Savers for retirement can take advantage of significant tax breaks by contributing to a 401(k) plan. The fact that certain plans provide matching contributions from employers gives them an additional competitive advantage. With a few exceptions, you can make money from your 401(k) once you are 59.5 years old. Even in such a case, the typical penalty is 10% of the original amount. It is considerably more difficult to withdraw money from a 401(k) plan without being subject to the standard income tax. Nonetheless, some tactics may be utilized to gain access to the money while avoiding distribution-related taxes and penalties. If you have questions regarding the withdrawals from your 401(k), consulting with a financial counselor is another option. You will owe taxes when you take money out of your 401(k). Here is a look at some of the ways you may reduce the amount of those taxes.
Examine The Value That Was Not Realized (NUA)
If you hold company shares in your 401(k) and take a distribution to a taxable bank you may be entitled to net unrealized appreciation (NUA) treatment. Doing so can reduce the capital gains tax on the stock's appreciation while still paying income tax on the initial purchase price.
Hence, you should consider transferring the money to a taxable account instead of retaining it in a 401(k) or a conventional IRA. (You should seriously consider the decision to roll over business stock.) Due to its complexity, it may be recommended to seek expert assistance while employing this tactic.
Pay Attention to Your Tax Classification
Since your 401(k) payout is taxed entirely (or at least in part) according to your tax bracket at the time of distribution, it makes sense to accept distributions up to the maximum of your tax bracket. Keeping your taxable income (after deductions) as low as possible is one of the best methods to reduce your tax burden. Take the case of a married couple who files taxes jointly. Earnings below $89,450 (from $83,550 in 2022) will keep you in the 12% tax bracket in 2023.
The next tax bracket up is 22%. Still, with a little forethought, you may withdraw only what you need from your 401(k) without incurring that additional tax burden and then supplement the rest of your withdrawals with after-tax investments, cash savings, or Roth savings. The same applies to major expenditures like a new car or an extended trip once you reach retirement age. You should take as little as possible from your 401(k) and consider making some or all of your withdrawals from a Roth IRA or after-tax funds.
The Tax Rate on Capital Gains Should Be Kept As Low As Possible.
Withdraw as little as possible from your 401(k) each year, so your long-term capital gains remain tax-free. For 2023, the income level for capital gains tax exemption is $44,625 for single filers and $89,250 for joint filers. In 2022, the 0% capital gains rate applied to taxpayers with taxable incomes of up to $41,675 for individuals and $83,350 for couples filing jointly. The additional sum was subject to a 15% tax. Pensions can be subtracted from yearly spending amounts, and the taxable component of Social Security income can be subtracted from the remainder. Then deduct the RMD if the person is over 73. Any remaining balance should be paid for by the retirees' 401(k) plans (k). Long-term capital gains in a brokerage account or Roth IRA can be liquidated to cover expenses beyond this threshold.
Think About Using Tax Loss Harvesting
Selling stocks underperforming in your normal investing account is a tax-loss harvesting approach. Your 401(k) payout will be taxed at a lower rate due to the stocks' losses. If done properly, tax-loss harvesting can help investors avoid paying taxes on the full amount of a 401(k) dividend they receive. But there are restrictions on how much of a loss can be harvested, and the wash-sale rule must be strictly followed.
Stay Away from the 20% Withholding Tax.
Distributions from a 401(k)-plan paid directly to you are subject to 20% federal income tax withholding. If this sum is too high, because you will owe 15% when filing your taxes, you will have to wait until then to receive the additional 5%. You should transfer the funds from the 401(k) to an IRA and then withdraw the money from the IRA. You can pay your taxes when you file your return rather than having 20% of your IRA's earnings withheld at the time of distribution.
