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Get the Money Out of Your 401(k) or IRA

How to Start Withdrawing Your Savings in Retirement

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As your career days draw to a close, it's time to think about the transition from living on your employment income to living on your savings. Beyond the emotional issues that make some of us terrified to break that piggy bank and try to enjoy it, there are many practical issues to face as well. How much do you withdraw or take out initially? What rate of withdrawal over time is safe enough that you won't outlive your savings, but substantial enough that you enjoy your life savings instead of hoarding it?

Also, consider this: Your retirement savings plan doesn't necessarily end once you start your retirement. That money still has a chance to grow even as you begin to withdraw funds to help pay for your living expenses. But the rate at which it will grow declines as you take out funds. Balancing a withdrawal rate with a growth rate is part of the science and art of investing for income.

A Safe Rate of 401(k) Withdrawal?

Many financial advisors would recommend "the 4% rule." That is, you can withdraw 4% annually and maintain financial security. A famous study in the 1990s by Bill Bengen showed how a 4% withdrawal rate over 30 years had the best chances for success even as it adjusted for inflation. But many variables could make this rule-of-thumb percentage too conservative or too risky. There are those who would tell you that a 7% withdrawal rate is relatively safe, others say realistic safety is closer to 2%, especially in the first year or so. Like so many financial solutions, the answer depends on you. Your life expectancy, the performance of your investments, how much you need to meet expenses, your spouse, Social Security, a second job, and so on.

For comparison's sake, see what a 4% withdrawal rate would amount to with your savings, and adjust from there. You can run your own retirement calculations to get a sense of what you will need and what you might be able to count on. There are many really useful retirement calculators on the Web. But as you near retirement, it's a good idea to get advice from a knowledgable financial professional.

Investments in Your Retirement Withdrawal Period

It's a common strategy to allocate more of a portfolio to fixed-income investments as you near retirement. Fixed income can be a safer bet, yes, but it can also help shift your portfolio to a place where it's producing income rather than reinvested growth. Income investments generate dividends or interest, not just bonds but stocks, real estate, and other types of assets pay either fixed or variable income. Ideally, you could use that income to cover living expenses without touching the principal or the initial investment amount.

The problem is, these days it's hard to get any yield on your investments without taking on a lot of risk. Even if you are willing to accept some risk, the payoff isn't huge. Unless your account has a large balance, you may not be able to live on 4% per year.

Many investors seeking a slight yield boost will try a laddering strategy with CDs, or short and medium-term bonds. In a low and stagnant interest-rate environment investors want the highest yield to be found. Longer term bonds have higher interest rates than shorter-term bonds, but if you lock in your money over a long period, you run the risk of missing out on better-yielding investments should interest rates rise. A ladder strategy tries to get blend the liquidity of short-term investments, with the higher yields offered by longer-term investments. Instead of buying one, say, five-year bond that pays 3%, you would buy five bonds that mature at different rates over the next five years. The shorter-term investments will pay less, the longer-term will pay more. Spreading your money across a variety of maturities can help you get a decent return without giving up your liquidity (in other words, a way to get your hands on the cash should you need it). With bonds maturing each year, you have the opportunity to reinvest (and we all have hopes that rates will be better by then).

Which Retirement Account Do You Withdraw From First?

The other consideration is which account to draw from first. But how to do this in the most tax-efficient way depends on your individual situation. You can start withdrawing funds from a retirement account without penalty after age 59 1/2, but you don't have to start taking required minimum distributions from tax-deferred retirement accounts until age 70 1/2. A Roth IRA works differently. There is no required minimum distribution, so let that money grow tax-free for as long as you'd like.

But there are some cases in which you want to strategize your withdrawals to reduce your annual tax bill. Because withdrawals from a Roth IRA are tax-free in retirement, you may want to take some money from that fund instead of a another. If you have a combination of investment accounts, talk to a financial advisor or specialist with your plan administrator to see if there is a strategy that makes sense for you. You may also consider converting to a Roth IRA before or during retirement. Again, a financial professional can outline whether this makes sense depending on your needs and goals.

What Happens to Unused 401(k) Savings?

If you don't outlive your funds or, worst-case scenario, you are not able to withdraw your retirement funds before death, the money will be passed on to the beneficiaries you named when you opened the accounts. This is why it's a good idea to check beneficiaries periodically, or after a life change such as marriage, the birth of a child, divorce, etc. Your beneficiaries will pay income tax on these withdrawals.

Disclaimer: The content on this site is provided for information and discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.

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