Your 401k represents one part of a portfolio that might also include an IRA, Social Security payments, pension checks and personal savings. You spend your life building up the money in your 401k plan by diligently diverting money from your paycheck into the plan. When retirement finally does arrive, you can withdraw as much from your 401k as you wish, but limiting the initial withdrawal rate is the best way to make the money last.
If you withdraw money from your 401k before you reach age 59 1/2, you could be subject to a 10 percent penalty from the IRS, as well as ordinary income taxes on the money you take out. But once you reach 59 1/2 years of age, you can begin to withdraw the money, using the funds you accumulated to supplement your other sources of income. While you can withdraw any amount you want, limiting those withdrawals increases the odds that your money will last as long as you do.
One of the best ways to determine how much you need in retirement is to create a post-retirement budget before you stop working. Start by looking at your current household budget and removing the items related to your employment, such as daily lunches with coworkers, your business wardrobe and the cost of the daily commute. Then add any new expenses, like health insurance and increased expenses for travel. Once you know how much you can expect to spend in retirement, you can determine how much you need to withdraw from your 401k to meet your living expenses.
Once you know how much you can expect to spend in retirement, your next step is to determine how much of those expenses are already covered by other sources of income. If you are currently drawing Social Security, add that to your guaranteed sources of income. The same is true of any pension or annuity payments that are guaranteed for life. Subtract those guaranteed sources of income from your expenses to determine how much you need to withdraw from your 401k each year.
Safe Withdrawal Rate
Once you know how much money you need to generate from your 401k, you can determine the necessary withdrawal rate and determine if you have enough in your plan to meet those expenses. Experts recommend an initial withdrawal rate of about 4 percent, meaning that you could withdraw $20,000 the first year from a $500,000 401k plan. If you need to withdraw more than 4 percent to meet your living expenses, you might want to consider working a bit longer to beef up your retirement portfolio.