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 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 [email protected] 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.
[email protected]: 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.
[email protected]: 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.
[email protected]: 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.”
[email protected]: 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.
[email protected]: 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.
[email protected]: 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.
[email protected]: 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