Don’t Take Even $1 From Your Retirement Account Until You Take This Important Step | Smart Change: Personal Finance
When you enter retirement, you will have to start withdrawing money from your 401(k) or other investment accounts. This requires a massive shift in mindset, given that you’ve been building these accounts your whole life. And you have to be smart about when and how much to quit.
Before you start calculating distributions, there is one basic thing you must do first.
Take this step before withdrawing money from your retirement account
Before making any withdrawals from your retirement savings, you need to determine a safe withdrawal rate. This is basically an amount of money that you can take out of your investment accounts without You take a big risk that you will dry up your account too soon.
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See, you’ll need to rely on your retirement investments throughout your entire graduation years. You cannot live on Social Security benefits alone without additional savings. This is not possible because Social Security only replaces 40% of your pre-retirement income, and you need to replace about 70% to 80% of what you earned before you left the workforce. Social Security benefits also decline in value over time, so you’ll need more of your savings later in life. This happens because the benefits and increases included in Social Security do not work well to account for the inflation experienced by the elderly.
If you take out too much money from retirement accounts too quickly, you won’t have enough money left over invested in income-producing assets. Your returns will start to decline, so your account balance will shrink more with each withdrawal. In the end, you may end up with $0.
Determining a safe withdrawal rate helps reduce the chances of this happening. You still have plenty of money to work for you and earn returns if you limit how much you get once. If, for example, you can earn 7% annually in returns and you only get 4% or 5% of your account balance, you won’t see the total value of your account go down even while withdrawing funds.
How do you determine a safe withdrawal rate?
In an ideal world, you would only be able to live off the benefits you earn and you would be able to avoid reducing your principal balance at all. But this often does not work in practice.
Older people tend to invest conservatively because they cannot risk significant losses if the market declines. They may not be able to wait for a recovery if they have a lot of exposure to stocks. And even if you get generous returns in some years, there may be years when you don’t and you will still need to rely on your savings to provide income.
This means that you will need a different withdrawal strategy.
One common rule that seniors follow is to withdraw 4% of their retirement accounts during the first year of retirement and then increase withdrawals according to inflation each year. While the chances of running out of money were very small with this approach, the lower expected future returns and longer life expectancy made following the so-called 4% rule more risky.
The Retirement Research Center recommends an alternative approach: Use the Minimum Required Distribution (RMD) tables created by the IRS to calculate 401(k) withdrawals to determine how much to deduct from all of your accounts—even if you’re not yet required to take RMDs.
You can also work with a financial advisor to develop a personalized approach that works for you given your age, risk tolerance, life span, and the amount you’ve invested to support yourself. Whatever you do, don’t take your money until you decide how much you can comfortably withdraw, or you may end up regretting it.
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