There’s a benefit to saving for retirement in a traditional 401(k) during your working years. Because you get a tax break on your contributions and investment gains are tax-deferred, you have a prime opportunity to build wealth for retirement.
If you’re 70 with a $1.5 million 401(k), you’re in a great place financially. For one thing, $1.5 million is well over the median $200,000 retirement plan balance among Americans aged 65 to 74 as of 2022, according to the Federal Reserve.
And if you just started taking Social Security at age 70, it means you’re looking at a higher monthly benefit because you delayed your claim more than three years past your full retirement age.
If you find that your lifestyle is comfortable while relying on Social Security alone for income, you may not need to tap your 401(k) every year during retirement. Unfortunately, though, once you turn 73, you’ll be on the hook for required minimum distributions (RMDs) and have to withdraw some of your retirement savings. Those payments can create a tax headache, but there is a possible solution — moving all or part of the balance of a traditional 401(k) into a Roth 401(k).
It’s called a Roth conversion, and the good news is that it’s not too late to do it at age 70. But you’ll need to consider the tax implications of taking this route.
The IRS offers tax breaks on traditional retirement plan contributions because it wants to help workers build a secure nest egg for their senior years. The IRS does not, however, want traditional 401(k)s and IRAs to become tools the wealthy use to pass assets onto their heirs, while enjoying tax breaks along the way. That’s why the IRS imposes RMDs.
The amount of your RMD each year will hinge on your savings balance and life expectancy. But you should know that RMDs count as taxable income. So if you don’t need the money, RMDs can be a huge pain.
However, blowing off your RMDs isn’t a good plan, either. You can be penalized with a 25% excise tax (though if you correct that mistake and take your RMD within two years, that penalty is reduced to 10%).
The nice thing about Roth 401(k)s is that they don’t impose RMDs for someone who will only reach 73 after 2024. So if you convert your traditional 401(k) to a Roth, you can get out of taking RMDs if you don’t want to worry about being taxed on those distributions every year starting at age 73.
