Using Your 401(k) in Retirement
February 09, 2012We recently received this question on the Ask a Question to a Financial Planner section of our blog:
“I have $35k in bank card debt+$30k in retail credit debt. Bank interest range 13/23%, retail 18/29%. I’m 63, and have $40k in a 401acct where I work. I want to retire this year with two company pensions ($1750/month) and early SS($2400/month, both wife and me). I need to get rid of some monthly payments of debt, where should I use my 401 money toward this goal. All my debt is unsecured, my home is paid off, health is good. I’m ready to go fishing.”
Here are some things to consider in deciding what to do in your situation:
1) Do you need the 401(k) to supplement your income or will the $4,150 from your pensions and Social Security be enough? Don’t forget to factor in taxes when determining how much of that income you’ll actually get to keep. All your pension payments are taxed as ordinary income (but no FICA tax) but only part of your Social Security is taxable. You can estimate how much with this calculator. Finally, compare your after-tax income with your projected expenses on this retirement budget planner.
2) If you need income from your 401(k), the rule of thumb is that you can generally safely withdraw 4% of the initial account value and increase it by inflation each year. This means the $40k in your 401(k) can yield about $1,600 a year or about $133 a month before taxes (the withdrawals are taxed as ordinary income if they’re from a pre-tax account or tax free if they’re from a Roth). This assumes that you have a diversified portfolio so consider using this risk tolerance questionnaire and asset allocation worksheet to make sure you’re properly diversified. If the pensions and Social Security are enough to pay your expenses, you can use your 401(k) money as an emergency fund or to pay off debt. Which brings us to the next question…
3) Do you have 3-12 months of expenses in savings? Make sure you have some cash for emergencies before using your 401(k) money to pay off debt. (A home equity line of credit don’t count since it can be cancelled just when you most need it.) If not, consider leaving some of your 401(k) in cash (in a money market or stable value fund) to cover unexpected emergencies. The exact amount depends on your comfort level.
4) If you have sufficient income and savings, using the 401(k) to pay off your retail debt can make a lot of sense. That’s because you’re unlikely to earn as much in your 401(k) investments as that debt is costing you.
5) Another alternative to consider — why not work one more year or however long it takes you to pay off your consumer debt? This will also force you to really manage your spending and make sure you live within your means, which will be an important skill to have in retirement. In the meantime, you can take a few days off here and there to fish or fish on the weekends and when you retire, you’ll know you’ll have the peace of mind that comes from being debt free.
In any case, enjoy telling the stories of the big one that got away!
Do you have your own financial question? Submit them to us at the link at the top for a free and unbiased answer from one of our CFP® professionals.