Building a nest egg for retirement is not an easy thing. It takes decades of hard work and some sacrifices to free up the money you'll put into your IRA, 401(k), or other accounts, as well as some smart choices about what assets to invest those funds in. But with any luck, your efforts will pay off with a nice pile of money that serves your needs well once you stop working.
But after putting in all that effort, the one thing you don't want to do is put yourself at extra risk of running out of money during your golden years. That's why it's important to approach your retirement plan withdrawals strategically. If your intent is to start tapping into your retirement savings this year, here are three key questions you need to ask first.
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1. What are my spending needs?
Before you decide how much money you're going to withdraw from your retirement savings, map out a budget for how much you actually need. If you're new to retirement, sit down and do a thorough review of your expenses. Make sure to include not just needs, but wants.
If you're no longer working, you'll need ways to stay busy. Maybe that means spending $65 a month on a gym, or joining a knitting club that has a $40 monthly fee. Maybe it means spending an extra $50 on subscriptions, or budgeting $1,000 a month for a long weekend getaway.
Once you figure out what your spending is going to look like, you can start to think about how much money to take out of your IRA or 401(k) each month.
2. What other income sources do I have available?
Your retirement nest egg may not be the only source of income you have at your disposal. Most American retirees are eligible for Social Security. Even if you're not ready to claim those benefits just yet, it's important to estimate their value and factor that into your longer-term withdrawal plan.
You may also be planning to work a few hours a week, or rent out property you own for income. Build a complete picture of all your income streams so you can see how much money you'll actually need to draw from your investment accounts.
3. What's a safe withdrawal rate based on how my portfolio is invested?
One thing you definitely do not want is for your retirement savings to run out in your lifetime. So it's important to establish a smart withdrawal rate from the start. That rate, however, should hinge on not just your income needs but also your portfolio composition.
The popular 4% rule, for example, gives your savings a good chance of lasting for 30 years. But it also assumes you have a pretty even mix of stocks and bonds in your portfolio. If that's not the case, you should prepare to adjust your withdrawal rate accordingly.
For example, say your portfolio is 75% bonds because that is the asset mix that allows you to sleep peacefully during a time of your life when you're less comfortable with financial risk. If so, a 2.5% or 3% annual withdrawal rate may be more appropriate for you. On the flip side, if you're keeping your portfolio more stock-heavy, you may be able to comfortably go above 4%, particularly if the timing of the market cooperates.
Your age at the time you start taking withdrawals should influence your decision, too. If you're retiring early, you may need to play it safer with withdrawals, simply because that money will have to last longer. If you're wrapping up your career on the late side, you may have the leeway to take larger withdrawals. Look at the whole picture to decide.
When you finally tap your retirement savings, it can be both exhilarating and nerve-wracking. Run through these questions first so you can feel more confident in your approach to taking withdrawals.
