When you retire, it would be convenient if all your expenses were to "retire" as well. But they won't.
In fact, you'll likely need 80-100 percent of your pre-retirement income to maintain your standard of living in retirement. And you may even need more, depending on what you plan to do during your retirement years. So, well before you retire, ask yourself a couple of key questions: Where will the money come from? And when can I get at it?
Let's take a look at some of your likely retirement income "pools," along with the rules governing withdrawals from these sources.
• 401(k) plan - If you have a 401(k) at work, take full advantage of it. Your earnings have the potential to grow on a tax-deferred basis and you typically contribute pre-tax dollars, so the more you put in, the lower your adjusted annual taxable income. Generally, you have to be at least 59-1/2 to withdraw money from your 401(k) without incurring a penalty of 10 percent of the taxable amount of your withdrawal. However, you can avoid this penalty under the following circumstances:
1. You leave your employer when you are at least 55 or you become disabled.
2. You take a series of equal periodic payments, made at least annually, for your life or life expectancy.
3. You "roll over" your 401(k) withdrawals into an IRA. Of course, you may not want, or need, to tap into your 401(k) at either age 55 or 59-1/2. If that's the case, you can leave your account alone and, hopefully, watch it continue to have the potential to grow. But you will have to start taking withdrawals when you reach 70-1/2, if you haven't already done so.
• IRA - As is the case with your 401(k), you will, in most cases, have to pay a 10 percent tax penalty if you take distributions from your IRA before age 59-1/2. And you must begin taking required minimum distributions from a traditional IRA once you reach 70-1/2. If you have a Roth IRA, you face no mandatory distribution rules, so you never have to touch the money, which means it can potentially grow tax-free for years.
• Social Security - You can start taking Social Security when you reach 62, but your monthly payments will only be about 70 percent to 75 percent - the exact amount depends on your age - of your payments if you waited until your reached "full" retirement age, which is probably 66 or 67. (Social Security determines your full retirement age by your year of birth.)
To most effectively incorporate your 401(k) and IRA withdrawals, and your Social Security payments, into your retirement income, you'll need to consult with your financial advisor. Also, to make sure you're not adversely affecting your tax situation when you start taking these withdrawals and payments, talk to your tax advisor. But don't wait until you're almost retired to start planning for it. Your decisions on when to start taking withdrawals from your various retirement accounts are usually irrevocable - so you'll want to get them right the first time.
Cardella is a financial consultant with Edward Jones in Hinesville