You’ve heard the advice over and over: You should be putting money into your 401(k) or IRA. And, on the surface, this is good advice. You want to have a generous nest egg saved for retirement.
However, some hidden catches could mean investing too much in your IRA or 401(k) actually ends up backfiring. In fact, once you dig a little deeper, you may discover that you want to stop funding these accounts sooner than you’d think. Here’s why.
This is the big problem with over-funding an IRA or 401(k)
The big problem with investing in a 401(k) or an IRA is that both accounts are subject to Required Minimum Distribution (RMD) rules. This means you have to start withdrawing money from these accounts on a schedule set by the IRS once you turn 73 if you were born in 1951 to 1959, or once you turn 75 if you were born in 1960 or later.
Your RMDs can be pretty substantial. The IRS requires you to use a Uniform Lifetime Table to calculate how much to withdraw. Based on that table, a 73-year-old with a $1 million nest egg could be required to take an RMD of around $37,700 in the first year of being subject to RMD rules.
Withdrawals from 401(k) and IRA accounts are taxable, so taking such a large withdrawal could potentially push you into a higher tax bracket. It could also:
- Trigger tax on Social Security: Up to 50% of your benefits become taxable if your provisional income exceeds $25,000 for single filers or $32,000 for married joint filers. This percentage increases to 85% for single filers with provisional incomes above $34,000 and married joint filers with incomes topping $44,000. Provisional income is half of all Social Security, plus all taxable and some non-taxable income — and 401(k) and IRA distributions count.
- Cause your Medicare premiums to soar: Medicare applies an Income-Related Monthly Adjustment Amount (IRMAA) if your modified adjusted gross income exceeds a certain threshold ($109,000 for single filers and $218,000 for married joint filers). IRMAA calculations are made using income from two years prior, so these numbers are based on 2024 income and determine if you’ll pay higher Medicare premiums in 2026.
If you don’t want to be forced to take out money when you don’t want to and get hit with a big tax bill because of it, investing as much as you can into a 401(k) or an IRA may not be the way to go. Investing less in these accounts and ending up with lower balances allows you to take lower RMDs, which gives you more control over your cash flow and can help keep taxes to a minimum.
What should you do with your money instead?
Not everyone should limit 401(k) or IRA contributions. The right choice depends on your specific needs. However, if you’re concerned about the IRS taking a big cut from your retirement income, consider capping your traditional 401(k) and IRA investments and opting for alternatives like Roth accounts and even taxable brokerage accounts.
Roth IRAs don’t require RMDs during the account owner’s lifetime, and Roth 401(k) accounts no longer require RMDs after 2024, thanks to changes made in the SECURE 2.0 Act. You do give up the upfront tax deduction with both accounts, but you also enjoy tax-free withdrawals from your 401(k) or IRA funds, plus you don’t have to worry as much about your high income impacting other benefits.
HSAs can also be a great alternative with a triple tax break if you use the money to cover qualifying medical expenses as a retiree. You won’t pay taxes on contributions, won’t pay taxes as your money grows, and won’t be taxed on withdrawals. If you don’t use the money for medical expenses, you also have the option to withdraw it after 65 penalty-free and just pay taxes at your ordinary rate. But you aren’t required to, as there are no RMDs for HSAs.
Exploring these other accounts could be a better approach than just continuing to sock away money in your traditional 401(k) or IRA. Talk to a financial advisor about them ASAP — especially if you’ve been investing heavily in your traditional accounts and are already on track for tax trouble as a senior.
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