Peak 401(K)

by: Ron Rowland

The baby boomer generation will begin forced mandatory distributions from their retirement accounts this year. The question at hand is whether or not we have reached the peak 401(k) inflection point. IRAs and 401(k) plans have been providing baby boomers (people born between 1946 and 1964) with a tax-deferred approach to saving for retirement. However, one key provision of those plans is that required minimum distributions (“RMDs”) must commence in the year the owner reaches 70½. That year is 2017 for the leading edge of baby boomer generation.

All three words that make up the RMD acronym are important. For many, this will be the first time to receive a “distribution” from their retirement account. Previously, it was a contribution plan, with money flowing in and hopefully appreciating in value. Distributions flow the other way, and now money is coming out of those accounts.

Whether you need the cash or not, these annual withdrawals are “required” distributions. Not only do you have to take them, but they are also taxable income, and you will be liable for the income taxes. That tax you deferred many years ago is now coming due.

The government also specified the “minimum” amount you must withdraw every year. The actual amount is a function of your age and account balance using the IRS distribution tables. For example, a person 70 years old must use a distribution period of 27.4 years. Therefore, the distribution percentage is calculated by taking the inverse (1 divided by 27.4), which is 3.65%. If your 2016 year-end balance was $300,000, then your 2017 distribution needs to be at least $10,950. As you get older, the distribution period shrinks and your minimum percentage increases. For someone like Betty White, who just turned 95, the distribution period is 8.6 years, making the minimum distribution 11.6% of the previous year-end balance.

These RMD rules apply even if you are still working and haven’t retired. Additionally, you are no longer able to make any contributions, forcing the flows to reverse direction. With the baby boomers now reaching this turning point, the aggregate flows across all 401(k) plans may be reaching a turning point too.

According to data from the Labor Department, the total amount of money flowing into U.S. tax-sheltered workplace retirement plans has exceeded outflows for all but a few years. The exceptions included 1999 and 2000, when the strong market gains of 1998 and 1999 pushed year-end balances and their resulting RMDs higher.

The other exceptions were 2013 and 2014. Net outflows totaled about $9 billion in 2013 and nearly $25 billion in 2014, establishing a record. One might be tempted to claim this is just another blip, similar to 1999 and 2000, but other factors are now at work. Since data for 2015 and 2016 is not available yet, we are left to speculate about the last two years. However, net annual flows peaked in 2009 and moved steadily lower the ensuing five years. If you believe in trends, the trend is moving lower.

As previously mentioned, the other factors at play include the baby boomer generation moving into the RMD zone. There are a reported 75 million baby boomers, and collectively, they have amassed about $10 trillion in various tax-deferred retirement accounts. Therefore, the relatively tiny $25 billion of outflows will not make a dent in the overall balance. In fact, a nominal market gain of 5% should boost assets by about $500 billion, more than offsetting the distribution-related outflows.

Therefore, given the demographics trends, there is a reasonable chance we have achieved peak 401(k) in terms of net contributions, at least for the baby boomer generation. As for achieving peak 401(k) in terms of overall assets, we still have a ways to go. When you hear the fearmongers screaming about the imminent collapse of the stock market due to baby boomer withdrawals, you can take it with a grain of salt—at least for the time being.

Disclosure: Author has no positions in any of the securities mentioned and no positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) is received from, or on behalf of, any of the companies or ETF sponsors mentioned.