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SAVING TO BE A 401(K) MILLIONAIRE? PLAN FOR TAXES NOW

Your tax bite in retirement could be excruciating. Here's why super savers need
to get serious about protecting themselves.

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(Image credit: Getty Images)

By Brian Gray
published 11 September 2024
in Features

Are you among the growing ranks of “401(k) millionaires”?



The number of customers with $1 million or more in a Fidelity 401(k) rose to
almost half a million as of June 30, according to a recent Retirement Analysis
report from Fidelity. That’s an all-time high — and a great incentive for those
who are still saving diligently for their future retirement. It’s good to know
it can be done, especially considering that Northwestern Mutual's 2024 Planning
& Progress Study found Americans now believe they’ll need $1.46 million to
retire comfortably.



But this 401(k) trend is also an important reminder that if you don’t have a
plan to minimize taxes, it’s time to get to work. Because if you have (or hope
to amass) $1 million in a 401(k), you’re likely headed for some hefty tax bills
when you begin withdrawing funds in retirement.


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WAIT, HOW DID THAT HAPPEN?

Remember when you first signed up for a 401(k) at work, and somebody (maybe the
nice person in HR, your dad or even a financial professional) told you that
deferring those taxes for years was OK, because you’d almost certainly be in a
lower tax bracket in retirement?

Well, that might be true for those who haven’t saved much and expect to live
mostly on their Social Security benefits. But without some proactive tax
planning, it likely won’t be the case for many of the 401(k) millionaires.



Those folks have done a wonderful job of saving and investing their money. But
often they’ve forgotten that Uncle Sam has been waiting — perhaps for decades —
to get his share of their contributions and earnings. Depending on the tax
bracket these retirees land in each year, the IRS’ share could be quite a chunk.
Those who live in states with income taxes should consider that cost as well.
For many, taxes will be their largest expense in retirement. And they won’t see
it coming.

That’s because so many people, even these smart, steadfast savers, still tend to
focus on minimizing what they’ll have to pay each year when it’s time to prepare
their taxes, instead of reducing their tax burden over the long haul.


A MICRO VS A MACRO VIEW

This micro, small-lens view may seem like the best way to proceed when workers
are young. They’re stashing away money for the future, after all, and saving on
taxes in the process. So, how could it go wrong?

Let me count the blind spots.

1. Tax rates are likely to be higher in the future.

Withdrawals from retirement accounts are taxed as ordinary income, which means
your tax bracket and tax rates in retirement will matter a great deal. We
already know certain parts of the 2017 Tax Cuts and Jobs Act (TCJA), including
provisions that reduced individual tax rates and doubled the standard deduction,
are scheduled to expire on December 31, 2025. But it’s unlikely that will be the
end of it. At some point, most experts seem to agree, the government is going to
have to find a way to deal with the growing U.S. budget deficit. Many expect
there will be changes in how — and how much — retirement savings and other
investments are taxed.

2. 401(k) withdrawals can impact how certain federal benefits are taxed.

Many people aren’t aware that if they receive significant income from a pension,
job and/or tax-deferred retirement accounts, they’ll likely be taxed on a
portion (up to 85%) of the Social Security benefits they’re paid that year.
Plus: The federal government also adds an extra charge, or “surtax,” known as
the income-related monthly adjustment amount (IRMAA), to your monthly Medicare
premium if your income is above a certain threshold.

3. 401(k) withdrawals aren’t optional.

When you turn 73 (or 75 if you were born in 1960 or later), you must take what
is known as required minimum distributions (RMDs) each year based on your life
expectancy as calculated by the IRS. It doesn’t matter if you don’t need the
money or that you might want to save it for your kids. You must take the
required amount or face IRS penalties.

4. Your tax filing status may change in retirement.

Many couples forget that when one spouse passes away, the surviving spouse
becomes a single filer and often faces a much steeper tax bill. That’s because
single filers get a smaller standard deduction on their income tax return than
joint filers do. With the same or similar amount of taxable income, there’s a
good chance the surviving spouse will land in a higher tax bracket and pay a
higher tax rate.

5. Your heirs could get stuck paying higher taxes.

Though there are exceptions, most 401(k) beneficiaries are now required to draw
down inherited IRAs and 401(k)s and pay the taxes on that money within 10 years
of the original owner’s death. If you or your surviving spouse leave a hefty
401(k) account to your children as part of your estate, it could end up pushing
them into a higher tax bracket during their peak earning years.


WHAT CAN YOU DO?

Pull back and look at the bigger picture. Think macro instead of micro. If you
haven’t already, you may want to get some help to avoid what could be an
expensive tax headache down the road for you and your loved ones.

According to this year’s Planning and Progress Study, only 3 in 10 Americans
have a plan to minimize the taxes on their retirement savings. Though most
people I talk to believe tax rates are going to go up, few are doing anything to
prepare.

The esteemed Judge Learned Hand once said, “In America, there are two tax
systems: one for the informed and one for the uninformed. Both are legal.” Be
informed.

Talk to a professional about how to manage your investments in a tax-efficient
manner — not just this year but every year. Ask about the benefits of moving
some of your money to a Roth account, which could lower your tax burden in
retirement and make things easier for your beneficiaries. Don’t hesitate to
inquire about other tax-saving strategies that might work for you and your
family.

Kim Franke-Folstad contributed to this report.

The appearances in Kiplinger were obtained through a PR program. The columnist
received assistance from a public relations firm in preparing this piece for
submission to Kiplinger.com. Kiplinger was not compensated in any way.

Investment advisory services offered through Graylark Financial, LLC, a
Registered Investment Adviser with the State of Colorado. Content on this site
is for informational purposes only. Opinions expressed herein are subject to
change without notice. Graylark Financial, LLC has exercised all reasonable
professional care in preparing this information. Some information may have been
obtained from third-party sources we believe to be reliable; however, Graylark
Financial, LLC has not independently verified, or attested to, the accuracy or
authenticity of the information. Nothing contained herein should be construed or
relied upon as investment, legal, or tax advice. An investor should consult with
their financial professional before making any investment decisions.


RELATED CONTENT

 * Is a Roth Conversion for You? Seven Factors to Consider
 * How the IRS Taxes Retirement Income
 * Retirees: Want to Keep Your Money? Make a Tax Plan
 * Four Do’s and One Don’t to Help Protect Your Inheritance
 * Social Security and Your Taxes: Five Things to Know

DISCLAIMER

This article was written by and presents the views of our contributing adviser,
not the Kiplinger editorial staff. You can check adviser records with the SEC or
with FINRA.





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Policy and are aged 16 or over.
Brian Gray
Social Links Navigation
CEO, Graylark Financial

As CEO of Colorado-based Graylark Financial, Brian Gray is passionate about
helping people achieve their financial goals and realize their bucket-list
dreams. Financial education is a priority in his practice, and he is the
co-author of three books (“Smiling Through Retirement,” “Retire Abundantly” and
“Giving Transforms You”) with another on the way. Brian has been a regular on
Denver radio and has been featured in several local and national publications,
including Fortune, Money, Bloomberg Business, Wall Street Select and
MarketWatch.



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