Old savings habits die hard.
Well-to-do retirees who are drawing down income from their savings are spending less than they withdraw, according to recent data from Vanguard.
That also applies to required minimum distributions, which generally must be taken from individual retirement accounts and 401(k) plans starting at age 70½. Most of that money went back into savings.
"It's the unknown that people are preparing for, and they want to be able to cover themselves," analyst Anna Madamba of the Vanguard Center for Retirement Research said in explaining the cash surplus. "When you plan for uncertainty, the force of that mindset is very strong."
The median withdrawal rate from tax-advantaged accounts was 4 percent, but curiously, the median spending rate was zero for withdrawals from retirement savings plans and 1 percent for distributions from IRAs, according to the Vanguard data.
"What it tells me is that maybe they have a nice pension and Social Security benefits, so they may never need to use this money," said Tim Steffen, director of financial planning at Robert W. Baird & Co.
"Required withdrawals get bigger as [time] goes on, so it's probably income that they are less likely to need," he said.
It's not typical for most retirees to have large required withdrawals.
For example, the average 401(k) plan at Vanguard held about $96,000 last year. But a fortunate few wind up with more cash than they need due to the forced distributions, which prompts the question: what to do with the extra cash? Here are a few suggestions that may strengthen your finances.
Stay in the market and have your extra cash routed to a taxable brokerage account.
Debbie Freeman, director of tax and financial planning at Peak Financial Advisors in Denver, said some of her clients are investing a portion of their distributions into dividend-paying stock and municipal bonds so that they can continue accumulating earnings over the long term.
Among her clients who are already taking required withdrawals, a couple of them are putting away as much as 30 percent of their distributions in taxable brokerage accounts.
Reinvesting the distribution is also a great opportunity to rebalance your overall equity and fixed-income allocation, Freeman said.
Think about your tax rate and your after-tax rate of return before you go whole hog into municipal bonds, Steffen said.
Investors who are in the 28 percent federal income tax bracket reap the biggest tax savings by investing in municipal bonds.
Those in lower tax brackets, however, may be sacrificing attractive yields available in other bonds for paltry tax savings by going into munis.
"If you invest in municipal bonds, you may get a lower rate of return than you would on corporates," Steffen said. "If you are in a low tax bracket, you may still have higher returns from corporates on an after-tax basis."
Bear in mind that neither corporate nor municipal bonds are risk free.
As with all debt obligations, consider the possibility that the issuer could default on the bond. Know the credit quality of the company or municipality that's offering the investment.
Also, all bonds face the risk of rising interest rates, which erode the market value of these securities.
A common error for retirees is to attempt a conversion of the required minimum distributions to a Roth IRA. It's a sensible mistake: You're required to withdraw the money and pay income taxes, so why not?
It's a simple answer, said Ed Slott, IRA expert and owner of Ed Slott & Co. in Rockville Centre, New York. You are not allowed to make that conversion.
However, you can use that money to pay taxes on other IRA dollars that you wish to convert.
Here's a better idea: Make a gift of the funds to your heirs.They can use this money to pay taxes on other IRA dollars they wish to convert to a Roth, said Slott. Roth IRAs are funded with post-tax dollars and any gains in the future, plus the original contributions, can be taken out tax-free.
You can make a gift up to $14,000 per recipient. An added bonus: These gifts reduce the size of your estate.
"The benefit of the Roth is longevity," Slott said. "The money grows fastest because it's never eroded by taxes. The longer the money is in the account, the more valuable it is."
If you want to save on taxes from very large withdrawals, consider a Roth conversion way ahead of time and in small chunks, Steffen explained.
"Start doing that early on in retirement in a year when income is low but before you trigger RMDs," he said.
Finally, talk to your advisor or accountant about having your bank or brokerage withhold income taxes from your required distribution. This way you save on penalties if you underpay for some reason.
"If it's the third quarter, and you've underpaid your taxes, you can have money withheld from the RMD so that you minimize your underestimated tax payments," Freeman said.
Don't forget the qualified charitable distribution, which allows you to donate all or part of your withdrawal without adding to your income.
In order to make this valid, the trustee of your IRA must directly transfer the money to a charity. You can give up to $100,000 per taxpayer per year.
"You don't have to donate the whole RMD, but the direct transfer will be excluded from income in your tax return," said Slott. "That keeps your income lower."