During your working years, you've probably set aside funds in retirement accounts such as IRAs, 401(k)s, or other workplace savings plans. Your challenge during retirement is to convert those accounts into an income stream that can continue to provide adequately throughout your retirement years.
If you’re approaching the age that you want to hang your hat from working, you may be wondering how to withdraw money from your 401(k) after retirement. It isn’t always exactly straightforward, which is why we’ve broken down some of the basics of using your 401(k). Here’s what you need to know.
When to Withdraw Your Retirement Money
There are a few rules about age that you should know about your employee-sponsored 401(k).
First, if you withdraw before age 59½, you will likely be penalized. The penalty for early withdrawal is 10% on top of the taxes that you must pay on the money.
After age 59½, you can begin to withdraw funds without facing any kind of penalty. Of course, if you want to keep your money growing in the account, you don’t have to take any money at all.
At age 72, you must start taking minimum distributions from your account. If you fail to start taking a withdrawal, there is a steep tax penalty to the tune of 50% of the amount not taken on time.
Your minimum required withdrawals are based on two factors: your account’s balance and a table published by the IRS that helps you determine your minimum distribution based on your age. The U.S Securities and Exchange Commission has a nifty required minimum distribution calculator that can help you calculate this amount.
Ways to Withdraw Your 401(k)
There are several ways to go about withdrawing your money in retirement.
- Rollover your funds: Instead of keeping your money in a 401(k), you can roll it over into a new account to keep it growing in retirement with more investment options.
- Take regular distributions: You can contact the financial institution managing your 401(k) and set up periodic payments to give you a fixed stream of income, much like a paycheck. You can also opt to take the distribution as you need them, as long as you take out the minimum required amount.
- Purchase an annuity: You can also purchase an annuity to ensure a fixed stream of payments.
- Take a lump sum: This is often not recommended by financial experts, but you have the ability to take out the money all at once.
Which option you pick will depend on your financial situation and goals in retirement. A financial planner can help you develop a plan that fits your needs.
Setting a Withdrawal Rate
Aside from the minimum required withdrawal, how much you take out is largely up to you.
The retirement lifestyle you can afford will depend not only on your assets and investment choices, but also on how quickly you draw down your retirement portfolio. The annual percentage that you take out of your portfolio, whether from returns or both returns and principal, is known as your withdrawal rate. Figuring out an appropriate initial withdrawal rate is a key issue in retirement planning and presents many challenges.
Take out too much too soon, and you might run out of money in your later years. Take out too little, and you might not enjoy your retirement years as much as you could. Your withdrawal rate is especially important in the early years of your retirement, as it will have a lasting impact on how long your savings last.
Finding a Good Withdrawal Rate
One widely used rule of thumb on withdrawal rates for tax-deferred retirement accounts states that withdrawing slightly more than 4% annually from a balanced portfolio of large-cap equities and bonds would provide inflation-adjusted income for at least 30 years.
However, some experts contend that a higher withdrawal rate (closer to 5%) may be possible in the early, active retirement years if later withdrawals grow more slowly than inflation. Others contend that portfolios can last longer by adding asset classes and freezing the withdrawal amount during years of poor performance. By doing so, they argue, "safe" initial withdrawal rates above 5% might be possible.
Don't forget that these hypotheses were based on historical data about various types of investments, and past results don't guarantee future performance. There is no standard rule of thumb that works for everyone— your particular withdrawal rate needs to take into account many factors, including, but not limited to, your asset allocation and projected rate of return, annual income targets (accounting for inflation as desired), and investment horizon.
Which assets should you draw from first?
You may have assets in accounts that are taxable (e.g., CDs, mutual funds), tax-deferred (e.g., traditional IRAs and 401(k)s, and tax-free (e.g., Roth IRAs). Given a choice, which type of account should you withdraw from first?
The answer is—it depends.
- For retirees who don't care about leaving an estate to beneficiaries, the answer is simple in theory: withdraw money from taxable accounts first, then tax-deferred accounts, and lastly, tax-free accounts. By using your tax-favored accounts last, and avoiding taxes as long as possible, you'll keep more of your retirement dollars working for you.
- For retirees who intend to leave assets to beneficiaries, the analysis is more complicated. You need to coordinate your retirement planning with your estate plan. For example, if you have appreciated or rapidly appreciating assets, it may be more advantageous for you to withdraw from tax-deferred and tax-free accounts first. This is because these accounts will not receive a step-up in basis at your death, as many of your other assets will. A step-up in basis is used to calculate tax liabilities for your beneficiaries.
Withdrawing from tax-advantaged accounts first may not always be the best strategy. For example, if you intend to leave your entire estate to your spouse, it may make sense to withdraw from taxable accounts first. This is because spouses are given preferential tax treatment when it comes to retirement plans. A surviving spouse can roll over retirement plan funds to his or her own IRA or retirement plan, or, in some cases, may continue the deceased spouse's plan as his or her own. The funds in the plan continue to grow tax-deferred, and distributions need not begin until the spouse's own required beginning date.
Retire with Peace of Mind
Your withdrawal strategy matters in retirement. It can mean the difference between having funds to last you for the rest of your life or falling short. It’s always best to research your options thoroughly and speak to a financial advisor to come up with a plan that works for you.
* Non-deposit investment products and services are offered through CUSO Financial Services, L.P. ("CFS"), a registered broker-dealer Member FINRA/SIPC and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. The Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.
Before deciding whether to retain assets in an employer-sponsored plan or rollover to an IRA an investor should consider various factors including but not limited to: investment options, fees and expenses, services, withdrawal penalties, protection from creditors and legal judgments, required minimum distributions and possession of employer stock. Before you elect to open an IRA account and engage your investment representative, please review all account statements and disclosure documents related to the IRA and services to be provided under a new relationship and consult with a qualified tax advisor as needed. If transferring an existing retirement plan into an IRA, you should be aware that (i) Those assets will no longer be subject to the protections of ERISA (if applicable) (ii) depending on the investments and services selected for the IRA, you may pay more or less in transaction costs than when the assets are in the Plan, (iii) if you are between the age of 55 and 59 ½, you would lose the ability to potentially take penalty-free withdrawals from the plan, (iv) if you continue working past age 70 ½ and transferred your plan assets to a new employer’s plan, you would not be subject to required minimum distribution and (v) withdrawing assets directly would be subject to federal and applicable state and local taxes and possibly be subject to the IRS penalty of 10% if under age 59 ½.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018.