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.
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.
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.