Your 401(k) and IRA Are Joint Accounts With Uncle Sam

In my experience, most corporate employees in their 50s and early 60s have two main sources of retirement income: A 401(k), and Social Security. Both are largely controlled by the government.

Most people understand that Social Security’s future is cloudy, and have been adequately conditioned not to rely too heavily on that income stream. What many don’t realize, however, is that their 401(k) is essentially a joint account with Uncle Sam.

With a 401(k), the government dictates when and how you can access your retirement savings. Withdraw funds before age 59½ and you’ll pay a penalty; wait too long, and you’ll be required to start taking distributions—at age 73, to be exact.

Worse, distributions from retirement accounts are taxed as ordinary income, and withdrawals over a certain amount can also trigger taxes on your Social Security benefits.

In 2022, according to the Social Security Retirement Planner:

“Some of you have to pay federal income taxes on your Social Security benefits. This usually happens only if you have other substantial income in addition to your benefits (such as wages, self-employment, interest, dividends, and other taxable income that must be reported on your tax return).

You will pay tax on only 85 percent of your Social Security benefits, based on Internal Revenue Service (IRS) rules. If you:

• File a federal tax return as an individual and your combined income* is

  • Between $25,000 and $34,000, you may have to pay income tax on up to 50 percent of your benefits.

  • More than $34,000, up to 85 percent of your benefits may be taxable.

• File a joint return, and you and your spouse have a combined income* that is

  • Between $32,000 and $44,000, you may have to pay income tax on up to 50 percent of your benefits.

  • More than $44,000, up to 85 percent of your benefits may be taxable.

• Are married and file a separate tax return, you probably will pay taxes on your benefits.”

As is the case with all taxes, these thresholds and rates are subject to change as tax laws evolve.

Even death doesn’t end your government partnership. Under the SECURE Act of 2019, non-spouse beneficiaries who inherit retirement accounts must withdraw the full balance within 10 years—no longer able to stretch it over their lifetime, as before. For someone inheriting $1 million, that accelerated timeline can push them into a higher tax bracket, significantly increasing the tax burden.

In other words, a non-spouse inheriting $1,000,000 in 2018 could have spread out the distributions over his or her life expectancy. The SECURE Act now requires it to be done in 10 years, which could bump the recipient into a higher tax bracket, leading to increased taxes paid on both the inheritance and their normal income.

Fortunately, there are strategies to reduce or even eliminate the government’s claim on your retirement funds. The key is proactive, personalized planning. Starting 10 years before retirement is ideal, but even 3-5 years makes a meaningful difference.  

Every situation is unique, and all strategies should be tailored to your specific needs; be wary of generic solutions and general strategies. Work with an advisor who understands your complete financial picture, goals, and priorities to ensure your retirement dollars stay where they belong—with you, and your family.

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