You can start taking money from your 401(k) penalty-free at age 59 ½. So you shouldn’t be penalized if you are 60 and beginning to withdraw money from your retirement plans. However, you will still be taxed at your ordinary income tax rate, so you’ll want to explore ways to reduce the burden.
Here are a few options.
Traditional 401(k) accounts allow you to invest with pre-tax dollars, but withdrawals are taxed. Roth accounts work differently, as you invest with after-tax money and don’t pay taxes on the money you take out.
If you are concerned about entering a higher tax bracket in future years or triggering higher Medicare premiums, especially when Required Minimum Distributions start at 73, consider converting the account to a Roth IRA. This could be done by rolling over the money to a Roth IRA when you leave your job.
While this has tax consequences, as you will be taxed on the converted funds, you can be strategic about when you do a conversion. You may want to convert small amounts at a time to stay in a lower income tax bracket or plan your conversion for a year when your income is low.
Keep in mind that a five-year rule applies after a conversion. That is, if you withdraw any earnings within five years of moving the money into your Roth, you may owe taxes on the withdrawal. However, you can withdraw your contributions without taxes or penalties at any time.
If you already rely on your 401(k) to provide income, or will in the coming five years, a conversion may not work for you.
Read more: An alarming 97% of older Americans are carrying debt into retirement — here’s why and 4 simple things you can do if you’re stuck in the same situation
Don’t just start withdrawing money from your retirement accounts. You need to be strategic about withdrawals. Otherwise, you could face much higher taxes if you have to withdraw a lot of money once Required Minimum Distributions (RMDs) begin.
Some experts recommend exhausting taxable accounts first while allowing tax-deferred accounts like a 401(k) to keep growing. However, depending on how much money you have coming from other sources and how much your RMDs will be, it may be better to take regular withdrawals from multiple accounts throughout retirement.
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