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How do I invest my 401(k) two years from retirement?

how_do_i_investQ: I am 60 years old and plan to retire at 62. Because social security would not be enough to live on, I want to keep investing some of the money I've accumulated in my 401(k) to generate extra retirement income. Could you suggest how I should be invested?

A: As you approach retirement, you may have to rethink your 401(k) investment strategy. To design an effective strategy for your 401(k) investments in retirement, consider these three elements:

  1. Your investment time horizon
  2. Your withdrawal rate
  3. Interaction with social security money

Read on to see how these elements work together to form a strategy for your 401(k) investments.

401(k) investment considerations as you approach retirement

Investing is often about striking a balance. In your case, that balance includes working out the trade-off between near-term and long-term needs, as well as understanding how your 401(k) money can complement your social security benefits. Here's what you should take into account in striking the right balance:

  1. Time horizon
    You might assume that being two years from retirement equates to a fairly short investment horizon. However, your actual time horizon is probably closer to 25 years than two years.

    You will need to invest for your probable life span, and that is long enough for inflation to significantly erode the value of your holdings if you don't retain a growth element to your portfolio. Therefore a blended stock and bond portfolio is probably more appropriate for you than shifting completely to stable income investments.

    Note that, even if you leave your company's 401(k) plan when you retire, you can roll the money over into an IRA. Traditional IRAs allow you to maintain similar tax treatment to a 401(k) and thus delay the point where you have to pay taxes on your retirement savings.

  2. Withdrawal rate
    One thing that impacts your time horizon is how quickly you withdraw money from your retirement plan. Try to draw down your retirement assets at a slow enough pace for them to last at least as long as your likely lifespan. If you need to draw down those savings more quickly, it effectively shortens your investment time horizon and that means you should be more conservatively invested.

    Be advised that if you withdraw a fixed dollar amount every year, as your savings draw down, that dollar amount will become a progressively larger percentage of the remainder. That means that the pace of depletion will accelerate. This is another reason to try to limit how much you take out every year.

    Note that, even if you reach a point where you have to make required minimum distributions from your retirement plan, you don't have to spend all of those distributions as you take them. You can keep the money invested in an after-tax investment portfolio, perhaps setting it up in CDs structured to provide you with liquidity to live off at regular intervals.

  3. Social security strategy
    If social security is able to meet a meaningful portion of your post-retirement expenses, then it effectively behaves like an income-producing investment and allows you to invest your other retirement savings a little more aggressively.

    However, if you retire at 62, you will have to decide whether to settle for smaller social security payments by beginning to draw them at that point or to delay taking social security in favor of larger payments down the road. You should make this decision before deciding how to adjust your 401(k) investments. If you decide to delay taking social security, it could mean drawing more heavily on your retirement plan savings in the interim, suggesting a more conservative stock/bond blend is appropriate.

As you can see, even though retirement may seem to be coming up in a couple years, the decisions you make about your 401(k) investments should be part of a much longer term retirement funding plan.


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