group of AAII members is asked a specific question, as well as follow-up questions intended to provide more clarity and background.

This sixth survey in the series was emailed to AAII members in October 2020. The results were tabulated based on responses sent to us. We received 538 responses from the survey invitation; 471 said they were currently taking retirement withdrawals from their portfolios. The average age of those taking withdrawals was 74, while the median age was 73. The oldest was 95, and the youngest was 57 years old. Respondents said they have been taking retirement withdrawals for an average of nine years and a median of seven years.

Required Distributions Rule Withdrawals

The most commonly used withdrawal strategy was to simply take the minimum amount required by the tax code (Figure 1). This was the approach followed by 45% of respondents. Required minimum distributions (RMDs) are mandated from tax-deferred retirement accounts, including traditional individual retirement accounts (IRAs), 401(k) plan accounts and 403(b) accounts, among others. Roth 401(k) accounts are also subject to the RMD rules.

The answer “only what I need for expenses” was chosen by nearly one-quarter of all respondents (24%).

More than 7% said they are using AAII’s Level3 withdrawal approach. This strategy, developed by AAII founder James Cloonan, calls for holding the equivalent of four years’ worth of living expenses in safe assets (cash and cash equivalents) and allocating the remainder to growth assets (equities). Whenever the market is within 5% of its high, withdrawals are taken from growth assets. During years when the market is below 5% of its high, withdrawals are taken from safe assets.

The 4% rule was followed by slightly less than 6% of respondents. This approach, developed by former financial planner William Bengen, calls for taking the equivalent of 4% of one’s retirement savings at the start of retirement. Each year thereafter, the starting amount is adjusted by the rate of inflation.

When asked why they chose their current strategy, two out of five respondents (42%) chose “a desire to limit withdrawals to what government requires” as their reason. Many respondents mentioned taxes and/or Medicare premiums. The answer from J. G. Traeger was representative. He limits withdrawals to “the RMD plus additional funds to convert to a Roth IRA before hitting the next federal tax bracket. He also stays “mindful of the potential impact of Medicare surcharges.”

The existence of other sources of retirement income was another reason why many members just rely on RMDs to guide withdrawals. Robert Wheeler explained that his “RMD plus pension plus Social Security provide more income than is needed for inflation-adjusted spending. The excess gets invested in non-retirement accounts to protect against future needs.”

Several respondents told us they try to stay below a certain percentage, including Kevin Lewis. He uses “the 4% withdrawal rate as the maximum to withdraw in a given year.” Lewis added “My expenses are much less than that maximum. I only withdraw what I need.”

Douglas Hudson limits his withdrawals to “generally between 4% and 5% per year.” He describes it as being “enough to live on without materially decreasing principal value.”

Most respondents have been sticking with the same withdrawal strategy since they first retired. Among the 16% who said they’ve changed their strategy were many who retired when the mandatory age for when RMDs must start was 70½. (The age is now 72.) Some other respondents are taking advantage of the CARES Act RMD waiver for 2020.

RMDs and Expenditures Drive Changes in Withdrawals

To gain more insight about the decisions individual investors make regarding their retirement portfolios, we asked how frequently they increase the size of their withdrawals. Respondents were nearly evenly split between those who adjust annually in accordance with their required minimum distributions (41%) and those who only make adjustments as needed to cover expenses (40%). RMDs change annually based on a person’s age and the amount of savings in accounts subject to mandatory distributions.

Only about 4% of respondents use inflation as a guide for adjusting their withdrawal amounts.

As a follow-up question, we then asked respondents what adjustments to withdrawals they make when their portfolio or the stock market falls in value. The majority (57%) do not make any changes (Figure 2). An additional 9% said they take just the RMD amount. This is not surprising, given the high reliance on using RMDs as a guide for taking withdrawals and the fact that RMDs are mandatory.

About 13% of respondents take withdrawals from their cash savings, as opposed to selling stocks or equity-based funds. Just 5% reduce the size of their withdrawals and only 3% said they reduce spending or expenses.

Impact of Taxes Varies

When asked how taxes impact their withdrawal decisions, 13% of respondents described taxes as being a major consideration. An additional 19% limit withdrawals to the RMD amount or otherwise minimize withdrawals to reduce taxes. Almost 7% use qualified charitable distributions (QCDs) to reduce taxes. QCDs can be made in lieu of RMDs for amounts up to $100,000 per year. Slightly more than 3% cited Medicare premiums as a consideration.

Conversely, more than one-third of respondents said taxes either have no impact (22%) or a minimal impact (14%).

Mark Hammer is among those who are actively doing Roth IRA conversions: “We figure this is about the lowest federal tax rate we’ll ever see so we are withdrawing some, paying taxes and redepositing the remainder into a Roth IRA.” J. B. Mitchell takes the RMD and then converts just enough to a Roth IRA “to exhaust 12% federal income tax bracket.”

“Tax considerations do not have a significant impact,” responded R. F. Leinig. “I minimize taxes by using QCD withdrawals for charity. I don’t typically sell taxable securities, but I will do some tax harvesting by selling gains and losses if it makes sense to me. I do Roth conversions, but I make sure not to jump into higher federal tax or Medicare brackets.” In a follow-up email, he added, “If you are in the RMD age group, and you don’t need the money, 2020 is an excellent time to maximize Roth conversions.”

When asked specifically about qualified charitable donations, more than half of respondents (61%) said they do not make QCDs. The difference between this answer and the percentage of respondents who specifically listed QCDs when describing how taxes impact their withdrawal decisions may be attributed to factors such as not needing the full RMD and/or a desire to make charitable donations.

IRAs Owned by Most

Most respondents (89%) make use of traditional IRAs, SEP IRAs and similar types of accounts. Nearly half (46%) say they own a Roth IRA. Employer-sponsored plans—401(k), 403(b), Thrift Savings Plans (TSPs)—were less frequently used but still owned by 22% of all respondents.

There is a high usage of taxable accounts. Almost two-thirds of respondents (66%) say they use a traditional brokerage account, a taxable mutual fund account or a similar type of account. Slightly more than 39% use a bank or savings account.

When we followed up by asking respondents which type of account most of their retirement savings are held in, the answers shifted. More than half (60%) listed traditional IRAs or SEP IRAs as the primary account for their retirement savings (Figure 3). Traditional brokerage accounts, taxable mutual fund accounts and a similar type of accounts were a distant second, named by 18% of respondents. Slightly more than 7% said employer-sponsored plans, while 4% have most of their retirement savings in Roth IRAs. The “other” in Figure 3 includes annuities and bank accounts.

Savings Are the Most Common Source of Retirement Income

Nearly two-thirds of respondents (62%) described retirement savings as a primary source of retirement income. This is a larger percentage than either Social Security or pensions, which were chosen by 46% and 34% of respondents, respectively. (Respondents were allowed to choose more than one answer.)

As far as sources of cash to fund portfolio distributions are concerned, dividends are most commonly used. They were named by 19% of respondents. An additional 4% use interest from bonds and/or bond funds. About 10% free up cash by selling investments.

Maintaining a cash allocation is common, with 18% of respondents saying they do so. An additional 11% said the amounts required for their withdrawals are already funded. About 13% said they use Social Security benefits, RMDs and/or pensions to provide cash.

AAII Members Are Confident About Maintaining a Comfortable Lifestyle

When asked about how confident they are about maintaining a comfortable lifestyle through the remainder of their retirement, three-quarters (75%) of respondents described themselves as being very confident. An additional 15% chose “somewhat confident” as their answer.

Retirees’ Advice: Be Conservative With Withdrawals and Spending

Finally, we asked respondents what guidance regarding withdrawals they would share with those nearing retirement. The most common advice centered around limiting the amount of withdrawals and having a budget to live on that withdrawal amount. Less frequently given were suggestions to maintain a cash balance or to follow a strategy incorporating safe assets. Other advice included doing Roth IRA conversions, limiting taxes and delaying retirement.

“Create an accurate spending budget before retirement and compare it to your income sources to determine cash flow,” advised R. P. Chichester. He suggests that “one should calculate RMDs before being required to take withdrawals to understand the tax impact and possibly withdraw from IRAs earlier to mitigate the tax burden when full RMD withdrawals are required.” ?

Discussion

ALAN H from MO posted over 5 years ago:

In addition to all of the considerations in the article, the SECURE Act passed by Congress in December, 2019, has significantly impacted how your heirs must handle inherited IRA assets. Whereas before they could take distributions over their lifetimes, now they are required to withdraw them within 10 years. Depending on your family's financial situation, this could result in your kids being bumped into significantly higher tax brackets vs you taking some extra withdrawals now. Turning 72 next year, I plan to have the IRA/401k custodians do the math for me and take monthly RMDs to meet IRS requirements. Then late in the year I'll look at expected income (including distributions, pensions, dividends, cap gains, etc.) and request an extra distribution (and/or Roth conversion) with tax bracket and Medicare break points in mind. In this way I hope to "buy down" some of my IRA/401k and avoid loading it on the kids. If those funds are placed in similar assets in other accounts, there should be no risk of "overdrawing" from funds invested for retirement (won't necessarily violate the 4% idea). Another option to avoid inheritance taxes on your IRA/401k savings is to designate a charity as beneficiary (they get assets tax-free) and purchase life insurance with your kids as beneficiary to replace the funds in their inheritance (death benefit also tax-free). This option, of course depends on you and spouse age, health, insurability, and how much you might want (or be able) to pay in insurance premiums for a benefit you'll never see. Check with your financial advisor, but be aware they may have an interest in trying to sell you a policy to implement this plan. Alan Life Member


ROBERT A from FL posted over 5 years ago:

Since there are no RMD's on your IRA this year, is there a tool for determining how much you can transfer from your IRA to your Roth IRA, before you have to pay a tax ? Robert A, Life Member


CHARLES R from IL posted over 5 years ago:

Hi Robert, Any amount converted from a traditional IRA to a Roth IRA is taxable in the year it occurs.

If you can estimate what your taxes will be for 2020, you can determine how close you may be to hitting the next tax bracket and/or triggering higher Medicare premiums. The tax forecasting worksheet in our tax guide provides a framework for doing this type of estimation. -Charles


DAVID G from NJ posted over 5 years ago:

Thank you for this insight into other people's retirement lifestyle. I am getting ready to end my working life and begin the next phase of my life. The actuarial society has stated that if we hold off taking Social Security until we turn 70, and draw down our IRA's using the RMD's only, we will never run out of money. It may not be a luxurious retirement, but it will be a financially comfortable one. Dave G. Monmouth Jct., NJ


RICHARD F from MN posted over 5 years ago:

People taking RMD's and who are on social security have to realize that their marginal rate will likely be much higher than the tax bracket they happen to be in if they take additional amounts from their IRA. And the marginal rate could be significantly higher--as much as nearly 50%! You can really only add income up to the top of your tax bracket without paying excessive taxes if you are not currently on social security and taking RMD's.


ALAN W from FL posted over 5 years ago:

I'm not in the RMD age bracket yet. Being under 65 and using the ACA Exchange for health insurance I watch my distribution rate to avoid 30% whammy from taxes, tax on Social Security and ACA premiums. If need be I will even draw on Roth to meet my needs before age 65 and Medicare begins. Once Medicare kicks in I might draw a little more. Year before age 70 I will evaluate whether I should suspend SS and make sizable withdrawal from IRA. Might get higher benefit and get to keep more of it. I've begun buying EE savings bonds for my old age. 3.5% compounded rate if held for 20 yrs. Income won't be recognized until the bonds are cashed. Good choice for very safe long term bond holding. I'm buying single person limit of 10k a year for 20k principal and interest in 20 yrs. My beneficiary may have more time to deal with tax ramifications since inherited IRAs now must be drawn in 10 yrs.


JOHN W from NC posted over 5 years ago:

Do more Roth conversions? 45% only draw RMDs for spending, and only 46% have a Roth IRA and 22% have a 401k or equivalent, and I'd guess that at lease some of these 401k's are not fully Roth. Assuming some overlap of the two groups of those taking only RMDs and those without a Roth, implies to me that some of these people may want to fill up their current tax bracket with Roth conversions, and is even more true for those under age 70 and not taking social security, and also for those under age 72 not taking RMDs yet. That is, at age 72+ any social security and RMD income not needed for spending may put some in a higher tax bracket and possibly increase tax paid. Doing Roth conversions now through 2025, after which the TCJA tax brackets expire, may be particularly helpful, resulting in possible smaller future RMDs at higher tax rates. So in conclusion, I would assume that at least some of the 45% taking only RMDs can live on smaller IRA/401k RMD distributions, and filling up tax brackets at low tax rates now with Roth conversions may on net result in fewer lifetime taxes paid. William Reichenstein and William Meyer provide guidance on Roth conversions with current TCJA tax rates: https://www.aaii.com/journal/article/retirement-planning-strategies-following-the-2017-tax-act


PETER T from NM posted over 5 years ago:

I would like to point out that the AAII Level 3 Withdrawal strategy is complementary to the other strategies. I have been using a form of this "bucket" strategy for many years. By having several years' worth of RMD in liquid assets, we can avoid selling equities during a downturn. This strategy has resulted in our IRAs being worth more now than when we first started withdrawing. This leads to a "Good News/Bad News" situation: we probably won't out-live our IRAs. Of course, increasing RMDs will eventually eat into that. I am fortunate to have a military retirement which covers our essential expenses. Prior to age 70, I withdrew discretionary funds from either our taxable savings or my IRA, depending on market conditions, taxes, etc. About 10% of my total IRA is in a Roth. My wife's IRA is over 90% Roth. We did the conversions many years ago to avoid potential taxes on the RMDs. We limit our current withdrawals to the RMDs. At our ages, converting the remainder doesn't appear to be viable. We do advise our children/grandchildren to maximize their Roth contributions. Since the QCD has been made easier to budget for and use, we make nearly all our charitable contributions through this mechanism. This is especially fruitful now that the Standard Deduction has been increased.


ERIC P from NE posted over 5 years ago:

Might there be another “line of programming” that could be added to the AAII Level3 withdrawal approach? Only In years where the portfolio value is down over 5%, to take an additional withdrawal (up to the next tax/Medicare bracket)and do a Roth conversion? Then promptly buy equities at that price level in the Roth. This occurred to me because I now realize the missed the chance to do this last March or April. Now with the market high, there is the risk of paying tax on a sale at high equity values to fund the conversion, (even if it is at a lower bracket), only to watch the Roth portfolio value (and what the cost of conversion otherwise would have been) fall should the market correct. Could of, should of, last Spring; but I don’t know if 2020 represents a pattern that a strategy would protect against. Perhaps this is overthinking it, and it would be better to do the Roth conversion up to the next tax bracket every year.


DONALD M from AZ posted over 5 years ago:

It is sort of interesting that a lot of retirees limit their withdrawals to their RMD's but hardly unexpected, Figure 3 largely predicts the results in Figures 1 & 2 In turn Figure 3 would be mostly predictable by knowing the retirees employment background, e.g. salaried vs self employed, large vs small employer. A more interesting question is how many having an IRA as their primary retirement account originally were in a 401k or 403b (which might explain the large number in IRA's vs small number in 403b's). Prior to retirement I was exclusively in 403b and 401a's but 22 years into retirement I am almost exclusively in an IRA. Within a couple of years I will be completely out of the 403b/401a (TIAA). The IRA was first created in 1974 and the current system of using :"divisors" only dates back to the 1990's. 403b's as employer sponsored plans date back at least to 1959.One big advantage for an IRA is that the former employer no longer has any control over investment decisions. The Roth IRA is an even more recent creation.Note the evolution of TIAA from being strictly a participant focused organization to now a more public financial institution. One downside of an IRA is the possibility of Congress tinkering with the rules retroactively. Is it likely that the info in the article will cause any retirees to change their system, not likely.


WILLIAM M from AK posted over 5 years ago:

Only about 3.5% of my liquid assets are in a retirement account. I was pondering how to go about liquidating that account but decided I'd just let it sit there until the law tells me I have to start withdrawing it. The problem is I'm in a high tax bracket and would have liked to have lost less of the IRA from taxation. I've been fortunate anyway... I retired with disabilities at age 46 and have managed to do well enough. My retirement plan has me spending no more than 3% of my assets per year, but I rarely manage to spend that much. Because I'm retired and have been now for almost 20 years, I don't like risking the savings since I depend on it to fund myself and the family. I do take advantage of what I call no brainer opportunities like when the market crashed big time in March of 2020. The only quandary I have is getting the IRA money out at an opportune time, and so far there really hasn't been a good time to do that.


MARK S from VT posted over 5 years ago:

I have a traditional IRA and was told by Fidelity that in order to make a QCD withdrawal, I have to first convert securities to cash and then donate to charity. However, as soon as I convert to cash, apparently the amount becomes taxable. How do you get around that?


CHARLES R from IL posted over 5 years ago:

Mark,

If you sell the securities while they are held in the IRA, there will not be any capital gains tax.

-Charles


Gary S from TX posted over 4 years ago:

You (AAII) need to know the difference of tax-deferred and tax free accounts. ROTH accounts, whether from 401K-or otherwise will NEVER require RMD's for account holders. How is this possible? These accounts are post-tax monies as long as YOU own them. If and when they are transferred,then your heirs have inherited accounts, which are subjected to RMD's.Stop spreading wrong information.


ROBERT A from NC posted over 4 years ago:

Gary, I think you're wrong about the Roth 401k. According to the IRS's website, RMDs DO apply to the Roth 401k (although they're not taxed). There is an easy fix though. All you have to do is convert your Roth 401k to a Roth IRA, and no more RMDs. In my humble opinion, the conversion of a 401k to IRA (preferably ending up in a Roth IRA) should ALWAYS be done as soon as possible after leaving an employer. In an IRA, you have a host of low-expense investing options that are not available through employers' plans.


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