Smart 401(k) Investing—Managing Income in Retirement
Once you turn 70½, you must begin withdrawals from your 401(k) unless you're still working. These required withdrawals are designed to ensure that you use the money in your account for the purpose it was intended: to provide retirement income. You may not be required to put money into a 401(k) plan. In fact, only a few employers have mandatory plans. But if you do contribute, you must eventually take required minimum distributions (RMDs) from your plan if you haven’t made arrangements for moving the accumulated assets out of your account. Check your minimum required distribution using our calculator.
The reason the government requires withdrawals is that these tax-deferred savings plans were established to provide you with retirement income, not as a way for you to accumulate an estate to leave to your heirs—though if you die before you have withdrawn your assets you can pass them on to a beneficiary or beneficiaries you name.
Of course, you’re free to begin withdrawing sooner than the law requires—which is when you reach 70½—if you retire or leave your job. You can also take more than the required minimum each year if your plan offers a flexible withdrawal arrangement. But if you take less for any reason, or if the required annual withdrawal isn’t made before the end of the year, you face a 50 percent federal penalty on the amount you should have taken but didn’t.
The age limits most commonly associated with 401(k) plans are 59½ and 70½. The first is usually the age at which you may begin to take money from your tax-deferred savings without owing a 10 percent early withdrawal penalty, provided that you’ve left your job. The second is the age by which you must begin taking mandatory withdrawals—though in fact you actually have until April 1 of the year following the year you turn 70½ to take the first withdrawal.
In most cases, you can begin withdrawing from your 401(k) account when you retire from your job, provided you’ve reached your employer’s retirement age. In fact, some employers require you to start withdrawing when you retire if your money is in the plan. Instead, you could take a lump-sum withdrawal or transfer the balance into an individual retirement account (IRA).
If you’re still working at 70½, you can postpone withdrawals from your 401(k) until April 1 of the year following the year you retire. The only exception occurs if you own at least 5 percent of the company. Then you can’t postpone taking income and must begin withdrawals on the regular schedule.
Social Security's Retirement Estimator
Determining the best age to start receiving retirement benefits depends on a number of individual and family factors, including the amount of your future Social Security benefit. Get a personalized online estimate of your potential Social Security benefit, and see how that benefit varies across different retirement scenarios, using the Retirement Estimator.
Paying the Tax
Tax-deferred investing has some strings attached, but it doesn’t have to tie you in knots. The one tangle you can’t avoid is owing federal income tax—plus state and local tax if they apply—at your regular tax rate on your retirement income. If the income is paid from your 401(k) plan, a percentage of each payment will probably be withheld to cover what you owe.
One argument for taking as little as permitted from your 401(k)—though not so little that you withdraw less than the required minimum—is that it reduces your annual income tax bill. But remember that anything that remains in your account at your death becomes part of your estate, potentially vulnerable to estate taxes.
If you take an early withdrawal, which usually means taking money out of your account before you turn 59½, you may owe an additional 10 percent penalty on the amount you take. However, if you retire, change jobs, or stop working at 55 or later and begin withdrawals, that penalty won’t apply.
There’s another alternative if you want to begin withdrawing early. You can set up what’s known as a series of substantially equal withdrawals over a period of at least five years or until you turn 59½, whichever is longer. The tax applies, but not the penalty. The drawback, though, is that you will probably have used up a substantial portion of your savings before you’re ready to retire. That could leave you short of cash when you need it.