Many Americans with retirement IRA accounts are taking early distributions, according to a recent study reported by the Employee Benefit Research Institute (EBRI). A recent article by a colleague on this site discusses the advisability of taking early Social Security benefits. The EBRI study shows that nearly half the people in lower income groups are taking early distributions from IRAs. The required age for IRA distributions is 71 1/2 years. However, there are many people taking distributions at a younger age.
In the first- (bottom) income quartile, nearly half (48 percent) of the households made an IR
withdrawal, as did those in the second-income quartile (48.2 percent). But the next two quartiles show significant drops in IRA-withdrawal rates: 42.7 percent of retired households in the third quartile and only 28.8 percent of retired households in the top-income quartile made an IRA withdrawal. This highlights the first area of potential concern: More people in the lower-income groups withdraw money early, i.e., before the RMD [required minimum distribution] kicks in.
Among those withdrawing, older 71-80 (required distributions) are putting much more into savings than the younger groups. Those with the lowest income had the highest percentages of withdrawals, not surprisingly. But high numbers (over one quarter) of higher-income ranges are also taking early withdrawals.
A Forbes article discussing the study says that early withdrawals can be part of a financial strategy, but that idea contradicts findings in other studies of how well retirement accounts are managed.
Forbes says this is very risky and potentially harmful practice:
Back to retirement. If you take an early IRA withdrawal — or early Social Security for that matter — does it hurt you financially? You bet it does!
In the case of Social Security, the risk is lower. Since the government runs the retirement program as a pension fund, you are somewhat protected from “longevity risk,” that is, running out of money in your old age. You’re not protected from political risk, of course, and inflation risk is a concern, but those are different topics.
If you fail to do the “time value” calculation on your IRA, though, chances are high that your early IRA withdrawals will cost you big. See, the longer you take out money (time), the less you can take out safely (value). It’s a car loan in reverse.
Unlike Social Security, you can very easily spend down your IRA to zero and have no way to recover, should you live longer than you expect. Other than owning an annuity or other form of guaranteed income, you are on your own when it comes to figuring your real risk of outlasting your savings.
Other figures from the EBRI study indicate that, in fact, the early withdrawals are not due to financial strategy, but due to necessity or expenditures. A breakdown of where the distributions are being spent shows that those in the required distribution age (between 71-80 years), 31.5% went to savings, half (50.2%) went to regular expenses, 13.5% was used for “special purposes”, and just over 5% was given to relatives or friends. In contrast, among those aged 61-70, only 10.9% went to savings, while fully 57.8% was used for regular expenses, fully one quarter (25.5%) was used for special purposes, and 4.9% was given to relatives or friends. While nearly one-third of the 71-80 year-olds were putting their distribution money into savings, nearly 85% of the younger group’s money was going toward either regular expenses or for “special purposes”.