Erin: Jordan, so good to see you. I’m going to start with a really important question. When should you start taking money out of your 401k?
A 401k is, of course, one of the most powerful savings tools available, but if you take the money out too early, you could face penalties, wait too long, and RMDs could push you into a higher tax bracket. It all comes down to figuring out your ideal retirement income strategy.
So, let’s start with the basics. For the most part, we all save in those tax deferred 401ks. Why is that important?
Jordan: Yeah. Well, a lot of people are making a lot of money and they say, “I want to save taxes.” So, this is a great strategy to reduce your taxes now, but eventually you will have to pay tax on that money. So, you need to make sure you have a plan to see does it make sense? But generally, most people want to save taxes now with their earning years because their incomes are higher and they want to reduce that taxable income,
Erin: Right. And we’re going to circle back to that theme in a second. But I do want to talk about if you take a distribution from your 401k before you’re allowed, before 59 and a half, what do you give up?
Jordan: It’s going to hurt, right. You’re going to have to pay the taxes at maybe your individual brackets, which is maybe 30% or so based on tax laws. You’re going to pay additional 10% IRS penalty. Almost half of those funds are not going to be going to your pocket. They’re actually going to be going to the IRS penalties. So generally speaking, you really don’t want to take out before 59 and a half unless it’s a crisis situation.
Erin: Now once you are 59 and a half though, you’re allowed to start taking those withdrawals and these distributions can affect your tax bracket again if these accounts have been tax deferred. Explain please Jordan.
Jordan: Yes. So now you say you’re 59 and a half, you want to take money out to live on it or supplement your lifestyle. Well, your taxable income is still going to go up every distribution you take. And based on the brackets we can see, you might be paying ~20% – 30%. It just really depends on your tax plan and what you have in place. But every dollar is not tax free. It’s going to be taxable when you take it out if it is in a prequalified 401k.
Erin: Now, there also comes a time when the government forces you to start taking those distributions. Those are known as required minimum distributions. And for the most part, when do these start? And just explain how this can be a real tax burden, Jordan.
Jordan: Yeah. The government you kind of save in taxes for decades. So they want you to spend the money. What they really want is your the tax revenue on that money. So at 73 or 75 based on your date of birth, they force you to take these distributions out, which is going to put you potentially in higher tax brackets, which could affect your social security being taxed. It could affect your Medicare excess premiums because they have a two-year look back. It could just put you in higher tax brackets because maybe taxes on 5 or 10 years are a lot higher than they are now. So, it can be a domino effect on those RMDs. So, we need to make sure we plan for that and make sure that we avoid that being a big impact in your long-term tax strategy.
Erin: So, then Jordan, if I came to you today and I wanted to talk through how to reduce my tax burden when I am retired and want to start taking distributions for my 401k, what strategies should we consider? Because of course, it is a delicate balance between wanting your nest egg to grow, but the larger it gets, so does the bigger your tax burden.
Jordan: Yeah, there is a lot of strategies out there based on everyone’s individual situation. So, we don’t just look at one strategy. We look at multiple strategies. But I’ll give you just one idea. So, one idea is doing some Roth conversions so that you have some of your money that’s tax-free that so if you need to draw upon that, you don’t have to go in the higher tax bracket, pay more Medicare excess premiums. You pay the taxes now so you don’t pay them in the future. We recommend for everyone though being diversified. And that doesn’t mean stocks, bonds, and mutual funds. That means being tax diversified. So you have some money that’s in non-qualified, some money that’s in qualified IRA or 401ks, and somebody in those tax-free Roth.
So based on the tax laws that are ever changing, we can pull from different accounts and different levers to make sure we stay in that nice tax glide path so we give less to the IRS and keep more of our hard-earned money in our pockets.
Erin: The key is creating that plan earlier rather than later, especially the fact that we are living in a historically low tax rate right now. So Jordan, I think now is the time for everybody to at least, you know, crunch the numbers on a Roth conversion, talk it through with a tax expert, have a tax plan, which again, I know is something you’re always preaching. So Jordan, if somebody would like to sit down and do that with you, how can they reach you?
Jordan: Yeah, just to clarify, a Roth conversion is not a tax plan. It’s one aspect of potentially a tax plan, but we need to make sure we look at all the different planning strategies to get you the most benefit. To start that conversation, our main number is 847-499-3454.
Looking forward to pay the IRS less and keep more of your hard-earned dollars.
Erin: Yeah, good point. All right. And everybody who’s watching us on YouTube, we’ve also done several different videos on Roth conversions and why they might help you in your retirement. So, please like and subscribe so that you don’t miss any of those great videos. Jordan, thank you so much for your time today.
Jordan: Thanks, Erin.
