How do I turn savings into income?

When you retire, you’ll need to decide where to keep your retirement savings and when to start withdrawing them. To avoid paying taxes on all your savings at once, you generally have a few options:

1. Keep your money in the plan.
   
   
2. Roll over to an IRA.

Most retirement plans allow you to keep your money in the plan after you retire as long as you keep a minimum balance. You’ll have the same investment options as you do now, including ones you might not be able to get if you leave the plan. Plus, you’ll be able to use all the same tools to manage your account.

Many plans also allow you to set up automatic installments so that you can pay yourself regular income from your savings. However, other plans may allow only a limited number of withdrawals per year during retirement. Carefully consider your plan rules if you are considering drawing income from your plan.

You could roll your retirement money to an IRA. IRAs at many financial institutions offer a wide range of investment options as well as automatic withdrawal plans. To make it easier to manage your savings, you can also combine savings from multiple retirement accounts into a single IRA.

If most or all of your savings is in one retirement plan, and the plan rules work for you, it might make sense to leave your money there. On the other hand, if you have savings in multiple accounts, it may be easier to consolidate them into an IRA.

In either case, you should compare the fees and investing costs, as well as any special services that one or the other may offer.

Whatever you do, remember that you will pay federal tax on whatever you take out of your retirement plan or IRA, assuming you made pre-tax contributions. 

You’ll still need to invest your money in retirement. Deciding how is important. You’ll probably want to invest in stocks to try for growth and bonds for income. Finding the right investment mix is a key decision.

Since you’re not getting a paycheck in retirement, you’ll have to create income from your retirement savings and Social Security payments. Your retirement can span decades, so you want to think about how much you’ll spend each year.

You can’t sit on your tax-deferred savings forever. Once you reach age 73* or retire, whichever is later, the IRS requires you to start taking out a certain percentage of plan savings each year. This is called your required minimum distribution (RMD).

The amount you must take out each year is based on your age, life expectancy, and account balance. If your regular income withdrawals don’t cover your RMD, you'll need to take out extra money to meet your RMD.

Vanguard and many other financial companies offer an RMD service. Some plans will calculate your required distributions for you, while others will calculate the amount and send it to you each year.

You could decide to use a portion of your savings to buy an annuity, which can give you guaranteed income for life or a length of time that you set. An annuity is an insurance contract. You pay a single payment and receive regular payments guaranteed by the insurance company that sold you the annuity. Some annuities pay income for as long as you live. Others pay for as long as you and your spouse live. Still others pay for a specific number of years.**

You could use the annuity to cover your basic living expenses, such as housing, utilities, and groceries. It can provide guaranteed income to help you keep your current standard of living. And it can reduce the risk that you’ll run out of money. With your basic needs covered, you could keep investing the rest of your retirement savings.

But keep in mind that you typically lose access to the money you spend on an annuity. So you could lose some flexibility to respond to financial emergencies.

Another option is to follow the 4% rule, a disciplined approach that can help make sure your savings won’t fall short. Here’s how it works:

In the first year of your retirement, take out no more than 4% of your balance.*** For example, Ruth is 67 years old and retires with $250,000 saved in her plan. In her first year of retirement, she takes out 4% of her balance, or $10,000 ($250,000 x 0.04).

In the following years, increase how much you take out to account for increases in the cost of living. The amount that the cost-of-living increases from year to year is known as inflation. In our example, inflation runs at 2% during Ruth’s first year of retirement. So in her second year, she bumps up the amount she takes out by 2% to $10,200 ($10,000 x 1.02).

If a sharp drop in the market drastically reduces the value of your account (say by 10% or more), you may want to skip your adjustment for inflation. Or you could cut back the amount you take out for a year. Using our example, at the beginning of Ruth’s third year of retirement, a drop in the market causes her balance to fall to $205,000. So she adjusts how much she takes out to 4% of her reduced balance, or $8,200 ($205,000 x 0.04).