Smart 401(k) Investing—Managing Income in Retirement
Retirement Income Basics
The two big decisions you have to make are the timetable for taking money from your tax-deferred retirement account and the amount you should take at each withdrawal. The questions are:
- Should you begin when you retire or should you postpone withdrawals until they're required?
- Will your money last your lifetime?
Retirement Income Considerations
If you need to withdraw from your 401(k) to live comfortably when you retire, there’s no reason to wait. But if you have other sources of income, or if you expect to be earning money from another job or a post-retirement career, you may want to wait as long as the law allows. Since there’s the potential your account value will increase, it may make sense to allow your tax-deferred accounts to continue to accumulate untouched as long as possible.
You can anticipate your post-retirement living expenses by analyzing what you’re spending in the year or two before you retire. You may feel comfortable estimating that you’ll need 15 percent to 20 percent less after you retire. But be sure to consider the possibility of increasing medical expenses, insurance costs, local taxes and other regular bills.
Then add up what you expect to receive from Social Security, any defined benefit pension you qualify for, your spouse’s income if you’re married and any income you’ll be earning. You might also add dividends and interest from your taxable investment accounts, or the possibility of taking capital gains. If that total is less than you’ll need, that may be a signal to begin withdrawals.
Time to Roll?
Remember, in some cases, your employer may require you to begin drawing on your assets at retirement. If immediate income fits in with your plans, there’s no issue. But if you prefer to wait, that may be a reason to roll over the assets into an IRA.
One way to receive income from a 401(k) plan or individual retirement account (IRA) is to arrange for a systematic withdrawal, sometimes called a periodic withdrawal. You do have to be certain, though, that this is an option your plan or IRA offers.
You can generally choose to receive:
- A regular, fixed dollar amount on a specific schedule
- A specific percentage of your account value on a specific schedule
- The total value of your account in equal distributions over a set period of time
You select a monthly, quarterly, semi-annual or annual schedule. But systematic withdrawal arrangements are usually flexible, which means you can adjust the withdrawal arrangement by notifying the plan administrator or your IRA custodian. You can generally stop the payments, readjust the amount you receive or choose another withdrawal method.
Systematic withdrawals can make it easier to budget, since your money arrives on schedule. And you don’t have to make the decisions about what to liquidate or when to sell. A professional handles those details. That includes ensuring that your withdrawal meets the required minimum distribution after you turn 70½. The one potential drawback of systematic withdrawals is that you could use up your assets during your lifetime. If your money is paid out at a faster rate than your account is growing, you’ll be receiving principal as well as interest and dividends, reducing the amount available to accumulate additional earnings. Eventually your account value could be zero.
In relatively rare instances, you may be offered the option of liquidating the assets in your 401(k) plan and purchasing a lifetime annuity. The annuity pays you income for your lifetime or for the joint lifetimes of two people—you and the person you name.
This alternative, sometimes known as annuitization, closely resembles the way that a defined benefit pension plan pays its retired workers. The chief advantage is that you can’t outlive your assets, something that many people fear. The drawbacks are those of other annuities: potentially high management and insurance costs and lack of flexibility. In most cases, once you have annuitized you can’t change your mind or you can do so only after paying a substantial fee.
If you annuitize, you may be able to choose between a fixed annuity and a variable annuity. With a variable annuity, your income depends on the investment performance of the funds you select from among those offered by the annuity company. A fixed annuity provides the security of regular income but exposes you to inflation risk. A variable annuity offers the possibility of larger payments in the future, but carries the risk that your payments could shrink.
Another Annuity Choice
You can rollover your 401(k) and buy an individual retirement annuity. For people who want to make sure they have income for life this may seem like a good option. However, before investing, you may want to consider their potentially steep fees, lack of flexibility for making unscheduled withdrawals and the financial condition of the insurance companies that stand behind them.
|Three Ways to Withdraw|
Your employer may provide lots of advanced notice about the details of arranging retirement income, but it's your responsibility to meet the deadlines. It's often a good idea to plan ahead and to get professional advice.
You don’t want to be forced to make decisions in a hurry, since once you’ve done certain things—such as a lump sum withdrawal—you can’t change your mind.
Start by finding out from your plan administrator what your distribution choices will be, since not all plans offer all the possible alternatives. Figure out the date you’ll want to start receiving retirement income and find out how much advance notice the administrator needs to meet that deadline.
Your account has to be valued to determine how much it is worth. Every plan values each employee’s account on a regular schedule. But no plan does a separate valuation for account holders who want to move their money or begin distributions. You have to wait until the next regular valuation. In addition, 401(k) plans may hold your money for up to 60 days after valuing your assets. A plan doesn’t have to wait the maximum amount of time, but it can and sometimes does.
Working with an experienced retirement planner can help you avoid some of the pitfalls of making inappropriate withdrawal decisions. It can also make you more confident about making the whole series of choices that are part of retiring and withdrawing from your 401(k) plan.
Through your employer, you may have access to someone who knows the ins and outs of your plan, and how other employees with similar situations have handled the issues you are facing. And, if you already have a good working relationship with one or more investment professionals, ask them if they are qualified to guide you on retirement decisions or if they could recommend a colleague with that experience. Using an investment professional with whom you are comfortable working can make your life simpler.
One area in which you may need help is in looking at the big picture. Rather than assuming you will—or should—withdraw all of your 401(k) assets before you die, an adviser should consider your retirement savings in the context of your estate plan. The larger your account balance and the more other assets you have, the more important a comprehensive plan becomes.
You’ll have to provide your adviser with a copy of your 401(k) plan document. Its terms have a direct impact on the decisions you can make, and on what will happen to your assets at your death.
When you’re choosing an adviser, be sure to ask how he or she is paid, and how much you should expect to pay each year. Some advisers charge a flat fee determined by the assets in your account. Others may charge a commission for each transaction. Be sure you read and understand the adviser’s fee structure before you hire him or her.
Also, ask about the adviser’s background. If an adviser has a credential, ask what it means and what’s required to earn it. If advisers are brokers or investment advisers, you should check their background.