If you've done a good job saving money in your 401k plan, you may have a lot of money to use for retirement income. But, saving is only part of the equation. You must understand how much money you can really withdraw from your 401k plan. If you don't know this, you run the risk of running out of money in retirement.
Your 401k plan is an employer sponsored retirement plan. This means that the plan is administered by your employer and managed either in-house or by a third-party financial institution. All of the investments in a 401k plan are sold by a brokerage. Your account balance at retirement is the total amount of money available for withdrawal from the plan.
The annuity method for withdrawals ensures that you will receive a guaranteed income for your entire life or for a set period of time. The annuity is purchased by rolling the money over to an IRA with an insurance company and then buying an annuity. The annuity then makes payments to you based on the contract you sign with the insurer. You must pay income tax on all payments from the plan.
Systematic withdrawals are based on actuarial tables. You will have to do the calculations yourself, however. Withdrawals may be based on IRS section 7520 actuarial tables. You will add up the value of your 401k plan and divide by the life expectancy associated with your age and based on an interest rate factor you think you can earn during your retirement. As with the annuity method, you must pay income tax on all payments.
A lump sum withdrawal is a full withdrawal of 401k plan benefits at retirement. The amount you receive from a lump sum amount is reduced by the taxes you pay on your withdrawal, like other withdrawal methods. But, you pay these taxes up front, instead of over time. You may end up with less total savings than you would otherwise have if you had paid taxes over time.
- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu, Robert A Crane; 2007