The Retirement Corporation of America

The Basic Ground Rules About Withdrawals

SOMEDAY, YOU'LL WANT to withdraw money from your retirement savings, because:

1. You've retired.
2. You've left a job, and want to move your 401(k).
3. You're at an age when you must start withdrawals from a tax-sheltered fund.
4. You are not earning enough from post-retirement work, annuities, and personal savings—and need more cash to fund your retirement.

The money has been piling up over the years for just such an occasion. Now, the time has come and you want to begin enjoying the fruits of your labor. Still, as with any other financial decision you must make in your life, you don't want to make hurried decisions. It took time to build up that retirement nest egg. It pays to spend a little time thinking about when, and how, you are going to start "dipping" into your retirement nest egg.

Getting Started on the Basics

There are three very basic issues about withdrawing money from your retirement savings plans:

•  Issue #1: When can you legally withdraw money from tax-deferred savings plans?

•  Issue #2: When must you start withdrawing money?

•  Issue #3: What are the practical considerations about withdrawing money?

On the legal side of things, Congress and the IRS have drawn up a fairly straightforward set of rules for withdrawing money, and they must be followed to the letter. Slip up, and it could cost you dearly. Still, you have been making increasingly complicated financial decisions all your adult life. Look on this as just another financial decision you must make.

Start planning to withdraw money well in advance of when it will be needed, so that you make sure you understand everything that must be done. If you have any questions, a session with a professional financial planner or a Certified Public Accountant (CPA) might be in order. It could cost a few hundred dollars to make sure you are handling the withdrawals correctly. But that money will be well spent if it helps you avoid tax issues on your withdrawals, and if it helps you develop a strategy for how you will handle withdrawals for the rest of your life.

When You Can Legally Start Withdrawing Money

Your retirement money is supposed to pay for your senior years. Uncle Sam didn't give tax breaks to you so that you could raid the piggy bank when you're young and use your retirement money to buy unnecessary luxuries. If you withdraw money from a tax-sheltered retirement fund before age 59 1/2, you'll pay a 10 percent penalty unless you:

1. Are 55 and already retired.
2. Are disabled.
3. Incur medical expenses that exceed 7 1/2 percent of your adjusted gross income (AGI).
4. Have died and your heirs claim the money.

Even if you've crossed the age threshold, you'll still owe taxes on withdrawals (and at ordinary income tax rates, as you'll recall). But you won't owe that 10 percent penalty.

When You Must Start Withdrawing Money

Even if you would rather leave your 401(k) and IRA intact, Uncle Sam won't let you. You must start withdrawals, and pay taxes, at 70 1/2. There are only two exceptions to this rule:

•  Exception #1: The 70 1/2 rule doesn't apply if you are still working. Then you can delay withdrawals until you retire.

•  Exception #2: There's no mandatory withdrawal age with the Roth IRA. Uncle Sam already collected taxes on what you have in your Roth IRA, so there's no reason to require you to start making withdrawals. You could just let the money build up over your lifetime, leaving the remainder to your heirs. More than likely, you will want to make use of your Roth IRA in retirement, but that's your call—you don't have to.

The Practical Considerations About Withdrawing Money

The point can't be made too often that your retirement nest egg must last you the rest of your life. Just because you can start dipping into it at 59 1/2 doesn't mean you should do so. On the other hand, just because you don't have to take money from a retirement savings plan at 70 1/2, doesn't mean you should wait that long to do so. In fact, financial planners say they keep coming across seniors making one of two serious mistakes about withdrawing money from their nest egg:

Serious Mistake #1: They start draining their retirement accounts too quickly—using the money to buy fancy cars, take lavish vacations, or buy a second home. Having scrimped and saved to build a nest egg, they regard it as a piggy bank to be used to finance all the good things in life they had to do without before.

Serious Mistake #2: They don't touch a penny in their retirement savings accounts until they are required to do so at 70 1/2. Having saved to live a great retirement, they let it pass them by because they can't break the habit of "spending little and saving more".

So what should you do? You should develop a retirement plan over the years and stick to it as closely as you can. That means:

•  Creating a retirement budget which tries to estimate how much it will cost you to live in retirement. You start working on that when you are young, and you keep revising it as you get older.

•  Creating a retirement nest egg big enough to provide you with that retirement.

•  Planning a post-retirement career to add to your retirement nest egg. Whatever you earn after retirement is money you won't have to drain from your savings.

•  Working on your own or with a financial planner or an accountant to develop a plan for withdrawing money that delivers just what you need when you need it. You'll find more on building a retirement withdrawal strategy at the end of this lesson. For the moment, just understand the considerations that go into withdrawing retirement savings.