The largest generation in U.S.
history has to start pulling its retirement money this year, kicking off a
mandatory movement of cash that could total hundreds of billions in the coming
U.S. law requires anyone age 70 ½
or older to begin annual withdrawals from their tax-sheltered retirement
accounts and pay taxes on those distributions. The oldest of the nation’s 75
million baby boomers cross that threshold for the first time this month,
according to a U.S. Census Bureau estimate of when that demographic group
The obligatory outflows from
401(k)s and IRAs are expected to ripple through the U.S. economy, the stock
market and a money-management industry that relies heavily on fees from
boomers’ tax-sheltered savings plans and assets.
Boomers hold roughly $10 trillion
in tax-deferred savings accounts and over the next two decades, the number of
people age 70 or older is expected to nearly double to 60 million—roughly the
population of Italy.
Firms that manage 401(k) plans
are trying to persuade clients to reinvest their withdrawals in other products
rather than spending or donating the cash to charity. It’s another pain point
for many traditional money managers already struggling to keep some clients
from shifting into lower-cost index-tracking mutual funds.
Many hope to offset the required
distributions with inflows from millennials, people in their 20s and 30s—who
recently became the largest living generation, even though boomers, at their
peak, were more populous.
Savers, meanwhile, are debating
what to do with their cash as they wrestle with tax bills triggered by required
distributions and worry about outliving their assets. On average, men and women
who turned 65 in 2015 can expect to live another 19 and 21.5 years
respectively, according to the U.S. Social Security Administration’s most
recent life-expectancy estimates; those post-65 expectancies are up from 15.4
and 19 years for those who turned 65 in 1985.
Jack Weaver, a retired
biopharmaceutical product developer, turned 70 in late 2015 and had to pay
taxes on his first required payout of $31,000 last year. “It’s unwanted
income,” he said. He reinvested the money, and says his wife plans to do the
same when she takes her first distribution this year.
The rise of the 401(k) is
inextricably linked with the surge in U.S. citizens born after the end of World
War II. Boomers, defined by the U.S. Census Bureau as people born in the 18
years beginning in “mid 1946,” embraced tax-deferred retirement accounts and
made them a widespread savings tool in the 1980s and 1990s. The plans largely
replaced traditional pensions, and helped create a multi-trillion-dollar
industry supporting hundreds of investment firms and financial planners.
Contributions to tax-deferred
retirement plans outnumbered withdrawals through much of the 1990s and 2000s.
That flow began to reverse as boomers entered their retirement years earlier
Investors pulled a net $9 billion
from workplace retirement-savings plans in 2013, according to the Labor
Department. In 2014 the withdrawals jumped to net $24.9 billion. Full-year
information for 2015 from the Labor Department isn’t yet available, but large
mutual-fund companies that manage the bulk of U.S. retirement assets say outflows
continue to rise. Fidelity Investments expects 100,000 customers to take their
first required distributions in 2017, up from 91,000 in 2016.
The withdrawals thus far are
small when compared with the roughly $15 trillion parked in U.S. tax-deferred
retirement plans, according to a September 2016 estimate by the trade group
Investment Company Institute. Brian Reid, chief economist at ICI, said asset
gains could help cover some of the amounts retirees would have to withdraw.
Still, distributions are expected
to grow exponentially over the next two decades because of a 1986 change to
federal law designed to prevent the loss of tax revenue. Congress said savers
who turn 70 ½ have to start taking withdrawals from tax-deferred savings plans
or face a penalty. Specifically, retirees who turn 70 ½ have until April of the
following calendar year to pull roughly 3.65% from their IRA and 401(k) funds,
subject to slight differences in the way the funds are treated by the Internal
Revenue Service. Then they must withdraw an increasing portion of their assets
every year based on IRS formulas. The rules don’t apply to defined-benefit
pensions, where retirees get automatic distributions.
The penalty for not taking
distributions on time is a 50% tax bill on funds the retiree failed to
The required distributions could
come as a surprise to many boomers, said Alicia Munnell, director at Boston
College’s Center for Retirement Research. “Individuals look at the pile of
savings and think that’s their whole nest egg, not that they’ll have to pay
some amount of that to the government,” she said. “It’s a very big deal when
people realize they only have two-thirds or three-quarters of what they thought
Bronwyn Shone, a financial
adviser in Pleasanton, Calif., said many of her clients aren’t aware of their
legal obligation to take distributions. “I think some people thought they could
let the money grow tax-deferred forever,” she said.
The outflows aren’t a surprise to
most asset management firms, but they could force some dramatic changes. Firms
will have to lower fees and offer more services to convince retirees to keep
their savings at the firms, said Walt Bettinger, chief executive of brokerage
firm Charles Schwab Corp. That would lower a firm’s profitability by raising
costs per customer, he added.
Charles Schwab, which manages
some $208 billion in 401(k) assets, typically has to move 10% of those funds
around in any given year due to retirement, death or job changes. Mr. Bettinger
expects that number to rise to 15% because of required withdrawals. “A 5 point
increment of trillions in assets is a big number,” Mr. Bettinger said. “What’s
happening is providers are having to be more aggressive to fill the gap.”
A Schwab spokesman said the
company lowered fees on 401(k) plans about two years ago, by offering more
low-cost options in exchange-traded or target-date funds. “We have been
anticipating fee competition in 401(k)s for quite some time,” he said.
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