If you’re like most working Americans, chances are good that you’ve had access to a workplace retirement plan such as a 401k for decades. Hopefully, you’ve been faithfully contributing over the years and, by now, you have a decent-sized, tax-deferred nest egg.
But if you’re in the 50s or 60s, retirement is getting closer by the day, and the way you think about your 401k should be evolving. Yes, it’s still the same tax-sheltered, nest-egg-accumulating vehicle it always was.
But it’s also a distribution vehicle. And how you handle your distributions can potentially save you a small fortune in taxes.
Using Your 401k: The Basics
Before we get to that, let’s start with the contribution basics. In tax year 2017, you can contribute up to $18,000 to a 401k plan via salary deferral. The IRS hasn’t officially announced the 2018 limits, but it’s safe to assume it will be something in the ballpark of $18,500.
Of course, if you’re 50 or older, you can contribute an extra $6,000, bringing your total to $24,000 in 2017 and — presumably — $24,500 in 2018.
And remember, this is just your contribution and it doesn’t include any employer matching or profit sharing. Depending on your salary and your employer’s generosity, that can add thousands in additional contributions.
If you’re in your 50s or 60s, you’re at the absolute peak of your career, and you’re probably an empty-nester by now as well. So, there is really no excuse for you not to be maxing out your 401k plan contributions. Chances are good that you’re currently in the highest tax bracket you’ll ever be in, so sheltering every dime you can makes all the sense in the world.
So, your first order of business is this: Check with your company’s HR department to make sure you’re maxing out your contributions. If it has been a while since you’ve reviewed your contribution level, it’s possible that you’re still “maxing out” at an $18,000 annual level. Make sure you bump that to $24,000 and be prepared to adjust it higher again come Jan. 1.
If you and your spouse are both still working, you can potentially put back $48,000 together, plus any employer contributions.
That’s the easy part. Now, let’s talk about the best way to take distributions. And here too, it makes sense to review the basics.
Once you reach age 59 ½, you can take penalty free distributions from a 401k plan. But just because you can doesn’t mean you should. You’re not actually required to start taking distributions until you reach age 70 ½, and even here, there is a little flexibility. If you’re still employed at age 70 ½ or older and actively contributing, you generally don’t have to start taking required minimum distributions (RMDs) until the year you retire.
Any dollar you take out of a 401k plan is subject to regular income tax. So it makes sense to delay taking distributions for as long as absolutely possible.
But, let’s say you’ve done well and plan to retire young, in your 50s or 60s. Even then, I recommend you push off taking distributions for as long as reasonably possible. If you’re retiring young, that presumably means you have ample savings outside of your 401k.