Withdrawing money from your retirement account is no fun when markets are acting badly. The biggest downer? Selling assets at depressed prices.
Selling low forces you to burn through more shares to raise the cash that you need. And that means you'll have fewer assets left in your 401(k) or IRA to grow when the market roars back. Taxes can take an additional bite out of your nest egg, depending on the type of retirement account you're withdrawing from. You might need cash because you're retired already, or working but making a big-ticket purchase.
The good news is you have some options to avoid this "triple whammy," says Cat Irby Arnold, who specializes in retirement planning for U.S. Bank Private Wealth Management.
Your goal is to preserve assets during periods of market turbulence. "You've got to look at this as a temporary situation," Arnold said. "You're not doing this forever. You're only doing these things until the market turns."
Here are five ways to avoid or minimize account-depleting retirement withdrawals.
Raise Cash From Outside Your 401(k)
If you have access to a home equity line of credit (HELOC) or an emergency fund stuffed with liquid cash, now might be a good time to tap those funds. "You want to buy yourself some time," Arnold said.
The benefit of this option is twofold. You get access to the money you need for daily living expenses. And you don't have to raid your 401(k) and liquidate holdings trading at much lower prices than a year ago. Just make sure you replenish your rainy-day fund and pay off your HELOC when the market recovers.
"It's not a bad thing to take on some debt for a little bit of time to benefit the trade-off on the upside," Arnold said.
Here's how a HELOC can work as a short-term fix. The average rate for a HELOC is now 7.74%, according to Bankrate.com. The monthly payment on an interest-only draw of $25,000 would be $161.25 per month, or $1,935 per year.
That interest might seem steep. But let's say you had a $100,000 investment in an index fund tracking the Nasdaq that's down 25%, reducing your balance to $75,000. All it would take is a 2.5% rise in the fund to boost your account balance by $1,875, which essentially pays for a year of interest on the HELOC. And a subsequent gain in the Nasdaq-focused index fund of roughly 33% would allow you to pay off the $25,000 HELOC loan using fewer shares.
Tap Your Tax-Advantaged Roth IRA First
If you have no other choice but to sell retirement holdings and you're 59-1/2 or older and have had a Roth IRA open at least five years, taking a distribution from your Roth is a way to preserve some shares. The reason: distributions from a Roth IRA are tax-free. The upside is you'll need to sell fewer shares to raise a set amount of income.
For example, if you're in the 22% tax bracket and need to withdraw $50,000, you'll only need to sell enough shares to raise $50,000 using a Roth IRA. In contrast, if you take the distribution from a traditional IRA or 401(k), you'll be taxed at regular income rates. As a result, you'll have to liquidate roughly $61,000, or $11,000 more, from your retirement account in order to cover your tax liability. The added tax burden effectively drains more shares from your account.
"If you're trying to maintain as much of your balance in your account as you can and want to pull out as little as possible to meet your needs, you would go for the accounts that create the smallest tax, which would be your Roth accounts," said Tim Steffen, director of advanced planning at Baird.
Use Distributions To Rebalance Your Portfolio
In volatile markets, it's not uncommon for your mix of stocks, bonds, and other assets to get out of whack due to the zigzagging market. So, you can prioritize your distributions to not only create income, but also to get your asset allocation back in line with your time horizon and risk tolerance, says Brian Walsh, senior manager of financial planning at SoFi, a personal finance company.
"Selling from positions that have performed better over the recent past and just kind of leaving the positions that are down is a natural way to rebalance," Walsh said.
You might, for example, lighten up on holdings in the energy sector, which rose 59% last year, and hold on to hard-hit information technology stocks, which suffered a market value decline of $3.5 trillion in 2022, according to S&P Dow Jones Indices.
Consider Using In-Kind Distribution For Your RMD
If you must take a required minimum distribution (RMD), but don't want to deplete the share count or stock position in your retirement account, you can take an in-kind distribution. Instead of taking the distribution in cash (which requires a stock sale), you take the distribution in shares. You then move the shares to a taxable account.
The plusses? You maintain the same number of shares and market exposure. And while you can't avoid the tax on the RMD, you could enjoy a tax benefit later as any future gains on the shares will be taxed at the lower capital gain rate as opposed to your income tax rate.
"You're taking the withdrawal that's required by the IRS, so you're checking that box, and moving the (position) to a non-retirement account," said Jim Colavita, a managing director at GenTrust.
Another way to avoid selling depressed assets is taking your RMD at the end of the year so as to give the market a longer time to recover. You could also pull money out monthly to avoid timing the market.
Focus On Tax-Efficient Withdrawals
"Before you pull the trigger on a retirement distribution have a conversation with a tax advisor," said GenTrust's Colavita.
What you want to do, Steffen said, "is pull money from your retirement accounts in a way that is as tax-efficient as can be."
