“Navigating the Risks of a Large Traditional IRA and Pretax 401(k) Nest Egg”

Participating in a 401(k) or other defined contribution plan can provide significant benefits, such as lowering taxable income. However, if your traditional IRA and pretax 401(k) accounts become too large, you may face challenges, such as required minimum distributions (RMDs) that can increase your tax bill. A case study of Jane, a retiree with a $5 million 401(k) account, highlights the potential tax implications of a large nest egg.

RMDs, combined with other taxable income sources, can push you into higher tax brackets and result in unexpected tax liabilities. In Jane’s case, her children could face substantial tax burdens due to the 10-year distribution rule for inherited accounts. One potential solution is to consider Roth IRA conversions to minimize future tax liabilities for yourself and your beneficiaries.

Contributing to a Roth 401(k) instead of a traditional one can also offer tax advantages, as distributions are tax-free and RMDs are not required. Employers can now deposit matching contributions into Roth 401(k) accounts, providing additional tax benefits. Additionally, taking advantage of other pretax opportunities, such as commuter expenses and health savings accounts, can further reduce tax liabilities.

Deciding whether to increase Roth contributions to mitigate future tax issues requires careful consideration and may benefit from advice from a tax professional or financial advisor. Ultimately, finding the right balance between pretax and Roth contributions can help you manage tax implications both during your retirement and for your beneficiaries in the future.