When you retire, you need to start withdrawing money from your 401(k) or other investment account. This requires a major mindset shift as you have been creating these accounts for the rest of your life. And you have to be smart about when and how much money you withdraw.
Before you start considering distributions, there’s one important thing you absolutely must do first.
Follow these steps before withdrawing money from your retirement account
Before you withdraw your retirement assets, you must determine a safe withdrawal ratio. This is basically the amount you can withdraw from your investment accounts. without Take a big risk that you will empty your account very soon.
Look, you have to rely on your retirement savings for your last few years. They cannot live on Social Security benefits alone without additional savings. That’s not possible because Social Security only replaces 40% of your preretirement income and you need to replace about 70% to 80% of your income before you can retire. Social security benefits also depreciate in value over time, leaving you with even more to save later in life. This happens because the built-in Social Security benefits are augmented, which don’t work very well to account for the inflation experienced by seniors.
If you withdraw too much money from your retirement account too soon, you won’t have enough money left to invest in income-generating assets. Your returns will start to decrease, so your account balance will decrease even more with each payout. Finally, you can end up with $0.
Setting a safe payout rate helps reduce the chances of this happening. If you limit how much money you withdraw at once, you still have plenty of money working for you and making returns. For example, if you can make a 7% return per year and only withdraw 4% or 5% of your account balance, the total value of your account will not decrease even if you withdraw.
How can you determine a safe payout rate?
In an ideal world, you could live off only the interest you earn and avoid reducing your capital in the first place. But that often doesn’t work in practice.
Seniors need to invest conservatively as they cannot afford to risk large losses when the market falls. If you’re heavily invested in stocks, you can’t wait for the recovery. And even if you make generous returns a few years from now, there may be years when you don’t and you still have to rely on your savings for income.
This means you need a different withdrawal strategy.
A general rule seniors follow is to withdraw 4% from their retirement account in the first year of retirement, and then increase their withdrawals each year to match inflation. While the probability of running out of money using this approach used to be very low, low projected future returns and longer life expectancies have made adhering to the so-called 4% rule more dangerous.
The Retirement Research Center recommends an alternative approach: Use the IRS-produced minimum payout (RMD) tables for calculating 401(k) withdrawals to determine how much you need to take from all your accounts — even if you don’t. You are not yet required to take RMDs.
You can also work with a financial advisor to develop a personalized approach that’s right for you given your age, risk tolerance, lifespan and the amount of money you have invested to support yourself. Whatever you do, don’t withdraw any money until you’ve decided how much you’re comfortable withdrawing or you might really regret it.