Managing Withdrawals


Sooner or later you'll have to withdraw — and later is better.

Before you start making required withdrawals from your 401(k) or Rollover IRA, you need a plan for how much to take and when to take it. That way you can be sure that you are withdrawing at least the required minimum for the year, providing enough income to meet your financial needs — ideally without withdrawing more than 5% of your account balance — and continuing to take advantage of tax-deferred growth.


DIFFERENT PATHS TO CASH

If you buy a lifetime income annuity with your 401(k) assets, you establish a payment schedule with the annuity provider at the time you make the purchase. While the responsibility for taking the correct amount is legally yours, the annuity provider guarantees that the amount you receive will satisfy the federal requirement for minimum distributions and that you’ll receive income for life. (This guarantee is contingent on the provider’s ability to meet its financial obligations.)

If you move your assets to a traditional IRA, you have more responsibility for making sure you take at least the required minimum each year. In many cases, you can set up a regular distribution schedule with your custodian that will meet the required minimum. But some custodians’ plans give you more control than others over which assets to liquidate. And some allow you more flexibility to change the amount you withdraw if your financial needs change.


HOT DATES

You have until December 31 of each year to take your required minimum distribution from your retirement savings for the year. But if you’re setting your own schedule, you can take the money as early as January if you prefer, in equal installments during the year, or whenever you need cash.

You can figure how much you have to take as a minimum distribution when your account is valued for the previous year. That means, for example, the amount of your minimum 2011 distribution is determined by the value of your account on December 31, 2010, divided by a number the IRS sets based on your official life expectancy.


A COMMON MISTAKE

Be careful not to assume that you’ll be taking the right amounts if you have mutual fund distributions paid to you rather than reinvested in your account. You might take the right amount by coincidence, but most of the time you’ll be off the mark. That’s because the payments are unlikely to equal precisely the amount you’re required to withdraw.

For example, if you have an average return of 10% on your retirement savings in a year that you’re obligated to take closer to 3.6% in required withdrawals — which happens at 70 1/2, when your life expectancy is 27.4 — you won’t face a potential penalty but you may end up withdrawing more than you should if you want your savings to last your lifetime. But if your return averages 3% in a year you’re required to take 5% — which happens when your official life expectancy is 19.5 years, when you’re 79 — you’ll be faced with a 50% penalty on the amount you should have taken but didn’t.

In addition, since the return you’ll get on your investments isn’t predictable, it’s hard to plan your living expenses or be sure you’ll be able to pay your bills if your income is based on taking distributions as they come.


THREE WAYS TO WITHDRAW

When you know the amount you’re required to withdraw for the year, you can take your income as a lump sum, you can take income as you need it, or you can set up a regular income schedule.

Income as a lump sum. Once you calculate the amount you must withdraw for the year, you can take it at any time by liquidating the assets in your 401(k) or Rollover IRA and moving the money to your regular checking or savings account. For example, if your equity investments increase dramatically in value in a stock market rally, you might decide to sell enough shares to equal the amount you must take for the year.

Income as you need it. If you have other sources of income, you can withdraw from your retirement savings account when you need extra cash — for example, to pay quarterly bills such as insurance or estimated taxes, to make gifts, take trips, or meet extraordinary medical expenses. The potential drawbacks of this approach are not taking enough to satisfy the minimum requirement or dipping too far into your principal too soon, which could put your future financial security at risk.

Income on a schedule. If your income from retirement savings is an essential part of your living expenses, you may find it easier to manage your cash flow by taking a fixed amount on a regular schedule, as if you were earning a salary. One appeal of regular withdrawals is that you don’t risk forgetting to withdraw, and you don’t have to liquidate your assets in a rush to meet the minimal withdrawal for the year.

It’s a good idea to work with your financial adviser, either to set up a long-term liquidation plan or to decide which assets to liquidate at a particular time.