Here’s how to get money from a 401(k)

Dear Pete:

I have a very simple but stupid question. How will I get money out of my 401(k) when I retire? Will they just send me monthly checks?

— Stephan

Answer: There are no stupid questions, just stupid people. I’m kidding, of course.

I rarely get this question, but I know it’s a question that very few people know the answer to. Most people assume money just shows up in your mailbox, a few days after the “Thank God Stephan is gone” party.

To begin, in a vast majority of instances, income doesn’t just flow from your retirement investments when you stop working. Your 401(k) will continue doing what it does, without receiving new contributions, upon your retirement. Your account will rise and fall in value, receive dividends, and generally reinvest those dividends. It’s like you never left.

But you did leave. And you may need income off of your 401(k). You’ve got lots of options to achieve your goal of distributing money from your account. But no matter what you choose, you should understand that your withdrawal is very likely to be a taxable event. Unless you have a Roth 401(k), which haven’t been around for that long and aren’t that popular yet, your 401(k) money has never been taxed. Yeah, you gotta pay taxes on that money, all of that money.

Most 401(k) plans give you several options for withdrawal, and if none of the choices work for you, you can simply roll over your 401(k) plan into an Individual Retirement Account of your liking. A rollover isn’t a withdrawal; thus it’s not a taxable event.

Here are the typical withdrawal options that don’t require rolling over your retirement plan into an IRA.

  • Systematic withdrawals: Many 401(k) plans allow you to predetermine a certain amount of money to have deposited into your checking account every month. You can choose to withdraw a fixed dollar amount or a fixed percentage of your account value.
  •  Random withdrawals: You can randomly request funds from your account, whenever you need money. However, if you plan on using your 401(k) as a regular retirement income source, I recommend you don’t randomly withdraw money. The situations I’ve seen when people run out of money in retirement, always begin with random withdrawals from a 401(k). Once you use the money, it’s gone. It is likely that you’ve never had access to so much money at once, and the mismanagement of withdrawals can be devastating.

There are many other ways to create retirement income from your retirement account, but most of them require you to roll over your retirement plan to an IRA. Some people choose to utilize either of the strategies I discussed above, after they’ve moved their money to an IRA.

Some investments like individual stocks and individual bonds, which normally aren’t available within a 401(k), naturally create income via interest and dividends. Many retirees try to simply “live off the interest and dividends.” Additionally, some retirees choose to formalize the income streams even more, by buying retirement income products, such as annuities.

Annuities give retirees two primary options from an income standpoint. First, a retiree can annuitize their annuity, which means giving up access to the money except for regular equal payments. If the annuitant wants more money than the monthly payment, too bad. All they’re getting is the monthly payment. A person can create an income stream off of an annuity without giving up access to the principal funds by taking withdrawals instead. If you want to maintain access and control of your retirement funds and you have an annuity, take withdrawals instead of annuitizing the annuity.

All of this is to tell you that if you don’t know what you’re doing, then you need to hire a financial adviser to facilitate the process. Your 401(k) will not just start sending you retirement income once you retire.

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