401(k) Withdrawals and the Minimum Withdrawal Age
401(k) plans can be a set-it-and-forget-it retirement account. In some ways, this is great—once you set them up, they continue to grow without any further input from you.
Once you check your balance several years later, you might realize how much money you have in your account. And having access to that much money can be quite alluring!
But these funds are intended to become your retirement income. With that in mind, you might wonder at what age you should start making withdrawals from your account.
When it comes to figuring out the right age to withdraw funds from your 401(k), there are several factors to consider, such as age, taxes, and retirement goals. So, let’s go over those factors to help you better understand what age is the right age to start making 401(k) withdrawals.
How Taxes and Age Impact 401(k) Withdrawals
When it comes to 401(k) withdrawals, there are two key factors to consider: taxes and your age.
401(k) plans, just like Traditional IRAs, are pre-tax retirement accounts. This means that you won’t need to pay taxes on the income you contribute. However, you’ll need to pay taxes when you withdraw that money from your 401(k).
The amount you’ll pay in income taxes depends on your tax bracket at the time of withdrawal. You’ll owe these taxes on top of any withdrawal penalty you might incur. For larger withdrawals, it’s best to consult with a tax expert before acting to avoid unexpected tax implications.
On the age side, the magic 401(k) withdrawal ages are 59 1/2 and 72. Age 59 1/2 is the threshold to avoid the 10% early withdrawal penalty on top of ordinary income taxes. While there are some exceptions to this penalty for reasons like disability or certain health expenses, the standard rule is that withdrawing funds before this age will incur the penalty.
At age 72, the IRS requires that you start taking Required Minimum Distributions (RMDs) from your traditional 401(k) or Traditional IRA. If you fail to withdraw the required amount, the penalty can be as much as 50% of the amount you were supposed to withdraw. Consulting with a financial advisor or tax professional as you approach this age can be crucial for ensuring compliance with RMD rules.
Withdrawing money from your 401(k) before the minimum withdrawal age can have significant financial implications. If you withdraw before 59 1/2 and don’t qualify for any of the few exceptions, be prepared to pay both ordinary income tax and an additional 10% early withdrawal penalty on the amount withdrawn.
Keep in mind that a 401(k) offers tax-deferred growth. So, if you can afford your lifestyle until age 72 without making withdrawals, your investments can continue growing even during retirement. This can help you maximize your retirement income after taking RMDs at age 72.
You should also consider your retirement goals. Accessing your 401(k) funds early could prevent you from having enough money for retirement. Generally, taking early withdrawals from your retirement plans should always be your last resort.
401(k) vs. IRA
When it comes to withdrawals, the rules for a traditional 401(k) and a traditional IRA are essentially the same. Both are pre-tax retirement accounts that require you to pay income taxes upon withdrawal. They also abide by the same age-based withdrawal rules and early withdrawal penalties. So, choosing between a traditional 401(k) and IRA can come down to their one primary difference: who manages the account.
Typically, employers offer a 401(k). The plan administrator is often either the employer themself or a financial institution they’ve chosen.
An IRA is an individual plan you shop for and buy yourself. So, you have greater control over the management and investment options, such as mutual funds, stocks, or bonds.
Converting Your 401(k) to an IRA
If you’ve left your employer or are considering more investment options, you might consider converting your 401(k) to an IRA. The process of converting a 401(k) into an IRA is called an IRA conversion. It might also get referred to as a 401(k) rollover, though this more often means rolling over funds from one 401(k) to another.
First, you’ll need to pick a custodian—the company from whom you’re buying the IRA. Many custodians are out there, so choose one that offers extensive education and support to manage your IRA effectively. If you’re planning a conversion, make sure they can accept qualified funds from a 401(k). Once you’ve selected a custodian and opened an IRA with them, you can then request a rollover from your 401(k) provider.
This process typically involves providing the name and account number of your new IRA, so it’s best to have this ready before initiating the rollover. Sometimes, your 401(k) provider might send you a physical check payable to your new IRA custodian. If this happens, you have a 60-day window to deposit these funds into your new IRA. If you fail to deposit the funds within 60 days, they’re considered taxable income, and you’ll be required to pay taxes on them.
Roth 401(k) and Roth IRA
Another option to consider in your retirement plan is the Roth 401(k) or the Roth IRA. Unlike traditional 401(k) plans and IRAs, these accounts are funded with after-tax dollars. This means that when you withdraw funds from a Roth 401(k) or Roth IRA, the withdrawals are typically tax-free, provided certain conditions are met.
In the case of Roth 401(k) plans, the same age rules apply as traditional 401(k)s. You can withdraw your contributions and earnings tax-free if you’re at least 59 1/2 and the account has been open for at least five years. For Roth IRAs, you can always withdraw your contributions tax-free and penalty-free at any age. However, to withdraw earnings tax-free, you must be at least 59 1/2, and the account must be at least five years old.
The Importance of a Strategic Retirement Plan
Creating a strategic retirement plan is more than just saving money in your 401(k) account. It involves understanding how and when to withdraw funds, managing your tax bracket, and potentially diversifying with other retirement accounts (like a Roth IRA).
A well-rounded retirement plan considers your current financial situation, your retirement goals, and the best ways to utilize your retirement accounts to achieve those goals. This includes understanding the benefits and drawbacks of early withdrawals, the implications of your tax bracket on your retirement savings, and the potential advantages of a Roth IRA.
It’s also important to remember that every individual’s circumstances are different. What works best for one person may not be the best solution for another. This is where the expertise of a financial advisor comes in. By considering your personal financial circumstances and goals, you can create a retirement plan tailored to your needs.