The Retirement Corporation of America

When To Start Thinking About Withdrawing Your Money

THE MOST BASIC rule for enjoying a your retirement is to hold off on tapping into your nest egg for as long as possible. Still, you don't want to cheat yourself in your final years by accumulating money in a savings account that you really could use to improve your life.

It would be great to be able to leave wealth to your heirs, but you should also be able to enjoy the sort of retirement you have always dreamed of. If you can do so and still leave money to your heirs—great. But your needs must come first. Spend what it takes to have a great retirement. Only leave wealth to your heirs if it does not affect your desired retirement lifestyle.

The point is that withdrawing money from your retirement nest egg is something you do fairly late in life—when your income has stopped and you need more than your pension can provide to pay for your retirement. The longer you delay tapping into your nest egg without shortchanging your life, the better off you will be.

Make Your Withdrawal Plans Early

Even if you don't start withdrawing money until late in life, you must start thinking about withdrawing money when you are still fairly young. As with the rest of your financial and retirement planning, the withdrawal strategy you execute late in life will be based on plans set in motion fairly early in life. Here are some issues you want to think through—long before you withdraw anything:

Issue #1: The Withdrawal Rules Are Very Complicated. There are penalties if you start to withdraw money too early, and penalties if you delay withdrawing money too long. But there are ways around these penalties if you know how to apply them. Finally, Congress keeps changing the rules about when and how you must start withdrawing money from retirement plans. The websites you'll find in this lesson will help keep you up to date on the laws and rules.

Issue #2: The Tax Rules About Withdrawals Are Equally Complicated. All money withdrawn from every tax-deferred retirement savings plan, except a Roth IRA, is taxable at your ordinary income tax rate. Only the capital gains on money withdrawn from taxable investment accounts is taxed—and then at the lower capital gains tax rate. With each contribution you make to your retirement nest egg, you will have to decide whether to put the money in a tax-deferred or a taxable account. Furthermore, you will invest your money differently over the years depending on whether the account is tax deferred or taxable.

Issue #3: The Rules on Roth IRAs Are Different. Remember, you don't get a tax break for contributing to a Roth IRA. But neither do you owe taxes on any money withdrawn from a Roth IRA that has been open for at least five years. You will have to decide whether you want to create a traditional IRA or a Roth IRA years before you start withdrawing money.

Issue #4: Your Employer Can Offer Either a Defined Benefit or a Defined Contribution Pension Plan.
With a defined benefit (DB) plan, the employer creates and funds the pension and your payout is based entirely on decisions made by the employer. With a defined contribution (DC) plan, the employer creates the plan, but it is mostly your contributions that fund it and the payout is based on how much you have contributed and how well your investment choices have performed. There are other types, but the most common type of DC plan is a 401(k). One consideration, which you may have to make fairly early in life, is whether to favor an employer with a DB plan or one with a DC plan. If it's a DB plan, you'll want to bet on a employer that looks solid enough to meet its pension obligations for as long as you live.


Issue #5: Your Employer Will Decide How to Distribute Money From a DB Plan. When it finally comes time to withdraw money from a DB pension, your employer will decide whether to give you everything at once in a lump sum, or whether to give you an annuity that spreads the payments out over the rest of your life, and your spouse's life, as well. Before you take a job, you should know how the employer pays out pension benefits. It probably would never be a "deal breaker," but it is something worth knowing about.

Issue #6: You Can Shelter More of Your Nest Egg With an Annuity. If you have contributed all you can to a DC plan and still have money left over, you can shelter more of your nest egg from taxes through an annuity. There is no up-front tax deduction for money spent buying an annuity, but money in the annuity compounds, tax deferred, until you begin withdrawing it. You may want to create an annuity fairly early in the retirement planning process, since the more years you have to invest in one, the more you stand to benefit. But you can buy one late in life with money withdrawn in a lump sum from a pension plan, or with money from the sale of a house. Keep your eye on annuities no matter what life stage you are in. They may prove useful for your retirement planning at almost any age.

Issue #7: If You Know What You're Doing, You Can Withdraw Money and Still Keep Your Tax Deferral.
You'll probably have to withdraw money from your 401(k) when you retire. But that doesn't mean you have to lose the tax shelter. You can roll the money into an IRA—traditional or Roth—and keep the tax shelter in place for many more years. The same holds true if you take your money out of a 401(k), or comparable plan, earlier in life. There are strict rules about a rollover from a 401(k) to an IRA. You want to make sure you know all the rules whenever you take money out of a 401(k), no matter what your age is.


There are many more rules about withdrawals. They tend to differ, depending on what sort of retirement account your money is in. The point is, you must learn those rules when you are fairly young. Otherwise, you risk getting into trouble in your senior years for mistakes made when you were in your 20s or 30s.