Editor's note: This article is adapted from Kiplinger's Retirement Planning 2007 guide. Order your copy today.
When it comes to making crucial decisions about retirement payouts, you don't get a second chance. Instead of checking off boxes and signing forms on the way to your retirement party, take time to weigh your options. Making mistakes can be very expensive. Avoiding them can save you thousands of dollars in taxes. Start planning your exit strategy a few years in advance to take full advantage of all your options.
Withdrawing money too soon
If you tap your retirement funds before age 59 1/2, you'll owe a 10% early-withdrawal penalty on top of the federal and state income taxes you'll pay on each distribution. There are exceptions that let you withdraw your money early without a penalty -- but only if you follow the rules.
From just $107.88 $24.99 for Kiplinger Personal Finance
Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
For example, if you are at least 55 in the year you leave your job, you may be able to start taking distributions from your 401(k) without paying a penalty, withdrawing as much as you like (but you will still owe income taxes on your withdrawals). The key is to keep your money in your employer's plan when you retire. If you transfer it to an IRA, you'll lose the "55-and-out" option.
That's what Jim Conrad of Huntertown, Ind., planned to do when he retired last fall after 33 years in the auto industry. But there's a catch: Your company plan isn't required to allow early periodic distributions. Conrad's plan didn't, forcing him and his wife, Colleen, to come up with Plan B. "We know we'll need to tap some of our savings for income," Conrad says. "We're just trying to figure out the best way."
Interrupting annual payments
So Conrad, 55, is considering another early-out strategy. If he rolls his 401(k) into an IRA, he can start tapping it penalty-free (but will still owe income taxes) as long as he takes "substantially equal periodic payments" based on his life expectancy for at least five years or until he's 59 1/2, whichever is longer. There are three ways to calculate these so-called 72(t) payments (named after the section of the tax code that waives the penalty), all of which can be done using the free calculators at www.72t.net.
Let's say you have $500,000 in your IRA when you begin taking distributions at age 56. The IRS life-expectancy table estimates that you will live another 28.7 years. Under the simplest minimum-distribution method, you would have to withdraw $17,422 the first year, then divide your subsequent IRA balances by your declining life expectancy for each of the next four years. The goal is to give yourself early access to some of your retirement savings without wiping out your account. The other two calculation methods would result in larger annual payouts.
If you don't need that much money, you can split your IRA into separate accounts and set up a periodic-payment plan with just one of them. The reverse calculator at www.72t.net lets you plug in the amount you want to receive each year and then tells you how much you need to allocate to the account.
Once you start, you can't change your mind. If you deviate from the payout schedule, you'll owe a 10% penalty retroactive to your first withdrawal, plus interest. Say you took out $75,000 in 72(t) withdrawals over four years, then stopped before reaching the five-year threshold. You would owe more than $8,000 in penalties and interest. Ouch!
Taking a check
If you decide to transfer your 401(k) or other retirement assets to an IRA, make sure they go directly to the new custodian. If your employer cuts you a check, the company will be required to withhold 20% for taxes and you will have to roll over the entire amount—including the 20% you didn't receive—into an IRA within 60 days. Any money not deposited into the IRA would be treated as a taxable distribution, subject to taxes and early-withdrawal penalties.
Forgetting about your spouse
If you're married and entitled to a traditional pension, you have to decide whether you want your spouse to receive survivor benefits. You'll get smaller monthly checks now, but your spouse will still get benefits if you die first.
As an alternative, some people choose to take the larger pension benefit and buy a term-life-insurance policy to provide for the surviving spouse. But that could backfire if the breadwinner outlives the term policy and then dies, leaving the survivor with nothing.
Even if the policy pays off, it can be an "emotional train wreck" for the surviving spouse, says Mary McGrath, a financial planner with Cozad Asset Management, in Champaign, Ill. The survivor would have to deal simultaneously with a loved one's death, an end to a monthly pension and a decision about how to invest the insurance money.
-
The Stoic Retirement: Ancient Wisdom for Today's RealityA "Stoic retirement" doesn't mean depriving yourself. It's a character-based approach to life and aging that can bring calm and clarity.
-
My Teen Crashed His Car and Now Our Insurance Has Tripled. What Now?Dealing with the costly aftermath of a teen car accident is stressful. Here are your options for navigating it.
-
11 Outrageous Ways To Spend Money in RetirementWhether you have excess cash to spend or want to pretend, here’s a look at 11 ridiculous ways retirees can splurge.
-
What Does Medicare Not Cover? Eight Things You Should KnowMedicare Part A and Part B leave gaps in your healthcare coverage. But Medicare Advantage has problems, too.
-
15 Reasons You'll Regret an RV in RetirementMaking Your Money Last Here's why you might regret an RV in retirement. RV-savvy retirees talk about the downsides of spending retirement in a motorhome, travel trailer, fifth wheel, or other recreational vehicle.
-
457 Plan Contribution Limits for 2026Retirement plans There are higher 457 plan contribution limits in 2026. That's good news for state and local government employees.
-
Estate Planning Checklist: 13 Smart Movesretirement Follow this estate planning checklist for you (and your heirs) to hold on to more of your hard-earned money.
-
Medicare Basics: 12 Things You Need to KnowMedicare There's Medicare Part A, Part B, Part D, Medigap plans, Medicare Advantage plans and so on. We sort out the confusion about signing up for Medicare — and much more.
-
The Seven Worst Assets to Leave Your Kids or Grandkidsinheritance Leaving these assets to your loved ones may be more trouble than it’s worth. Here's how to avoid adding to their grief after you're gone.
-
SEP IRA Contribution Limits for 2026SEP IRA A good option for small business owners, SEP IRAs allow individual annual contributions of as much as $70,000 in 2025, and up to $72,000 in 2026.
-
Roth IRA Contribution Limits for 2026Roth IRAs Roth IRAs allow you to save for retirement with after-tax dollars while you're working, and then withdraw those contributions and earnings tax-free when you retire. Here's a look at 2026 limits and income-based phaseouts.
