It's a good idea to save for retirement in a 401(k) plan, IRA, or both. First of all, these plans offer a host of tax benefits. With traditional IRAs and 401(k)s, you get tax-free contributions. With Roth accounts, you get tax-free gains and withdrawals.
Plus, you'll need money in a retirement plan to supplement your Social Security income. Otherwise, you might struggle to cover your senior living costs on those benefits alone.
If you've amassed a nice sum of money in your IRA or 401(k) plan, you may be at a point where you're contemplating a withdrawal. But before you remove so much as a dollar from your retirement plan, be sure to run through these key questions.
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1. Have I reached age 59 1/2?
Age 59 1/2 is a big one in the context of retirement plans. That's the age at which you can first start taking IRA or 401(k) withdrawals without incurring a penalty (though there are some exceptions that let you take money out sooner).
If you're not old enough to take a penalty-free withdrawal, you're best off finding other ways to get your hands on money when you need it. For example, you may be able to borrow against the equity you've built in your home.
2. Am I still working?
You may be tempted to take a retirement plan withdrawal once you're old enough to do so penalty-free. But first, think about whether you really need the money. If you're still working and therefore have a paycheck to live on, it could pay to leave your savings alone and let it continue to grow.
Remember, when you take an IRA or 401(k) plan withdrawal, you don't just leave yourself with that much less money for retirement. You also make it so that money can't grow.
Let's imagine you want to take a $10,000 IRA withdrawal at age 60 to fix up your home. At that point, you won't face penalties, so you might assume it's OK to remove that money.
But what if you don't otherwise plan to tap your IRA until age 70? And what if your IRA recently started generating an average annual 6% return? (This is a bit conservative but a reasonable assumption to work with if you're a saver who's nearing retirement.)
In that case, taking a $10,000 withdrawal now will mean potentially having almost $18,000 less in savings come age 70. That's a big deal.
3. Is the market down right now?
Let's say you're already retired and have been steadily tapping your IRA or 401(k) for a good number of years. You may be inclined to keep doing so. But it's a good idea to have a pulse on the market because if turbulence causes the value of your investments to sink, waiting to tap your portfolio could be a smart idea.
Granted, by the time you're in retirement, you should, ideally, have a decent percentage of your assets in less volatile vehicles, like cash and bonds. But still, if the market is down, taking a retirement plan withdrawal could mean locking in losses.
At that point, you may want to think of different options that could allow you to leave your savings alone until your investments recoup their value. You might, for example, be able to pick up a part-time job temporarily so you can ride out a market downturn.
Think carefully before tapping your IRA or 401(k)
Taking an early retirement plan withdrawal is generally not a great idea. And even if you're old enough to take distributions without penalty, you'll still want to make sure that's the right way to go. After all, you've no doubt worked hard to build up your nest egg -- so you don't want to dip into it without thinking it through carefully.
