Over your working years, you diligently contribute to your 401(k) in preparation for retirement. But what happens once you get there? Retirement marks a significant life transition, which includes switching from saving your money to creating more with your savings.

So, how does a 401(k) work when you retire? In short:

• Once you’re 59½, you can begin taking withdrawals without penalty.
• With a traditional 401(k), you’ll have to pay income tax on your withdrawal.
• If you haven’t started taking withdrawals by age 73, you’ll need to begin doing so in the year you turn 73.

You can begin withdrawing funds penalty-free at age 59½

When you withdraw funds from your 401(k) before you turn 59½, you will typically be hit with a 10 percent penalty. But once you turn 59½, that penalty is waived, Woo!. At this point, you can begin taking withdrawals ( known as distributions). Even if you don’t need the money, the IRS will require you to start taking withdrawals from your 401(k) if you’re retired beginning at age 73, a requirement known as required minimum distributions (RMDs). The RMD withdraw amounts depend on your retirement account balances and life expectancy. You will want to stay on top of your RMDs. If you fail to take them, you’ll have to pay added taxes on the distributions. 

You will owe tax on your 401(k) distributions.

Traditional 401(k) contributions are often pretax, lowering your taxable income during your working days. Because the money was not taxed when you contributed it, you’ll have to pay income tax on your distributions, regardless of age. This is where some strategy comes in. You can take smaller withdrawals over a long period or group withdrawals into larger lump sums. But be careful. If you withdraw too much in a given year, you could put yourself into a higher tax bracket, meaning the government will take a larger portion of your savings. To make sure you can keep more of what you’ve saved, your financial advisor can assist you look at strategies to reduce your taxable income in retirement, thus reducing your income tax rate during retirement.

How does a 401(k) work when you retire?

It’s important to know that there are no rules for how you should use your 401(k) when you retire. You may keep your 401(k) with your employer and take distributions from it or, if you’d like to take advantage of better investments, you can roll over your 401(k). How and when you choose to access those funds will depend on your retirement plan, which you’ll want to have mapped out well before you retire. Planning ahead is key to a smooth retirement transition.

Remember that a 401(k) is not a retirement income plan. While it’s undoubtedly a smart way to save for your future and plays an important part in building your foundation a 401(k) is just one source of income you’ll probably depend on in retirement. The key to maximizing what you’ve saved in your 401(k) is deciding how you’ll use it with other sources of income in retirement.

Source: https://www.northwesternmutual.com/life-and-money/how-does-a-401k-work-when-you-retire/