If you spend too much of your 401(k) account balance early on in retirement, you will reach your later years with very limited resources. But there are steps you can take to make your retirement account balance last longer. Here are some strategies to make sure your retirement savings lasts the rest of your life.
Postpone withdrawals. Most retirement savers aren’t dipping into their nest egg immediately upon retirement. In fact, most investors don’t even touch their 401(k) savings until they are required to. Only 18 percent of households with retirement accounts make any withdrawals in a typical year between ages 60 and 69, according to a recent National Bureau of Economic Research (NBER) study of IRA, Keogh, 401(k), and Thrift Plan account holders between 1997 and 2005. The proportion of households making a retirement account withdrawal grows slowly from about 10 percent at age 60 to 23 percent at age 69. Delaying 401(k) withdrawals early in your retirement gives you additional time to build up more tax-deferred growth.
Avoid tax penalties. After decades of delaying taxes, retirees age 70½ and older are required to take distributions from traditional retirement accounts and pay any resulting income tax. (Seniors who are still working and not at least 5 percent owners of the company may be able to further delay 401(k) withdrawals.) Account holders who fail to withdraw the required amount from their traditional 401(k) or IRA face a 50 percent tax penalty on the amount that should have been withdrawn in additional to the regular income tax due. Between ages 69 and 71, the proportion of households taking retirement account withdrawals jumps from about 20 percent to over 60 percent. And after age 73, about 70 percent of households take withdrawals annually. “The sharp increase in withdrawals when distributions become mandatory suggests that many households in their early 70s would not make withdrawals if it were not for the required minimum distribution rules,” write NBER researchers James Poterba, Steven Venti, and David Wise. Withdrawals from Roth 401(k)s and Roth IRAs are not required after age 70½ because account owners already paid income tax on that money.
Avoid two distributions in the same year. The year you turn 70½, you have until April 1 of the following year to take your required distribution. But every year after that, required minimum distributions must be taken by December 31. If you wait until the April 1 deadline to take your first distribution, you will have to make two withdrawals in the same year, which could result in a hefty income tax bill that year.
Reduce withdrawal rates. The less you withdraw from your 401(k) each year, the longer your money will last. Before age 70, the average 401(k) withdrawal is about 1.9 percent of the account balance each year. “In most years, the average real rate of return earned on personal retirement account balances would exceed this value, so the pool of personal retirement account assets would grow even in the absence of new contributions,” NBER found. After age 70, the average annual withdrawal rate is 5.2 percent. “Rather than declining in value after households retire and begin to finance retirement consumption, our findings suggest that personal retirement account balances continue to grow through at least age 85, although the rate of growth is slower at older ages than at younger ages,” according to the NBER report.
While most retirees spend about 5 percent or less of their nest egg each year, some retirees do withdraw unsustainable amounts from their retirement accounts. Between ages 60 and 69, about 7 percent of households withdraw more than 10 percent of their retirement assets. And 11 percent of those over age 72 withdraw more than 20 percent of their balance in a single year. These households are in danger of using up their savings too quickly.
Reinvest withdrawals. Taking money out of your retirement accounts doesn’t mean you need to spend it. “Withdrawals from personal retirement accounts do not necessarily translate into consumption,” the NBER study found. “Households may simply redirect their assets from personal retirement accounts to other investment accounts.” If you don’t need the money right away, consider reinvesting your 401(k) withdrawals in a taxable investment account, bonds, or a savings account for future use.