When you retire, you will need to start withdrawing money from your 401(k) or other investment accounts. This requires a huge shift in mindset, since you’ve been building these accounts all your life. And you need to be smart about the timing and amount of your withdrawals.
Before you start considering account distributions, there is one key thing you absolutely need to do first.
Take this step before withdrawing money from your retirement account
Before making withdrawals from your retirement savings, you need to set a safe withdrawal rate. It is basically an amount of money that you can withdraw from your investment accounts without take a huge risk that you empty your account too soon.
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You see, you’re going to have to rely on your retirement investments throughout your retirement years. You cannot live on Social Security benefits alone without additional savings. This is not possible since Social Security only replaces 40% of pre-retirement income and you need to replace about 70% to 80% of what you earned before leaving the workforce. Social Security benefits also decline in value over time, so you’ll need your savings even more later in life. This happens because the benefit increases built into Social Security don’t work very well to account for the inflation that older people are experiencing.
If you take too much money out of your retirement accounts too quickly, you won’t have enough money left in income-producing assets. Your returns will start to fall, so your account balance will decrease even more with each withdrawal. Eventually, you might end up with $0.
Establishing a safe withdrawal rate helps reduce the chances of this happening. You will still have plenty of money to work for you and earn income if you limit the amount you withdraw at one time. If, for example, you can earn 7% in returns per year and only withdraw 4% or 5% of your account balance, you will not see your total account value decrease even when withdrawing money.
How to set a secure withdrawal rate?
In an ideal world, you would be able to live on just the interest you earn and you would be able to avoid reducing your principal balance at all. But this often does not work in practice.
Seniors tend to have to invest cautiously because they can’t afford to risk big losses if the market goes down. They may not be able to wait for a rally if they are too exposed to equities. And even if you earn generous returns in some years, there may be years when you don’t and you’ll still have to rely on your savings to generate income.
This means you will need a different withdrawal strategy.
A common rule seniors follow is to withdraw 4% from their retirement accounts in the first year of retirement, then increase their withdrawals with inflation each year. While the odds of running out of money were pretty low with this approach, lower projected future returns and longer life expectancies made the so-called 4% rule more dangerous to follow.
The Center for Retirement Research recommends an alternative approach: use the Required Minimum Distribution (RMD) tables established by the IRS to calculate 401(k) withdrawals to determine how much to withdraw from all of your accounts, even if you don’t. you’re not yet. obliged to spend RMD.
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 how much you’ve invested to support yourself. Whatever you do, however, don’t withdraw money until you’ve decided how much you can comfortably afford, or you might really regret it.
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