A stunning 80% of American retirees are getting this RMD rule wrong ‘out of fear’ — and it could cost them thousands of dollars in lost income. Are you making this mistake?

Based on research done in the 1950s by Nobel Prize-winning economist Franco Modigliani and his student, Richard Brumberg, many economists argue that we base our spending and saving decisions on our beliefs about lifetime income and spending — and therefore aim to keep our level of consumption steady throughout our lives.

When we’re younger, we typically have a lower income and may take on more debt, such as a mortgage, with the belief that we can pay it off with a higher income later in life. As our income increases, we begin saving so we can continue our current level of consumption by drawing on these savings when our incomes decline in retirement.

The retirement consumption paradox

In reality, people often reduce their inflation-adjusted consumption when they retire, a phenomenon known as the “retirement consumption paradox.” This may occur from choice or from necessity.

For instance, 32% of retirees “are convinced they have not accumulated enough savings” and 68% are worried they will outlive their assets, according to the Schroders 2024 US Retirement Survey. Whether they’ve saved enough or not, they’re worried about inflation, healthcare costs, and market downturns.

It’s no wonder retirees are being prudent about how they withdraw their funds. But this is leading more than 80% of retirees to make the mistake of only taking their required minimum distributions (RMDs) from accounts that require them.

Doing this can cost retirees greatly because it may mean they’re restricting their income when they’re in a more active stage of their retirement and could potentially enjoy it the most. They then get the most income once they’ve slowed down and may have less need for it.

What’s a required minimum distribution (RMD)?

An RMD is an annual withdrawal from a pre-tax retirement account, mandatory under Internal Revenue Service (IRS) rules. These include 401(k)s, 403(b)s, 457s, the government TSPs, and traditional IRA accounts.

You’re required to start taking RMDs by Dec. 31 of each year, beginning the year you turn 73. There’s a first-year exception that allows you to take your first RMD by April 1 of the year following the year you turn 73, but this will require you to take two RMDs that year. If you don’t take your RMD, you can face a tax penalty of up to 25% of the RMD that was due.

RMDs are calculated by dividing your account balance as of Dec. 31 of the previous year by the life expectancy derived from tables posted on the IRS website.