Key takeaways

• Some 401(k) plans require funds to be distributed in a fixed order, which can reshape portfolio risk.
• Required minimum distributions (RMDs) and withdrawal rules are evolving, often with more exceptions and flexibility than in the past.
• Loans and hardship withdrawals can help meet short-term needs, but may carry long-term tradeoffs as well

Withdrawal settings and tax rules may affect how long 401(k) savings last, and how much of it remains in the participant’s account.

People may be familiar with the requirements around withdrawing money from a 401(k) account, whether it’s for retirement expenses or keeping up with required minimum distribution (RMD) rules. Fewer may realize their plans could restrict how that money comes out. Plan withdrawal rules can determine which investments types get sold first.

This structure has the potential to shift a 401(k)'s risk profile. Withdrawal hierarchies can create changes that can go without notice, but may end up altering the overall structure of a portfolio in a person’s retirement years.

What withdrawal hierarchy rules mean

Some retirement plans allow account holders to choose which funds to draw from. Others require withdrawals to be made on a “pro-rata” basis, which means withdrawals happen across all the account’s investments at any risk level.¹ This can help keep the same amount of risk, even as people draw down from their retirement account.

Hierarchy-based withdrawals operate differently. These plans pull from a ranked list of investments, and may draw down more conservative holdings (such as cash or conservative bond funds), and then working their way up in terms of risk. This means the highest-risk investments could be the ones left in the account the longest.²

Although this may provide a longer investment period for higher-yield potential assets, it may also leave a portfolio with higher risk when low- to moderate-risk 401(k) strategies are preferred. In other words, these plans may gradually increase volatility exposure rather than decrease it, all while retirees may want to preserve their account balance against market trends.

Account holders may not know whether their plan is pro-rata or hierarchy-based.³ Plan summaries may not always include specifics on redemption rules. The recordkeeper, who executes on day-to-day operations, has access to information on what investments come out first.

Read more: 401(k) withdrawal rules: How to avoid penalties

Why the withdrawal order matters

The asset allocation in a 401(k) can shift with every withdrawal. Pulling cash, bonds, or low-risk liquid investments may reshape the portfolio by having in medium- to high-risk holdings.⁴ Over time, what started as a balanced 50/50 portfolio could quietly shift to 60/40 — with more money in riskier investments than originally planned. 

This drift may seem minor at first, but it may add up over time. Retirees tend to draw down during volatile markets, rather than neutral or bullish periods.⁵ If hierarchy withdrawals pull conservative assets first, the 401(k) balance may be more exposed to market swings.⁶

Withdrawal mechanics may not always be easy to find

Retirement plan documents may tend to focus on contribution rules, fees, and eligibility.⁷ Withdrawal mechanics may not be as visible, even though they’re important.

Some plans follow pro-rata rules to meet IRS distribution requirements. But in this case, “pro rata” may only refer to how tax obligations are sourced, rather than which investments are sold and when.⁸ Participants may assume withdrawals are spread evenly across holdings, even though their plan actually uses a hierarchy system.⁹

Read more: 401(k) vs. 403(b): What's the difference?

What retirees can do about 401(k) withdrawals

Pro-rata and hierarchical drawdowns are about how the mechanics of a plan works, rather than trying to time the market. There are several things retirees should consider if they are curious about their plans’ draw-down method:

• Ask about their plan’s withdrawal protocol: Find out whether the plan uses a hierarchy or pro-rata format, and if holdings can be selected for sale.
• Request information: Account owners in hierarchical plans may want to request a copy of plan documents describing the order of execution for accounts, which may serve as a blueprint for what assets are sold and when.
• Consider rebalancing before withdrawing:^* Adjusting assets to match risk tolerance may help offset the chance of high-risk investments dominating one’s account after low-risk investments are sold.
• Watch for allocation drift: Small withdrawals may also tilt the portfolio mix. Staying on top of withdrawals can help preserve the asset allocation, which can be particularly important for keeping a sustainable 401(k) balance.

Keeping it in balance

One of the biggest potential retirement risks may not take the form of volatile markets or funding missteps. It may come from gradual, potentially unnoticed changes within a portfolio. 

Withdrawals processed automatically may shift the account’s balance without much notice. Not all plans sell off lower-risk investments first: it’s also possible that the plan could sell higher-risk stock investments and sell more conservative mutual funds and exchange-traded funds (ETFs) later on.¹⁰ The order, method, and mix all influence how a portfolio performs in different market conditions. Retirees may not see it happen unless they know where to look. But when they do, they may be able to help keep their balance while pulling out the funds they need.