Many retirees think that deciding when to start taking Social Security is one of the biggest decisions they’ll make in retirement. However, what’s more important is considering 401(k) withdrawals in tandem with Social Security checks. That’s because your total income impacts your tax rate, including whether or not your Social Security benefits are taxed.
If you diligently saved in a retirement plan during your working years, and you’re wondering the best way to withdraw your earnings, here is everything you need to know about 401(k) withdrawal rules.
As a rule, 401(k) withdrawals will affect your taxes
If you have a traditional 401(k), you haven’t paid tax on your earnings yet. That’s because during your working years, you’re able to use your 401(k) contributions to lower your taxable income. In retirement, that means you pay taxes on the amount you withdraw from your 401(k).
If you’re currently collecting Social Security at the same time you’re making 401(k) withdrawals, your taxable income will increase. Sometimes, retirees are caught off guard at tax time when they realize their income is much higher than they expected. Having to pay a larger tax bill than expected can reduce retirees’ cash flow and impact their ability to pay their bills, so planning ahead of time is essential.
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The IRS calculation that determines your Social Security taxes
The IRS has a calculation called the provisional income formula, which is another way of describing how it taxes your total combined income. For this formula, the IRS considers your adjusted gross income, part of your Social Security benefits, and other factors to calculate your total income for the year. Because your traditional 401(k) withdrawals are taxed, it means that your total income could cross certain limits that make your Social Security income taxed at higher rates.
Your income determines whether Social Security is taxable
There are three main income thresholds that determine whether or not your Social Security income is taxable. In general, retirees who earn below $25,000 a year are not taxed on their Social Security income. Single-filers who earn between $25,000 and $34,000 could have up to 50% of their Social Security income taxed. Finally, those who earn above $34,000 a year in retirement may see up to 85% of their Social Security income taxable. If you’re close to the next threshold, speaking with a financial advisor may help you determine the most tax-advantaged withdrawal plan.
More retirees are reaching the Social Security tax limits
The government created these taxable Social Security income limits in 1983, and they were not tied to inflation. As a result, the taxable Social Security income limits are quite low and have not changed, whereas people get frequent cost-of-living increases on their Social Security checks. As a result, more retirees are reaching these Social Security tax limits and need to be aware that 401(k) withdrawals may cause their benefits to be taxed at a higher rate.
Required Minimum Distributions (RMDs) can increase retirement income
If you delay withdrawing money from your 401(k), the law eventually forces your hand. Under current rules, retirees born between 1951 and 1959 must start taking RMDs at age 73, while those born in 1960 or later won’t have to start until age 75. So whether you actually need the money to live on or not, you have to take out a portion of your 401(k) once you hit your required age. For some people, the withdrawal amount required may put them in a higher tax bracket. If retirees unexpectedly enter a higher tax bracket, they may pay more in taxes than planned. This is one of the many reasons why having a strategic withdrawal plan is helpful in retirement.
Not all retirement accounts have RMDs
If you have several types of retirement accounts, like a 401(k) and a Roth IRA, it’s helpful to know that not all retirement accounts have RMDs. In fact, because you contribute to Roth accounts with after-tax income while you’re working, you can withdraw your money tax-free in retirement as long as you meet certain qualifications. Additionally, Roth IRAs do not have RMDs, so you can leave your money in that account as long as you like. This allows it to compound and grow over time as you age.
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How to get help creating a withdrawal strategy in retirement
If you’re not sure whether you’re on the right track with your retirement withdrawals or how those withdrawals will impact your taxes, consult with a financial advisor. A financial advisor can create a plan specific to your income, retirement goals, and current nest egg. Many financial advisors can also connect you with an accountant who can help you prepare and optimize your taxes each year.
Bottom line
Chances are, if you’re retired, you worked for many decades to reach your retirement goals. And if you’re living on a combination of your 401(k) withdrawals and Social Security checks, it’s important to consider how both income streams work together to create your total income. This total income will impact how your Social Security income is taxed and as a result, how much you’ll have to pay in taxes each year.
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Author Details
Catherine Collins
Catherine Collins is a nationally recognized personal finance writer with 15 years of experience who has made 401(k)s her specialty. She covers the policy changes, tax implications, rule updates, and common mistakes that shape how Americans save for retirement, translating Washington proposals and regulatory shifts into practical guidance. Her bylines include U.S. News and World Report, Newsweek, Money, and Entrepreneur.
