What to do before taking money out of your 401(k) in retirement

At retirement, your 401(k) changes from a savings account to a withdrawal account. To prepare for this change, you should take three steps before you retire: 

1. Figure out how much you’ll need from your 401(k) to meet expenses
2. Investigate your 401(k) plan’s withdrawal options
3. Decide how to invest your 401(k) so that it can meet your withdrawal needs

These aren’t easy tasks, which is why you may want to get help from a financial professional or your 401(k) provider. But even if you’re getting help, you should understand what’s involved in each step.

The amount you need to withdraw from your 401(k) is the gap between retirement income—for example, Social Security—and what you think you’ll need to meet expenses. And if you have other retirement accounts, such as IRAs, they can help fill your gap, as well. To estimate your gap, you’ll need to make a budget. You can do this yourself, or get help from an online budget and cash flow calculator. Your budget might look something like this example.

In this example, your total expenses minus your total income is $6,000. That’s how much you’ll need from your 401(k) every year, plus a little extra to cover inflation.

Nonessentials is a tricky category. It all depends on what you plan to do in retirement. Do you want to travel, play golf, join a bridge group, or volunteer? To estimate spending on nonessentials, start by visualizing yourself in retirement. What will you do each day? And will that cost more or less than you spend on leisure today? That’ll give you a good, realistic estimate for spending on extras in the early stages of retirement.

Inflation is hard to predict. But it’s been fairly stable over the last decade, averaging around 2%. If you use that for your estimate, you’ll need to add 2% to your expected 401(k) withdrawal each year.

And remember that you’re likely to spend more early in retirement and less as time goes by. Then, rising healthcare costs later in life may cause your spending to pick up again. Plan for a u-shaped spending pattern in retirement.

Once you know how much you need from your 401(k), you’ll want to understand how you can take money out. Some plans offer installments or flexible withdrawals that allow you to take money when you need it. Others require you to take it all out at once.   

The simple budget presented earlier assumes nice, even spending. But your withdrawal needs are likely to vary each year. In this case, you’ll need a plan that offers flexible withdrawals. Tell your 401(k) service provider how you’ll need to withdraw your money, and find out if they can accommodate you. Be sure to ask them about:

Expense and income planning—Do they offer services to help you estimate and plan for withdrawals?

Withdrawal options—Can you take money when you need it, and are there any limits? Are installments available?

Investment advice—Will someone be available to help you decide the best way to invest? (More on this later in this post.)  

Fees—Do withdrawals carry a charge? And what other fees apply to retirees?

Answers to these questions will help ensure that your 401(k) can meet your needs both today and over time as your retirement lifestyle evolves.

In retirement, the job of your 401(k) is to pay you income—and preserve your wealth. Investing for income is different than investing to grow wealth.  

Conservative investment options are generally designed to provide principal stability and income to retirees. Types of conservative funds include:

• Money market funds, which seek to preserve your principal and may pay modest interest,
• Stable value funds, which seek to preserve your principal and pay income, and
• Conservative asset allocation funds, which are a mix of bonds, stable value, or cash, as well as some stocks.

Although diversification doesn't guarantee a profit or eliminate the risk of a loss, it's important while you’re saving for retirement and when you’re in retirement. So you may want a balanced mix. But be careful. If you invest too much in funds that own stocks, your savings and lifestyle could be hurt by a market downturn. 

Investing too conservatively could also jeopardize your lifestyle or cause you to run out of money. Striking the right balance sometimes requires professional management. Your 401(k) plan may offer professionally managed fund options, such as target-date funds, for retirees. And your 401(k) provider might offer personalized investment advice. Ask your provider about your options for getting help. And if you think face-to-face advice might be better for your needs, find a financial professional with experience helping retirees.

You need to plan for retirement withdrawals so you can prepare your 401(k) for its new job—supporting you. That means figuring out how much you’ll be spending, understanding how to take money out of your account, and looking at how your investments may finance your retirement lifestyle for as long as you need them.

Decades of hard work and saving got you to this point. You can make sure that your sacrifice pays off by planning for 401(k) withdrawals before you retire.