To the extent possible, it makes sense to spend every taxable nickel you have before taking distributions from your 401k plan (or at least taking distributions larger than the minimums required by the IRS). Every year you postpone taxation is an extra year for your 401k plan to compound and grow.
As an example, let’s say you have a liquid net worth of $1 million, half of which is in a 401k plan and the other half in a taxable brokerage account invested in stocks and bonds. It makes sense to spend down that half a million dollars in the taxable brokerage account to nearly zero before touching the 401k assets.
And this is equally true if you are thinking of leaving a legacy to your kids or grandkids. RMDs on inherited retirement accounts are based on the life expectancy of the beneficiary, not the original owner. So, your kids or grandkids could potentially benefit from additional decades of tax-deferred compounding. Taxes indefinitely deferred are effectively taxes avoided altogether.
One word of advice regarding 401k funds you intend to leave to your heirs: Not all plans allow your heirs to stretch out their distributions, so if you’re already retired, it probably makes sense to roll the assets into a Rollover IRA. Your heirs will potentially have more flexibility and less headache with an inherited IRA than they might with an inherited 401k.
And naturally, you shouldn’t just take my word for it. My advice here is extremely broad, and everyone’s situation is a little different. So, it’s probably worth your time and money to sit down with a financial planner.
Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas.