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Your First 401(k) Withdrawal: 5 Things You Need to Consider

Source: Flickr user Steven Dipolo.

There is certainly no shortage of advice on how to save for retirement and invest those savings. However, what should you do with your money once you retire? Should you start tapping into your retirement savings right away, or should you wait a little while?

While there is no one-size-fits-all answer to this question, there are some guidelines that can make your 401(k) withdrawal choices easier.

How old are you?
While 401(k) plans generally require you to wait until 59-1/2 years of age before you can begin taking distributions, most people are not fortunate enough to retire that young. However, if you're one of the lucky few whose dream of early retirement is coming true, you can begin to take 401(k) distributions as soon as you reach that milestone.

On the other end of the spectrum, you are required to take a distribution by April 1 of the year after you turn 70-1/2. Generally, the required minimum distribution is calculated by dividing your account balance by the IRS estimate of your life expectancy.

Are you still going to work after retirement age?
For those who plan to continue working past reaching retirement age, you can delay mandatory distributions until April 1 of the year after you retire. With more and more Americans choosing to work longer, either to bolster their finances or simply to stay active, this rule allows you to wait to withdraw money until you actually need it.

Source: Flickr user kdothq.

Think of it this way: If you're 72 and earning $100,000 per year, why would you want to tap into savings you might need further down the road?

Bear in mind that this is true only of a 401(k), not an IRA. So, while rolling your money into an IRA does have its benefits (I'll get to those in a minute), it may not be the best choice for you if you don't plan on tapping into your account anytime soon.

Beware the taxman
If you want to wait until it's mandatory to take a distribution, you probably should wait until the April 1 deadline to do so.

Source: Flickr user 401(k) 2012.

If you choose to delay your first distribution until April 1 -- or any date after Dec. 31, for that matter -- your next distribution will still be due before the end of that same calendar year. In other words, you'll be forced to take two distributions during the same tax year.

Depending on your personal situation, this can easily catapult you into a higher tax bracket. Because 401(k) contributions are made on a tax-deferred basis, withdrawals are taxed as ordinary income. So when you turn 70-1/2, it may be a good idea to take your first mandatory distribution sooner rather than later.

Do you have any "regular" investment accounts?
When you retire, if you have any money in traditional investment accounts, it may be a good idea to use it before tapping into your 401(k) or IRA accounts, so long as you haven't hit the mandatory distribution age yet.

The longer your money sits before you make a 401(k) withdrawal, the longer you get to take advantage of the benefits of tax-free compounding. If you're fortunate enough to have money in taxable brokerage accounts to support yourself for a few years, using that first can mean thousands in tax-free investment returns in your 401(k).

Maybe you should roll it over
Another option is to take all of the money in your 401(k) and roll it into an IRA account. There are many similarities between the two account types. They have similar tax treatment and similar requirements for taking distributions.

However, one area where IRAs are the clear winner is choice. Usually, your 401(k) investments are restricted to a specific basket of funds. On the other hand, with an IRA, you can invest in any stock, bond, or mutual fund offered by your brokerage. More advanced investors also have access to certain options strategies.

Whatever you do, make it last
More than ever before, retirees are living well into their 90s and even 100s. Therefore the best answer to the question of when to start taking 401(k) withdrawals is generally "Not until you have to."

If you need the money, by all means use it -- that's what it's there for. However, if you have other money to live on for a few years and you haven't reached the mandatory distribution age, why not let your money continue to grow tax-deferred? It'll go a long way toward making your money last as long as you do.

How to get even more income during retirement
Social Security plays a key role in your financial security, but it’s not the only way to boost your retirement income. In our brand-new free report, our retirement experts give their insight on a simple strategy to take advantage of a little-known IRS rule that can help ensure a more comfortable retirement for you and your family. Click here to get your copy today.


Read/Post Comments (15) | Recommend This Article (41)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 09, 2014, at 12:02 PM, BoBo1948 wrote:

    How about taking 401K payment instead of Social Security at 62 to increase your Social Security check at 70??

  • Report this Comment On August 09, 2014, at 12:29 PM, porkchopmor wrote:

    Good point BoBo

  • Report this Comment On August 09, 2014, at 12:44 PM, johnnywitt wrote:

    That's what I'm leaning towards Bob. I look at SS as an Annuity type thing in case I live substantially longer than expected. I plan to use all accounts and the substantially younger wife to get me to the 70 mark. Additionally, the Wife will do better on the survivor benefit if we wait because she won't work enough of the 35 years in order to have a substantial SS benefit on her earnings alone because she was a stay at home Mom for quite awhile.

  • Report this Comment On August 09, 2014, at 12:59 PM, Nelle49 wrote:

    "If you want to wait until it's mandatory to take a distribution, you probably should wait until the April 1 deadline to do so." If you want to wait until it's mandatory to take a distribution, you probably should "NOT" wait until the April 1 deadline to do so.Shouldn't that read "

  • Report this Comment On August 09, 2014, at 4:31 PM, kitcat9 wrote:

    Question...If you have a 401K and you have the ability to take SS at 62 ( because you are retired and no longer working) Isn't better in some ways to take the SS money early and not tap into your 401K until you have to? Once you die, the SS stops ( assuming you are single) Your 401K can be left to your beneficiaries.....your SS can't. I think I'd rather use my "free money" and let my 401K build up more interest from age 62 to 70 1/2.

  • Report this Comment On August 09, 2014, at 4:59 PM, rogerlig wrote:

    If I'm reading this correctly, if I'm still working at 70 1/2, I MUST take mandatory withdrawals from my IRA, but DON'T have to take mandatory withdrawals from my 401(k).

    Is that what's being said here?

    rogerlig

  • Report this Comment On August 09, 2014, at 10:45 PM, FoolishAdvice wrote:

    This is vague or misleading or just wrong...

    "How old are you?

    While 401(k) plans generally require you to wait until 59-1/2 years of age before you can begin taking distributions, most people are not fortunate enough to retire that young. However, if you're one of the lucky few whose dream of early retirement is coming true, you can begin to take 401(k) distributions as soon as you reach that milestone."

    If you retire at 55, you can take distributions at 55.

    http://www.irs.gov/Retirement-Plans/Plan-Sponsor/401%28k%29-...

    Tax on early distributions. If a distribution is made to a participant before he or she reaches age 59½, the participant may be liable for a 10% additional tax on the distribution. This tax applies to the amount received that the employee must include in income.

    Exceptions. The 10% tax will not apply if distributions before age 59½ are made in any of the following circumstances:

    .

    .

    .

    Made to a participant after separation from service if the separation occurred during or after the calendar year in which the participant reached age 55.

  • Report this Comment On August 10, 2014, at 6:34 AM, Rjay777 wrote:

    I'm glad so many people are commenting on the question I've been over-analyzing for months now:

    If I hypothetically increase my salary by 10,000 by taking my SS benefits early, am I not better off taking 5,000 out of my 401, since I DO need more money, but not the increase SS would give me? I just turned 62. I can't find much about this topic anywhere.

  • Report this Comment On August 10, 2014, at 9:51 AM, Password1900 wrote:

    Can anyone give some info to this question from "BoBo 1948" Thanks

  • Report this Comment On August 10, 2014, at 10:09 AM, graytonbeach wrote:

    How can I can find out what 1/2 of my ex's SS benefit will be (was married over 10 years and I haven't remarried). When I call the SS office they can't answer this question and I am afraid to apply online to try to find it out as I don't want to tap into it until 1 1/2 years from now,.but need to know the amount so I can plan corrctly. My plan is to let my own SS benefit grow until 70 as it will almost double what it is today at 64. I'm female and mom lived until 93 so I want to be sure to let grow or tap into the right accounts....SO confusing!

    Until then, comments above seem to favor tapping into IRA funds instead of 401K mostly because of tax rasons, right?

  • Report this Comment On August 10, 2014, at 10:21 AM, TMFKWMatt82 wrote:

    @graytonbeach

    The SSA has a good estimator and some other calculators to try to determine SS benefits based on age and income. You can find these at http://www.ssa.gov/planners/benefitcalculators.htm

    Bear in mind these are just estimates, but they should give you a good general idea.

  • Report this Comment On August 10, 2014, at 10:25 AM, TMFKWMatt82 wrote:

    @Password1900

    It may indeed be a good idea to take a 401(k) distribution instead of tapping into Social Security early. Delaying until 70 makes a tremendous difference, and here is an article by one of my colleagues that details why you should wait to collect SS.

    http://www.fool.com/retirement/general/2014/08/08/3-reasons-...

  • Report this Comment On August 10, 2014, at 10:36 AM, tyyyroneee wrote:

    graytonbeach. use the ss calculator based on what you know about your ex. you will at most receive half of what he gets when he starts drawing. Your age doesn't matter. bobo's plan is a good one. you need to plan retirement based on your needs. not what you are able to leave your kids. leave your kids knowledge to build their own retirement. Of you plan to die before 70 or you have so much money you can't count it all then none of this applies to you anyway.

  • Report this Comment On August 10, 2014, at 3:09 PM, BenFlorida wrote:

    Keep in mind if you are in a 401K, while you have limited investment options,your money is protected from litigations against you. With an IRA it is not. If you are sued, such as a personal liability for car accident, your personal assets are at risk but your 401K is not treated as an asset. As soon as you roll it into an IRA it becomes your asset.

  • Report this Comment On August 10, 2014, at 8:09 PM, GetDown2 wrote:

    Kitcat9, that is exactly what I did. I took early retirement from the company which I had a tenure of more than 29 years with a couple of months before I reached 62. My severance package included 6-month pay which helped my wife and me bridge to my early SS benefit at 62. I also started receiving my pension the month after I retired. It turned out either my pension or my SS benefit alone was enough to cover our monthly expenses. Later on when my wife reached 62, I convinced her also apply for SS benefit and she received about half of my SS benefit. My strategy was we would live on my pension and our SS benefits and let both of our 401Ks grow with interests so that our 401Ks will be passed to our children when we're gone.

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After several years as a high school math teacher, Matt brought his love of teaching and investing to the Fool to help people invest better. Matt specializes in writing about the best opportunities in bank stocks, real estate, and personal finance, but loves any investment at the right price. Follow me on Twitter to keep up with all of the best financial coverage!

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