If You Have a Tax-Deferred Plan, You Have a Silent Business Partner
Your 401(k) balance is not entirely yours. Here is how to think about the IRS's unclaimed share — and how to buy them out on your terms.
Open your 401(k) statement and you see one number. In reality there are two owners on that account: you, and a silent partner who has never contributed a dollar, never taken a risk, and gets to decide their own share later.
That partner is the IRS. Every dollar in a qualified, tax-deferred account — 401(k), 403(b), Traditional IRA — has never been taxed. When it comes out, it comes out as ordinary income. A $1,000,000 balance in a 22% bracket is really about $780,000 of spendable money. In a higher bracket, less.
Here is what makes the partnership uncomfortable: the partner sets their price after you have finished saving. Tax rates in your 70s and 80s are not something you control, and current rates are scheduled to change. Meanwhile the partner's share grows right along with your account, because they own a percentage, not a fixed amount.
RMDs are when the partner finally calls. Starting at 73, the IRS requires withdrawals on their timetable, and those withdrawals can lift your Social Security taxation and Medicare premiums along with your bracket. Do nothing and your largest tax years may arrive when your income needs are lowest.
You can buy the partner out early. Roth conversions settle the tax at today's known rate, in years you choose, on amounts you choose. Bracket-filling during gap years between retirement and Social Security is the cleanest version. Qualified Charitable Distributions can retire part of the obligation entirely. Balancing pre-tax, Roth, and taxable buckets gives you a dial to turn each year instead of a bill you receive.
The goal is not to eliminate the partner. It is to decide, while you still can, what you pay them.
Want this applied to your numbers?