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RETIREMENT PLANNING
5 Worst Ways to Withdraw Retirement Savings
written by Mike Ballew October 15, 2023
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We hear a lot about saving for retirement, but not so much about how to access our savings. That may explain why so many people make mistakes when taking account distributions. Join us as we count down the 5 worst ways to withdraw retirement savings.

Number 5: Take Whatever you Want

“It’s my money, I earned it, I’ll take as much as I want. Plus, it’s so much – look at all those zeros!"

Your retirement savings need to last throughout the course of your retirement. If you start taking withdrawals with no regard for the future, you could outlive your savings. 

How long is retirement? No one knows, but you can look to your relatives for clues. It’s not an exact science, but it’s better than having no plan at all. 

How do you determine the amount you can safely withdraw each year? It’s a question not easily answered. Your best bet is to sit down with a financial planner or avail yourself to sophisticated retirement planning software. Check out this article entitled Best Retirement Planning Software.

However you arrive at the answer, if your withdrawals together with your Social Security benefits are not enough to cover your expenses, you may need to make some changes. It’s a matter of adjusting your spending habits or re-entering the workforce.

Number 4: Withdraw After-Tax Savings First

“Years ago I got some good advice and opened a Roth IRA. It’s a nice chunk of change and I can’t wait to spend it."

What’s wrong with this picture?

After-tax accounts are the last place to turn for cash. Of all the forms of retirement savings, Roth accounts are the most tax-advantaged. It’s best to let them grow for as long as possible. Roth account investment earnings grow tax-free. Pre-tax accounts such as 401(k)s should be depleted first before accessing after-tax accounts.

Number 3: Cash Out and put the Money in the Bank

“I’ve had it with the stock market! All the ups and downs and crashes! Who needs it? We’re taking our money out of that 401(k) and putting it in the bank!"

Sounds like a reasonable response, so why is this number 3 in our countdown of the 5 worst ways to withdraw retirement savings? 

Employer-sponsored plans like 401(k)s are pre-tax accounts. That means any withdrawals are taxed as ordinary income. If you withdraw all of the money at once, you create a taxable event that can easily push you into a higher tax bracket.

If you want to get out of the stock market, there are ways to do that without breaking the bank. Most investment institutions allow you to move money out of stocks and into interest-bearing accounts. Account names vary by institution, but look for “settlement account" or “stable fund" or something similar. You can stash cash in these accounts for as long as you wish.

That said, it’s important to note interest-bearing accounts do not keep pace with inflation. That means over time you are losing money. Like a harbor in a storm, most investors park money in interest-bearing accounts for a relatively brief period of time. When the storm clears, they reinvest in the stock market.

Number 2: Not Taking Withdrawals until RMDs Kick In

“We never do anything! We don’t go out, we don’t take vacations, and look at this place! It’s falling apart! Ever since we retired, it’s like you’re afraid of spending money. What is wrong with you? How long do you think we can go on like this?"

RMDs, or Required Minimum Distributions, are government-mandated withdrawals from retirement accounts beginning at age 73. From that point on, you are required to withdraw a portion of your pre-tax savings on an annual basis. The amount depends on your age and your account balance.

Avoiding retirement withdrawals until RMDs take effect is a common practice among financially-conservative retirees. Something happens when the paychecks stop rolling in. A crippling paralysis takes hold which can prevent you from spending money. Before long you are grumbling about retirement not being what it’s cracked up to be.

Develop a plan to determine how much you can afford to withdraw each year and start taking distributions from pre-tax accounts as soon as you retire.

Number 1: Cashing Out Between Jobs

“They’re idiots! You must have to get a lobotomy to become a manager. One thing’s for sure, I’m not leaving my 401(k) there. By the time I retire I doubt they’ll be in business."

We’ve reached number 1 in our countdown of the 5 worst ways to withdraw retirement savings. The worst thing you can do is withdraw money before reaching 59½ years of age.

Taking withdrawals from pre-tax retirement accounts prior to age 59½ results in penalties for early withdrawal. A 10 percent penalty tax is added on top of taxing the withdrawal as ordinary income.

No matter how much you may despise your former employer, you should never cash out a 401(k). Keep in mind it’s not “their" 401(k). Employer-sponsored retirement plans are under the control of financial institutions which are regulated by the federal government. If your employer goes out of business, it doesn’t mean the financial institution will also go out of business.

When changing jobs, the right move is to leave your money where it’s at. Or, you can roll it over into another pre-tax account. Either approach will prevent you from paying unnecessary taxes.

Final Thoughts

When it comes to taking withdrawals from your retirement accounts, how you do it matters. With a little research and planning you can optimize your savings and avoid unnecessary taxes. It’s a much better approach than taking a wrecking ball to your savings.

Photo credit: Pixabay Eggstack News will never post an article influenced by an outside company or advertiser. Our mission is to help you overcome uncertainty about retirement planning and inspire confidence in your financial future.
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MIKE BALLEW
Eggstack founder, Financial Planning Association member, engineer, and software developer.