Saving for retirement is difficult, and once you reach retirement age, you may think the difficult part is over. However, you have one more challenge: making sure your savings last as long as possible.
Regardless of how much you’ve saved for retirement, it won’t matter unless you manage your expenses properly. If you withdraw too much from your retirement account too soon, your savings can only last for a few years.
While everyone’s retirement plan will be slightly different, there are a few rules to keep in mind when determining how much you can safely withdraw from your 401 (k) during retirement.
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1. Be flexible
One of the most common retirement guidelines is the 4% rule, which states that you can withdraw 4% of your total savings during the first year of retirement, and then adjust your withdrawals each year thereafter to adjust for inflation. While it’s a good benchmark, it doesn’t take into account the fact that many retirees see their expenses fluctuate from year to year.
56% of US households experience volatility of retirement spending, according to a report by JPMorgan Chase. You may also experience waves of higher or lower spending levels. For example, you could spend more than usual during your early retirement years if you plan on traveling a lot or acquiring expensive new hobbies, then your expenses may decrease as you adjust to your retirement lifestyle. However, your expenses may increase again as you age and potentially develop costly health problems.
Although you may not be able to predict exactly how much you will spend each year in retirement, try to be flexible with your retirement plans. If you hope to stick to a rigid spending plan, you could void your retirement if you end up spending more than expected.
2. Don’t ignore the minimum required distributions
Once you turn 72, you will need to start taking your 401 (k) Minimum Required Distributions (RMD). Exactly how much you will need to withdraw depends largely on your 401 (k) balance, and is calculated by the IRS.
If you don’t take your RMD on time, you’ll be charged a hefty tax penalty – 50% of the amount you were supposed to withdraw. So if you have RMD of for example $ 20,000 per year and skip a year you will face a fine of $ 10,000.
RMDs can potentially put a key in your strategy if you plan to continue working until age 70. In general, you should still take RMD even if you are still working at age 72. However, you may qualify for an exception if you have a 401 (k) through your current employer. However, if you also have a traditional IRA or old 401 (k) accounts from previous employers, you will still need to take RMD from those accounts.
3. Factor taxes on your withdrawals
Your 401 (k) is a tax-deferred account, which means you won’t pay taxes when you make initial contributions, but you will owe income taxes when you start making withdrawals. So if you’re not accounting for taxes while planning your withdrawals, you might be surprised.
The amount you owe in taxes depends on where you live, as well as how much you plan to withdraw. If you withdraw approximately the same amount that you are earning now, your taxes may not be drastically different. But if you move to a new state or spend much more or less on retirement than you do now, your tax situation could change significantly.
Before you retire, consider how taxes will affect your withdrawals. If you plan to move to a new state, determine if that state taxes retirement income. Depending on where you live, you may be able to get out of paying your income taxes in full. If not, consider how your retirement expenses can change and think about how that will affect your tax category. By budgeting taxes now, you can adjust your 401 (k) withdrawals accordingly.
Planning your 401 (k) withdrawals is a crucial step in the retirement preparation process because it will ensure that your money lasts as long as possible. And by following these rules, you’re on your way to reaching your retirement goals.
