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Columns: Dr. Don
Don Taylor, Ph.D., CFA, CFP   Expert: Don Taylor, Ph.D., CFA, CFP
Ask Dr. Don
Taxes, inflation can eat into returns
Ask Dr. Don

Frugal lifestyle can keep 401(k) flush
 

Dear Dr. Don,
To supplement my income upon retirement at 60, I plan to begin drawing from a 401(k) without disturbing the principal balance. Is it possible to do this? If my principal is $500,000, what can I draw monthly while preserving the principal? What about taxes?
-- Retiring Robert

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Dear Robert,
Because you'll be over age 59 and separated from service when you retire at age 60, you can draw down as much or as little as you like from your 401(k) account between ages 60 and 70. After age 70, you must draw down enough to satisfy the required minimum distributions, or RMD, rule.

The concept of a principal balance in a 401(k) account is a little elusive, because it's all principal. Obviously, you're earning some kind of return on this nest egg, but as it's earned, it becomes principal in the account.

Still, it's quite feasible to take the account balance at retirement and try to preserve that level as you take distributions. You can achieve this simply by investing conservatively and spending frugally. If your investments earn more than your withdrawal rate plus the inflation rate, you can increase distributions year over year by the inflation rate without reducing the account's principal balance.

The problem comes about when the investment returns don't meet your spending requirements, either because of how you're invested or because you need more income. Inflation is a big consideration in this equation.

Regarding taxes, it's important to remember that 401(k) distributions are taxed as ordinary income. This differs from taxable accounts, in which only the investment returns are taxed and the taxation differs depending on whether the investment returns are capital gains, interest or dividend income.

It's really worth spending the time and money to consult with your professional tax adviser and a financial planner on how best to structure your distributions in retirement. The Bankrate feature, "Financial planners: not just for millionaires anymore" can help you find a planner.

Bankrate.com's corrections policy -- Posted: Nov. 12, 2007
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