Have A Large 401(k) Balance and Entering Retirement? Make Sure You Do This Now

If you have a large 401(k) balance, you’re in a good position heading into retirement. Far too many people have too little saved, and given that Social Security replaces only 40% of income, having money in a 401k(k) or other retirement plan is key to having financial security as a senior.

However, while it’s undoubtedly positive to have plenty of 401(k) funds, you also need to make sure that you have a plan for how you’ll manage this money. In particular, there’s one thing you should check off your to-do list before you enter retirement to ensure you’re making the most of your 401(k) funds. 

Take care of this critical task when entering retirement with a large 401(k)

When you are retiring with a big 401(k) balance, making a tax plan is one key task you have to take care of. That’s beause there are a few big issues that could be created by the large balance in your retirement plan. Here’s what they are:

• You will have to take RMDs. If you were born between 1951 and 1959, you must take RMDs starting at age 73. If you were born in 1960 or later, your RMDs start at 75. RMDs mandate that you take a certain amount of money out of your 401(k) each year, with the specifics based on your age and life expectancy. With a large 401(k) balance, you may have to withdraw a substantial sum. This could affect your tax rate since 401(k) distributions are taxable. 
• You may find your Social Security benefits are partly taxed. When you take withdrawals from a 401(k), this is considered taxable income that counts when a determination is made on whether your Social Security benefits are taxable. Specifically, once your provisional income hits $25,000 for a single tax filer or $32,000 for a married joint filer, you will be taxed on up to 50% of your benefits, and once your provisional income hits $34,000 for single filers and $44,000 for married joint filers, you will be taxed on up to 85% of your benefits. 

These are major issues that you need to plan for, because otherwise, you could take a huge tax hit as a senior.  

How can you devise a smart 401(k) withdrawal strategy?

Before retiring, you should take a close look at the total assets you have and the total amount of income you will have coming in from different sources, including your large 401(k). This can help you to decide:

• Which accounts to draw from first
• What your tax bracket looks like now versus later in retirement
• Whether you should delay your Social Security and rely more on your 401(k) withdrawals temporarily in order to increase your monthly Social Security benefit and draw down your 401(k) balance before RMDs begin
• Whether you should convert some or all of your 401(k) funds to a Roth account

These are complicated questions, especially given that a Roth conversion is a taxable event that can create new limits on when you’ll be able to access your money without penalty. 

Working with a financial advisor can be the best way to create a tax-efficient plan that preserves your wealth, helps you avoid being bumped into a higher tax bracket, and gives you the best chance at having a sustainable income throughout your retirement. Do this before you retire so you don’t just start taking money out of your 401(k) and come to regret it.