Navigating A Million-Dollar 401(k) Tax Maze

Navigating A Million-Dollar 401(k) Tax Maze

February 02, 2024

Working hard to save a million dollars in your 401(k) is a significant achievement on the road to a comfortable retirement. However, Uncle Sam can put a damper on your parade.

Saving six figures for retirement is an impressive accomplishment, but many Americans must understand that taxes can be pivotal in how much of that million dollars you get to keep. In this blog, we'll explore various strategies for managing your wealth, 401(k), and other retirement accounts while keeping taxes in check. Here’s what you need to know.

Why Is Tax Planning So Important?

Why is tax planning crucial for individuals with $1 million or more in their 401(k)s or IRAs? Because, likely, you won't find yourself in a lower tax bracket in the future. One of the primary reasons for tax planning is to help ensure you're not caught off guard by changing tax brackets and liability. Your tax bracket may shift up or down. And the order in which you tap your retirement accounts and other savings could have a big impact on how much tax you owe — and consequently, how long your retirement assets could last.

Tax planning can also help preserve your future assets. By carefully selecting when and how you withdraw funds from your retirement accounts, you can help ensure that your savings last longer and provide financial stability throughout your retirement years. This can result in more money for living expenses and a more financially secure retirement. 

The U.S. tax laws consider most forms of retirement income fair game, including Social Security benefits, pensions, and withdrawals from your 401(k)s and traditional IRAs. And unless you live in a state without an income tax, you can expect your home state to hit you in retirement as well. So which are the tax-free states? As of 2024, nine states — Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming — have no income taxes.

Ready to dive into some strategies that can help you protect your retirement savings? Let's get started.

Retirement Account Contributions and Withdrawals

Effectively managing your retirement accounts, such as 401(k)s and Roth IRAs, involves a strategic approach that maximizes tax benefits throughout your financial journey. During your working years, making the most of contributions to these accounts can be smart, as they often come with the advantage of being tax-deductible. This tax deduction lowers your taxable income, setting the stage for a more tax-efficient retirement.

One of the key aspects of retirement planning is understanding the contribution limits for retirement accounts such as 401(k)s and IRAs. These limits determine how much you can contribute to these accounts each year, helping you build a robust nest egg for retirement. Let's take a look at the expected contribution limits for 2024:

  • 401(k) Plans: The contribution limit for 401(k) plans is projected to increase to $23,000 in 2024, up from $22,500 in 2023. For those aged 50 and older, an additional catch-up contribution of $7,500 will remain the same. It's important to note that these new amounts apply to 403(b) and most 457 plans.
  • IRA Contribution Limits: Individual Retirement Accounts (IRAs) are another popular retirement savings option. The contribution limits are to remain relatively stable for IRAs. For 2024, individuals under 50 can contribute up to $7,000, up from $6,500 in 2023. Catch-up contributions for adults 50 and older will remain at $1,000.
  • Roth IRA Contribution Limits: Beginning in 2024, more Americans will qualify for Roth IRA contributions, with the AGI range rising between $146,000-$161,000 for single filers, up from $138,000-$153,000 in 2023. The Roth IRA contribution phaseout for married couples filing together will rise to between $230,000 and $240,000 in 2024, up from between $218,000 and $228,000.

It's essential to consult with a financial advisor or check the latest IRS guidelines to confirm these limits for 2024 and adjust your retirement savings strategy accordingly.

Enhancing Tax Efficiency Through Income Source Diversification

Diversifying your income sources is a crucial strategy when protecting your million-dollar 401(k) from potential tax complications. Relying solely on your 401(k) for retirement income can expose you to substantial tax liabilities. 

Exploring other income streams, such as investment returns, rental income, or income from a business venture, is important to mitigate this risk. This diversification offers financial flexibility and empowers you to manage and optimize your taxable income during retirement. Furthermore, the choice of assets within your 401(k) portfolio plays a pivotal role in shaping your tax scenario. 

Different investments carry varying tax implications, and some are inherently more tax-efficient than others. Take municipal bonds, for instance; they often enjoy federal tax-exempt status, and in certain cases, they are also exempt from state taxes. Allocating a portion of your investment portfolio to tax-efficient assets effectively lowers your overall tax burden, thus contributing to a more tax-friendly retirement strategy.

Managing Medicare Costs Effectively

When managing Medicare costs effectively, one important thing to consider is the Medicare Income-Related Monthly Adjustment Amount (IRMAA). This can lead to higher premiums if your income exceeds a certain limit. Remember that the IRMAA calculation examines your income from the last two years. So, it's a good idea to start considering how it might affect your Social Security benefits as soon as you're eligible.

Many people worry about the cost of healthcare, with 80% expressing concerns about how to pay for it. Surprisingly, only 56% of those nearing retirement have included healthcare costs and long-term care costs in their plans, and even among those who have, 50% might be underestimating these expenses. To deal with these challenges, taking a strategic approach to managing your retirement account withdrawals is important.

This strategic approach serves a dual purpose: reducing your taxable income and potentially avoiding Medicare surcharges. The ultimate goal is to ensure that the hard work you've put into building your million-dollar 401(k) isn't eroded by increasing healthcare expenses during your retirement years.

Last Thoughts

If you are worried about protecting your million-dollar 401(k), working with a qualified fiduciary advisor like the fiduciary advisors at Agemy can help provide valuable guidance and transparency regarding retirement planning. Founder Andrew A. Agemy, MRFC®, and son Daniel J. Agemy, CPM®, RFC®, can help you develop a personalized retirement plan, optimize your investment strategy, and stay on track to achieve your financial goals.

At Agemy Financial Strategies, we are committed to educating our clients on various financial matters, including retirement planning, wealth management, tax planning, and more. With over 30 years of experience in helping individuals reach retirement stress-free, our unwavering dedication to educating and serving our clients remains at the core of our mission. Our financial guide to retirement planning is one of the many tools we offer to help you take control of your finances and plan for the future. 

Contact us today to learn how we can help you achieve financial security.