Top 12 Questions People Ask About Retirement Withdrawals

January 13, 2016

By Dan DeMarest • VP of Wealth Management 

I recently wrote a post about the Top 12 Questions People Ask About Retirement Planning, which paired the most common questions with our most common advice for retirement preparation. This week, I'd like to focus on the next phase of retirement planning, which is preparing for imminent retirement. Keep in mind; as with the last blog, the answers I'm giving to these questions are fairly general, but they should cover enough ground for you to have an educated discussion with your financial advisor when the time comes.

Whether you live in Iowa, Nebraska, or South Dakota, getting prepared for imminent retirement involves more than planning trips or picking up new hobbies (although that is certainly allowed). It also includes knowing how much money you’ll have available each month, what, if any, fees or penalties will be assessed, and how to manage your retirement income long term.

Q: HOW MUCH MONEY CAN I WITHDRAW EACH YEAR?

The answer to this depends largely on the amount you've saved and how long you think you’ll need it. A visit with your financial planner will explore your asset allocation, your lifestyle, and which withdrawal method you plan to use. In general, most advisors suggest limiting withdrawals to 3% to 5% of your total at the outset, and then adjusting as necessary for short-term and long-term need.

Q: WHEN DO I NEED TO START WITHDRAWING FROM MY IRA?

While you can begin making qualified withdrawals from a traditional IRA as early as age 59½, the Internal Revenue Service states you must make "required minimum distributions" starting in the year you turn 70½. The amount of you must withdraw at that time depends on how much you have saved in the account and your life expectancy.

Q: WHEN DO I NEED TO START WITHDRAWING FROM MY 401K?

Generally, once you reach the age of 59.5 you can withdraw money from your 401(k) free of penalty of the 10% early withdrawal penalty. Keep in mind that you’ll still owe state, federal and local income taxes on the amount you withdraw.

Like your IRA, you must begin taking distributions from your 401(k) plan by April 1 of the calendar year following the calendar year in which you turn 70.5. Otherwise you will be liable for a penalty of up to 50% of what you should have withdrawn. An exception to this rule is if you are still working for the employer of your sponsored 401k. In this case, you’ll be required to withdraw funds by April 1st of the calendar year following your retirement.

Q: WHEN CAN I START WITHDRAWING FROM MY 401K/IRA WITHOUT PENALTY?

In most situations, investors need to be 59 ½ before they can qualify for penalty-free withdrawals from their 401k or traditional IRA. Note that penalty-free does not mean tax-free; you’ll still need to pay state, federal, and local income taxes on the amount you withdraw each year.

That being said, there are some special situations in which a traditional IRA can offer withdrawals without a penalty. For instance, the government will allow investors to withdraw money from a traditional Roth to pay for unreimbursed medical expenses, as long as they exceed 10% of adjusted gross income and the withdrawal is made in the same year the medical expenses were incurred. Also, if you become totally and permanently disabled, you may also be able to dip into your IRA savings without the 10% fee. You’ll just need to provide the burden of proof (like disability benefits from the government or a private insurance carrier).

It’s also important to note that employer plans may offer different provisions. You’ll need to check your specific plan for more details.

Q: WHAT FEES DO I PAY FOR MY 401K?

There may, and usually are, fees associated with maintaining and administering a 401k plan. These services are usually described as plan administration fees, investment fees, and individual service fees. Depending on the plan and the service provider, your 401k may be subject to one or all of such fees. It is always a good idea to evaluate how the fees are distributed, how those fees are paid, and how those fees compare to other investment providers.

Q: HOW MUCH MONEY CAN I CONTRIBUTE TO MY 401K THIS YEAR?

In 2015, the maximum contributions allowed for the year were increased to $18,000 (up from $17,500 in the years previous) for those investors under the age of 50. Investors ages 50 and above are eligible for an additional $6,000 in catch-up contributions for the year.

Q: WHAT ARE THE PENALTIES FOR WITHDRAWING MONEY FROM MY 401K?

The penalties for early withdrawal are two-fold. The first immediate penalty is a huge bite out of your available funds. In addition to state and federal income tax, withdrawals made before the age of 59 ½ are subject to a 10% penalty. This means a 401k with $50,000 may end up being just $35,000 if withdrawn all at once before retirement. The second, and more detrimental, consequence is the stunted earning potential over the lifetime of the 401k savings. Investors choosing early withdrawal need to carefully weigh the long-term effects of their decision, because once 401k savings are withdrawn, they can be very difficult to replace.

Q: WHAT IS A VESTING SCHEDULE?

When it comes to your retirement plan, “vesting” basically means ownership. Typically, each employee owns a growing percentage of their retirement account each year they are employed. An employee who is 100% vested in his or her account balance owns 100% of it; the employer cannot touch any portion of the funds, whether or not they helped contribute to it. If employment ends before an employee is fully vested, or if an employee does not work more than 500 hours in a year for five years, the remaining unvested percentage will be forfeited.

Q: WHAT IS A MUTUAL FUND? INDEX FUND? BOND? TARGET RETIREMENT DATE PORTFOLIO? MANAGED PORTFOLIO?

Here’s a list of quick definitions for your reference. We can dive into these a bit more deeply with when you make your appointment.

• Mutual Fund: A mutual fund is an investment program funded by shareholders. It is professionally managed and trades in diversified holdings.
• Index Fund: A type of investment fund with specific rules and construction parameters, usually grouped by stock index, investment type, or a subset of the financial market.
• Target Retirement Date Portfolio: A retirement fund that automatically sets the asset mix of bond, stocks, and cash equivalents in its portfolio based upon the selected retirement timeframe of the investor.
• Managed Portfolio: To put it simply, a managed portfolio is a series of investments that are being professionally managed, whether actively or passively.

Q: DOES MY 401K PLAN ALLOW FOR LOANS?

Only your employer can answer this question. While the law allows for loans to be placed against a 401k, an employer is not required to offer them with their plan. If it is offered with your plan, keep these two things in mind:

• You are essentially borrowing from yourself, except you’ll be required to pay interest to someone else.
• You’ll be repaying the loan with after-tax dollars.

Also, some plans only allow for loans under specific circumstances (college tuition, home purchase, etc.), and most are limited to $50,000 or half of the value of your account, whichever amount is smaller.

Q: DOES MY 401K PLAN ALLOW FOR HARDSHIP WITHDRAWALS?

Like loans, hardship withdrawals from your 401k are allowed by law, but your employer is not required to provide them in your plan. While most companies provide this option, it is important to ask your human resources department what options are available in your plan. To qualify for a hardship withdrawal, you’ll need to prove an immediate, heavy, and necessary financial need; in other words, you must prove you have no other funds available to meet an IRS-acceptable need (medical expenses, college tuition and related costs, home purchase, avoiding home foreclosure or eviction, necessary home repairs, or funeral costs).

Q: WHAT IS A QDRO?

A QDRO is a qualified domestic relation order and is often pronounced “quadro” by those who prepare them regularly. They refer to the documents required to create or recognize the existence of an alternate payee—namely a spouse, former spouse, child or dependent--on a retirement account.

We hope you’ve found these answers helpful, or at least a start in the right direction. If these questions bring up more questions, it may be time to schedule an appointment with one of our financial planners. And now is a great time to do it.