when (and how) should I liquidate my tiny 401K? ELI 5, if possible

October 16, 2023 9:25 AM

I have a 401K that's less than $2500. I turn 65 in January. When is the best time to take distribution?

I understand that you are not my tax accountant. I have a low income—under 25K USD. I also have a small (~ $2300) 401K. I turn 65 on January 8 of next year. I need to know what I should do to liquidate this 401K with the lowest possible tax hit.

If it matters, I'm about to go on Medicaid, and will be enrolling in Medicare in January.

If you could explain this to me in the least complicated terms possible, I would be deeply appreciative (this will help me pay my property tax and homeowner's insurance without dipping into my savings).

Thanks in advance to all who response.

posted by ivanthenotsoterrible to Work & Money (5 answers total)

Best answer: It sounds like you have contributed to a traditional (pre-tax) 401k and not with Roth contributions. (If it was Roth contributions, your taxing is already done.)

What you want to do is go into your 401k account online, or call your 401k provider, and get the form to take a "qualified distribution." You're older than 59.5, so you can do this now if you want, or wait.

The amount you take out is taxable like income for you, so it's whatever your tax rate is. How much income tax do you pay now? Probably not a whole lot as you're low income. The additional $2300 won't move the needle that much.

You can also set up your retirement distribution in periodic payments (to supplement your income in part and to break up how much additional taxable income you have over time) if you think that may work out more advantageously for you. Or of course you can take it out as a lump sum.

Anyway long story short:
keyword is "qualified distribution"
tax burden is your personal tax rate on your income + however much you take out of your 401k in a tax year
posted by phunniemee at 9:40 AM on October 16, 2023 [3 favorites]

Best answer: First, this is your savings. Emotionally it might feel like a different bucket but it is just money that you saved so you would have it for later. The only difference is the tax treatment.

Money in your 401k went in tax-free and it will be treated as taxable income when you withdraw it.
The amount of money that you pay will depend on how much other income you have in the year. Ideally, you want to withdraw it at a time when the tax on this income is as low as reasonable possible.

Here are the tax brackets for 2023. So if you are single person and your taxable income (after you do any deductions) is between $10,276 to $41,775 then you will pay 12% tax. With your income around $20k, the extra $2500 is probably be taxed at 12% no matter when you tax it out.

On the other hand if you are married, filing jointly, the 12% range is $20,551 to $83,550. So if you think your income might be below $18,0550 (so the extra $2500 is still in the 10% category) then you might want to use different savings for your current expenses now and save money. Except that the money that you save is only 2% of the extra income, so trying to be tricky to save money only saves you $50. And then only if you are married filing jointly and expect your taxable income to be below about $18000 in another year.

So, that is the calculation. Bottom line, given your numbers, it is unlikely to make a difference and if it does then the difference is probably only $50.
posted by metahawk at 9:52 AM on October 16, 2023 [3 favorites]

Money in your 401k went in tax-free and it will be treated as taxable income when you withdraw it.

This is only true for Traditional 401(k)s.
posted by saeculorum at 10:32 AM on October 16, 2023

Following up on metahawk's helpful explanation: If 1) your income is from work and 2) you expect to stop working before you will need the 401k proceeds and 3) this is a regular (not Roth) 401k, you may wish to wait until you stop working and your taxable income drops. At that point, you will very likely not owe any taxes on the withdrawal.
posted by Mr.Know-it-some at 10:38 AM on October 16, 2023 [2 favorites]

If it matters, I'm about to go on Medicaid

You need to look up your state's maximum income for Medicaid so as to avoid exceeding it. As others have said, the withdrawal counts as taxable income.
posted by praemunire at 12:44 PM on October 16, 2023 [2 favorites]