If you've amassed a solid nest egg in time for retirement, congratulations -- you've done your part to help ensure that you'll have enough money to live comfortably. But if you're now retired and are gearing up to start taking withdrawals from your 401(k) or IRA, you shouldn't just do so blindly. Rather, you should make sure to take these important steps first.
1. Figure out the right withdrawal rate
You want the money in your retirement plan to last throughout your senior years, so to that end, you'll need to figure out how much you can afford to remove each year to avoid depleting your nest egg prematurely. Many financial experts swear by the 4% rule, which has you start off by removing 4% of your savings balance your first year of retirement and then adjusting subsequent withdrawals for inflation. But that doesn't mean a 4% withdrawal rate is right for you.
If your retirement plan is invested conservatively, you may need to start out with a lower annual withdrawal rate -- somewhere in the ballpark of 2% to 2.5%. On the other hand, if you're retiring on the later side, you may be able to get away with a higher withdrawal rate -- say, 5%. Either way, put some thought into your withdrawal rate before you start dipping into your savings.
2. Make sure your investments aren't down
Your 401(k) or IRA shouldn't consist of just cash. Rather, you'll need to keep that money invested in both stocks and bonds to ensure that your savings continue to generate growth. But if you take a withdrawal immediately after the stock market tanks and your portfolio value plummets, you could wind up locking in permanent losses that hurt you down the line.
Before you remove money from a retirement plan, see how your investments are doing. If your portfolio is down, it could pay to wait a month or so and see if your investment values come back up. In fact, it's a good idea to have at least six months' worth of cash on hand in the bank during retirement. That will give you the option to let your portfolio be during periods of market turbulence.
3. Calculate your tax bill
The money you remove from your retirement plan isn't necessarily all yours to keep. Unless you have a Roth 401(k) or IRA, you'll need to pay taxes on the distributions you take. Before you initiate a withdrawal, figure out what portion of it will need to go to the IRS so you don't wind up spending more than you can afford to and getting stuck with an unpayable tax bill after the fact.
The money in your 401(k) or IRA should serve the purpose of getting you through your entire retirement, not just a portion of it. To make that happen, you'll need to be smart about how and when you take withdrawals from your long-term savings. Otherwise, you could wind up running out of money at a dangerously early age and struggling during the latter part of retirement because of it.