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Six Steps to Consider Before Tapping Your Retirement Savings Plan

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You’ve worked long and hard for years, saving diligently through your employer-sponsored retirement savings plan. Now, with retirement on the horizon, it’s time to begin thinking about how to tap your plan assets for income. Before you take any action, consider the below steps to ensure you are getting the most out of your retirement funds.

Step 1: Evaluate your needs

The first step in any retirement income plan is to estimate how much income you’ll need to meet your desired lifestyle. The conventional guidance is to plan on needing anywhere from 70% to 100% of your pre-retirement income each year during retirement; however, your amount will depend on your unique circumstances. While some expenses may fall in retirement, others may rise. So before even thinking about how to tap your plan assets, you should have a concrete idea of how much you’ll need to (1) cover your basic needs and (2) live comfortably, according to your lifestyle.

First, estimate your non-negotiable fixed needs — such as housing, food and medical care. This will help you project how much you’ll need just to make ends meet. Then, focus on your variable wants — including travel, leisure and entertainment. This is the area that you’ll have the easiest time adjusting, if necessary, as you refine your income plan.

Step 2: Assess your sources of predictable income

Next, you’ll want to determine how much to expect from sources of predictable income, such as Social Security and traditional pension plans. These could be considered the foundation of your retirement income.

Social Security

A key decision regarding Social Security is when to claim benefits. Although you can begin receiving benefits as early as age 62, the longer you wait to begin (up to a certain age), the more you’ll receive each month.

The Social Security Administration (SSA) calculates your retirement benefit using a formula that takes into account your 35 highest earning years, so if you had some years of no or low earnings, your benefit amount may be lower than if you had worked steadily.

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 so that you can view your Social Security Statement online. Your statement contains a detailed record of your earnings, as well as estimates of retirement, survivor, and disability benefits, along with other information about Social Security.

Pensions

Traditional pensions have been disappearing from employer benefit programs over the past couple of decades. If you’re one of the lucky workers who stand to receive a pension benefit, congratulations! But be aware of your pension’s 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 or joint and survivor annuity. A single annuity provides benefits until the worker’s death, while a joint and survivor annuity generally provides reduced benefits until the survivor’s death.1

Step 3: Reflect

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 retirement savings plan assets to fund the extra wants. On the other hand, if those 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.

Step 4: Understand your plan options

Upon leaving your employer, you typically have four options:

  1. Plans may allow you to leave the money alone or may require that you begin taking distributions once you reach the plan’s normal retirement age.
  2. You may choose to withdraw the money, either as a lump sum or a series of substantially equal periodic payments for the rest of your life, or you might use other withdrawal options offered by your plan. Note that the Government Accountability Office (GAO) found that only a third of 401(k) plans offer other withdrawal options, such as installment payments, systematic withdrawals, and managed payout funds.2
  3. You may roll the money into an IRA. You’ll want to carefully compare the investment options, fees, and expenses of both your current plan and the IRA before making any rollover decision.
  4. If you continue to work during your retirement years, you may be able to roll the money into your new employer’s plan, if that plan allows. Again, be sure to compare plans before making any decisions.

If, after assessing your anticipated Social Security and pension benefits, you discover they will not be enough to meet your basic needs, one option may be to use a portion of your retirement plan assets to create another source of predictable income using an annuity.

An annuity is an insurance contract designed to provide steady income over a set period of time or over either your lifetime or that of you and your spouse. According to the GAO, only about 25% of 401(k) plans offer an annuity option as a plan feature. If your plan is not one of them, you may want to consider rolling at least some of your tax-deferred money into an IRA and purchasing an immediate fixed annuity. As noted above, however, you’ll want to carefully compare fees and expenses associated with all options before making any final decisions. 3

Step 5: Compare tax deferred and tax-free

If you have both tax-deferred and tax-free (Roth) accounts, consider that the taxable portion of distributions from tax-deferred accounts will be taxed at your current income tax rate, while qualified withdrawals from Roth accounts are tax-free. For this reason, general guidelines often suggest tapping tax-deferred accounts before Roth accounts to allow those accounts to continue potentially growing free of taxes.

Note that all assets in employer-sponsored retirement savings plans — even money held in Roth accounts — will be subject to required minimum distributions (RMDs). These rules are set by the Internal Revenue Service(IRS).

Roth IRAs, however, are not subject to RMD rules until after your death. This is just one reason you might consider converting your employer-sponsored retirement assets to a Roth IRA. Keep in mind that a conversion will trigger an immediate tax consequence on the taxable portion of the converted assets, which can result in a hefty bill from Uncle Sam.

Step 6: Seek professional assistance

Determining the appropriate way to tap your assets can be challenging and should take into account a number of factors. These include not only your tax situation, but also whether you have other assets you’ll use for income, your overall health, and your estate plan. A financial professional can help make sense of your options in light of your unique situation.

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