401(k) Withdrawal Tax Strategies: Keep More of Your Money

You’ve worked hard, saved diligently, and watched your 401(k) balance grow. But as you approach retirement, a new challenge emerges: how to withdraw those funds in a way that keeps more money in your pocket and less goes to the IRS. Taxes can take a big bite out of your retirement savings if you’re not careful. That’s why having a smart withdrawal strategy is just as important as saving in the first place. By understanding 401(k) withdrawal tax strategies, you can stretch your savings further and enjoy a more comfortable retirement.

Withdrawing money from a 401(k)? Get ready to face a tax burden. The good news is that this can be done tax-free if not done strategically. We look at how 401(k) withdrawals are taxed and how to skirt them. Read on!

How Are 401(k) Withdrawals Taxed?

Most people contribute to a traditional 401(k) with pre-tax dollars, which means you get a tax break up front. But when you start taking money out in retirement, those withdrawals are treated as ordinary income. The amount you withdraw is added to your other income for the year and taxed at your marginal rate. Depending on your income and filing status, this can range from 10% to 37%.

For example, if you withdraw $30,000 from your 401(k) and your other income is $40,000, you’ll be taxed on a total of $70,000. This could push you into a higher tax bracket, especially if you take large withdrawals in a single year.

Early Withdrawal Penalties

If you take money out of your 401(k) before age 59½, you’ll usually face a 10% early withdrawal penalty on top of regular income tax. There are some exceptions: for example, if you become disabled, face high medical expenses, or separate from your employer at age 55 or older (the “rule of 55”). However, early withdrawals are costly in most cases and should be avoided if possible.

Roth 401(k) Withdrawals

Roth 401(k)s work differently. Contributions are made with after-tax dollars, so qualified withdrawals in retirement are tax-free. To qualify, the account must be at least five years old, and you must be at least 59½. Non-qualified withdrawals of earnings may be subject to tax and penalties, but your contributions can always be withdrawn tax-free.

Sequencing Withdrawals for Tax Efficiency

Conventional Wisdom: Taxable, Tax-Deferred, Then Tax-Free

One common strategy is to withdraw from your taxable accounts first (like brokerage or savings accounts), then from tax-deferred accounts (like your 401(k) or traditional IRA), and finally from tax-free accounts (like Roth IRAs or Roth 401(k)s). This approach allows your tax-advantaged accounts to keep growing as long as possible and can help you manage your taxable income each year.

Proportional and Personalized Strategies

While the conventional wisdom works for many, it’s not always the best for everyone. Some retirees benefit from a proportional withdrawal strategy, taking a mix from taxable, tax-deferred, and tax-free accounts each year. This can help you “fill up” lower tax brackets and avoid big jumps in your tax rate. Personalized strategies, often developed with a financial planner, can be tailored to your unique income, expenses, and goals.

For example, you might take enough from your 401(k) to stay within the 12% tax bracket, then supplement with Roth withdrawals or taxable accounts as needed.

Managing Required Minimum Distributions (RMDs)

RMD Rules and Tax Impact

Once you reach age 73 (as of 2025), the IRS requires you to start taking Required Minimum Distributions 401k Withdrawal Age: Planning Your Retirement Finances(RMDs) from your 401(k) each year. Using IRS tables, the amount is based on your account balance and life expectancy. RMDs are taxed as ordinary income and can’t be rolled over into a Roth IRA or other retirement account.

If you don’t take your RMD by the deadline (usually December 31), you’ll face a penalty of 25% of the amount you should have withdrawn (reduced to 10% if corrected quickly). RMDs can push you into a higher tax bracket and may increase your Medicare premiums or the portion of your taxable Social Security benefits.

Strategies to Reduce RMDs

• Roth Conversions: Converting part of your 401(k) to a Roth IRA before RMDs begin can reduce your future RMDs, as Roth IRAs are not subject to RMDs for the original owner.
• Early Withdrawals in Low-Income Years: Taking withdrawals before RMD age, especially in years when your income is lower, can help spread out your tax liability.
• Qualified Charitable Distributions (QCDs): If you’re charitably inclined and over age 70½, you can direct up to $100,000 per year from your IRA to a qualified charity, satisfying your RMD and avoiding income tax on the amount.

Advanced Tax-Saving Strategies

Roth Conversions

A Roth conversion involves moving money from your traditional 401(k) or IRA into a Roth IRA. You’ll pay income tax on the amount converted, but future withdrawals will be tax-free. Converting in years when your income is lower (such as early retirement or after a job loss) can minimize the tax hit. Spreading conversions over several years can help you avoid jumping into a higher tax bracket.

Tax-Loss Harvesting and Capital Gains Management

If you have taxable investment accounts, you can use tax-loss harvesting to offset gains and reduce your overall tax bill. Selling investments at a loss allows you to deduct up to $3,000 in losses against ordinary income each year, with the rest carried forward. Coordinating withdrawals from your 401(k) with capital gains management in your taxable accounts can optimize your total tax situation.

Timing and Spreading Withdrawals

Instead of taking large lump-sum withdrawals, consider spreading your 401(k) distributions over several years. This can help keep you in a lower tax bracket and reduce the impact on your Medicare premiums and Social Security taxation. Planning withdrawals to “fill up” lower tax brackets each year is a powerful way to keep more of your money.

Charitable Giving

Qualified Charitable Distributions (QCDs) are a win-win for retirees who want to support causes they care about. By directing RMDs from your IRA to charity, you avoid paying income tax on the withdrawal and satisfy your RMD requirement. This strategy is only available from IRAs, not 401(k)s, but you can roll over your 401(k) to an IRA to take advantage.

Common Mistakes to Avoid

• Making Lump-Sum Withdrawals: This can push you into a higher tax bracket, increase Medicare premiums, and make more of your Social Security taxable.
• Forgetting About State Taxes: Some states tax 401(k) withdrawals, while others do not. Know your state’s rules to avoid surprises.
• Missing RMD Deadlines: Missing an RMD can result in steep penalties. Set reminders and double-check calculations.
• Overlooking Social Security and Medicare Impacts: Higher income from withdrawals can increase the taxes on your Social Security benefits and raise your Medicare Part B premiums.
• Ignoring Spousal Planning: Married couples should coordinate withdrawals to optimize household tax brackets and manage RMDs effectively.

How Beem Can Help Optimize Your 401(k) Withdrawal Strategy

Beem offers a suite of digital tools to make your retirement withdrawals more tax-efficient:

• Budget Planner for Withdrawal Scenarios: Model different withdrawal strategies and see the tax impact in real time.
• Reminders for RMDs and Tax Deadlines: Never miss an important date with automated alerts.
• Track Balances, Conversions, and Charitable Distributions: This will help you organize all your retirement accounts, Roth conversions, and QCDs in one place.
• Holistic Planning: Integrate your withdrawal strategy with your broader retirement plan, including Social Security, Medicare, and taxable accounts.

With Beem, you can confidently approach retirement withdrawals, knowing you have the tools to maximize your income and minimize your tax bill.

Conclusion

How you withdraw money from your 401(k) can hugely impact your retirement lifestyle. By understanding the tax rules, planning your withdrawals carefully, and using advanced strategies like Roth conversions and QCDs, you can keep more of your money working for you. 

Avoid common mistakes, stay organized, and consult a financial advisor when needed. With careful planning and the help of digital tools like Beem, you can take control of your retirement savings and build a more secure financial future. It is a smart wallet app with numerous features, from cash advances to help with budgeting and even tax calculations. In addition, Beem’s Everdraft™ lets you withdraw up to $1,000 instantly and with no checks. Download the app here.

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