Drill Down: 401k Withdrawals and Other Assets
All this information about how much to withdraw is good, but you are likely facing another challenge. It’s quite possible that you have accumulated assets other you’re your 401k throughout your lifetime. You might ask, “From which account should I withdraw funds first?” This could seem especially complicated if you have numerous assets like a CD, a 401k, an IRA, and stocks, but don’t worry. The reasoning is straightforward and we’ll take it one step at a time and go through some examples to make it clear.
Let’s start with a simple example. Assume you have a 401k plan and a CD (or a savings account), and now you’re looking to fund your retirement. From which one should you make a withdrawal first? It should definitely be from your CD (providing that it’s not within an IRA), and I’ll explain why.
As we’ve mentioned before, what makes a 401k plan such a great investment vehicle is that it permits your money to grow, tax deferred. By holding off on making withdrawals from your 401k plan, you are making your money work for you. All that you have contributed over the years will continue to grow as quickly as it can, without taxes undermining your efforts, to give you even more to carry you through your latter retirement years. That’s always a good thing. Compound interest and tax deferral are what make it possible, and that is a combination lacking with your CD.
In short, you should withdraw money from your CD or savings account before your 401k, or even before other assets like IRA’s, stocks, or mutual funds.
What if you have an IRA in addition to your 401k and CD? Or what if you have a complicated asset combination that includes a 401k, CD, Roth IRA, and bonds? What would be the ideal order to withdraw funds? This may seem complicated, but don’t worry, it isn’t. There is a general strategy for withdrawing your funds and it is outlined below.
General Withdrawal Strategy
First: Use your most liquid assets that are not tax-sheltered (i.e. you are taxed on all gains—no tax is deferred) and have the lowest rate of return. This can include savings, CD’s, and others.
Second: Begin tapping into your others assets that are earning a higher return, but the gains are still taxable. This can include mutual funds, stocks, bonds, etc. that are not part of a retirement plan.
You may need to do some rebalancing along the way. For example, a smart strategy for someone who has both a 401k and a regular, taxable investment account is to put stocks in the taxable account, and bonds in the non-taxable account. That makes sense because the stocks enjoy lower capital gains tax rates.
However, if you sell those stocks, you may not have the right balance of stocks and bonds. You can easily restore your desired balance by shifting assets within your 401k. Sell some bond funds and buy some stock funds.
Third: Once all your taxable accounts are used, now you can tap into your retirement plans. It is important to leave these until the end to take full advantage of that tax-deferred growth. Now let’s say you have a traditional IRA, Roth IRA, and a 401k plan. Which order? It really depends on what the tax situation looks like. If you are in a high income tax bracket early on in your retirement, and you expect to be in a lower one later, tap into your Roth IRA first. You’ll be able to pull out your funds without paying the high taxes (since you paid them already). If the situation is reversed and you’re in a lower tax bracket early on in your retirement but expect, for some reason, to be in a higher one later, use your traditional IRA or your 401k first. If you have a Roth 401k and a traditional 401k, just follow the same reasoning for the IRA.
That is all there is to it. The basic strategy is to let your funds grow as long and fast as possible (without unnecessary tax). With the information here, you are well on your way to making your retirement secure.
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Lesson 1: What the Heck is a 401k, and What’s So Great About It?
Lesson 2: Contributions to Your 401k
Lesson 3: Investments “Cook Book” Approach
Lesson 4: Investments: How Investments Work
Lesson 5: Loans and Hardship Withdrawals from Your 401k
» Lesson 7: Your Retirement
Lesson 9: Your 401k, Your Other Assets, and Your Life
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