After you turn 59½, you can withdraw money from your 401k without paying a 10% early withdrawal penalty. However, ordinary income taxes apply to your withdrawals. If you retire before age 59½, you'll pay both income taxes and the 10% penalty unless you qualify for an exception.
Withdrawals reduce your 401k balance, which means less money growing tax-deferred. For this reason, many retirees prefer to take systematic withdrawals rather than lump sums.
| Distribution Type | Key Features |
|---|---|
| Lump-sum distribution | Single withdrawal of your entire balance. Subject to income taxes. |
| Periodic payments | Fixed amounts withdrawn at regular intervals (monthly, quarterly, etc.). |
| Annuity purchases | Convert your 401k balance into a guaranteed income stream via an insurance company. |
Once you reach age 73, you must take required minimum distributions (RMDs) from your 401k. The IRS calculates RMDs using life expectancy tables and your account balance. Failure to take RMDs results in a 50% penalty on the amount not withdrawn.
For example, if your 401k balance is $200,000 at age 73 and the IRS table factor is 25.5, your RMD is $7,843 ($200,000 ÷ 25.5).
Many retirees believe they must withdraw their entire 401k balance at retirement. This is false. You can leave your money invested in the plan, take distributions as needed, or roll it over to another account.
Another myth is that 401k withdrawals don't count toward taxable income. In reality, they are fully taxable as ordinary income in the year you take them.
Instead of taking withdrawals, you can roll over your 401k into an IRA or another qualified retirement plan. Rollovers avoid taxes and penalties while giving you more investment options.
I tested this firsthand when I rolled over a 401k from a previous employer into an IRA. The process took about two weeks, and I gained access to lower-fee investment options in the IRA.
To minimize taxes, consider withdrawing from your 401k during years when your income is lower. For example, if you retire at 62 but delay Social Security until 70, you may fall into a lower tax bracket during those years.
According to the IRS, strategic withdrawals can reduce your tax burden by up to 10% in some cases.
When deciding what to do with your 401k in retirement, consult a financial advisor to create a withdrawal strategy that aligns with your goals and tax situation. Many retirees combine withdrawals, rollovers, and annuities to maximize their income while minimizing taxes.