You’ve been saving diligently for years, and now it’s time to think about how to convert the money in your traditional 401(k)s (or similar workplace savings plans) into retirement income. But hold on, not so fast. You may need to take a few steps first.
Evaluate your needs
If you haven’t done so, estimate how much income you’ll need to meet your desired lifestyle in retirement. Conventional wisdom says to plan on needing 70% to 100% of your annual pre-retirement income to meet your needs in retirement; however, your specific amount will depend on your unique circumstances. First identify your non-negotiable fixed needs — such as housing,
food, and medical care — to get clarity on how much it will cost to make basic ends meet. Then identify your variable wants — including travel, leisure, and entertainment. Segregating your expenses into needs and wants will help you develop an income strategy to fund both.
Assess all sources of predictable income
Next, determine how much you might expect from sources of predictable income, such as Social Security and traditional pension plans. Social Security: At your full retirement age (which varies from 66 to 67, depending on your year of birth), you’ll be entitled to receive your full benefit. Although you can begin receiving reduced benefits as early as age 62, the longer you wait to begin (up to age 70), the more you’ll receive each month. You can estimate your retirement benefit by using the calculators on the SSA website, ssa.gov. You can also sign up for a my Social Security account to view your Social Security Statement online.
Taxable distributions from traditional employer-sponsored plans and IRAs prior to age 59½ may be subject to a 10% penalty tax, unless an exception applies.
Different rules apply to Roth accounts. For information on how Roth accounts may fit into your retirement income picture, talk to a financial professional.
Traditional pensions: If you stand to receive a traditional pension from your current or a previous employer, be sure to familiarize yourself with its features. For example, will your benefit remain steady throughout retirement or increase with inflation? Your pension will most likely be offered as either a single life or joint-and-survivor annuity. A single-life annuity provides benefits until the worker’s death, while a joint-and-survivor annuity generally provides reduced benefits until the survivor’s death.1
If it looks as though your Social Security and pension income will be enough to cover your fixed needs, you may be well positioned to use your other assets to fund those extra wants. On the other hand, if your predictable sources are not sufficient to cover your fixed needs, you’ll need to think carefully about how to tap your retirement savings plan assets, as they will be a necessary component of your income.
Understand your savings plan options
A key in determining how to tap your retirement plan assets is to understand the options available to you. According to the Government Accountability Office (GAO), only about one-third of 401(k) plans offer withdrawal options, such as installment payments, systematic withdrawals, and managed payout funds.2 And only about a quarter offer annuities, which are insurance contracts that provide guaranteed income for a stated amount of time (typically over a set number of years or for the life expectancy of the participant or the participant and spouse).3
Plans may allow you to leave the money alone or require you to take a lump-sum distribution. You may also choose to roll over the assets to an IRA, which might offer a variety of income and investment opportunities, including the purchase of annuity contracts. If you choose to work part-time in retirement, you may be allowed to roll your assets into the new employer’s plan.
Determining the right way to tap your assets can be challenging and should take into account a number of factors. These include your tax situation, whether you have other assets you’ll use for income, and your desire to leave assets to heirs. A financial professional can help you understand your options.
1 Current law requires married couples to choose a joint-and-survivor annuity unless the spouse waives those rights.
2 “401(k) Plans: DOL Could Take Steps to Improve Retirement Income Options for Plan Participants,” GAO Report to Congressional Requesters, August 2016
3 Generally, annuity contracts have fees and expenses, limitations, exclusions, holding periods,
termination provisions, and terms for keeping the annuity in force. Most annuities have surrender
charges that are assessed if the contract owner surrenders the annuity. Qualified annuities are
typically purchased with pre-tax money, so withdrawals are fully taxable as ordinary income, and
withdrawals prior to age 59½ may be subject to a 10% penalty tax. Any guarantees are contingent on the claims-paying ability and financial strength of the issuing insurance company. It is important to understand that purchasing an annuity in an IRA or an employer-sponsored retirement plan provides no additional tax benefits other than those available through the tax-deferred retirement plan.