I'm 60, retired, and have around $2 million in my 401(k). How do I plan my withdrawals in a way that minimizes taxes?

Convert to a Roth IRA

Traditional 401(k) accounts allow you to invest with pre-tax dollars, but withdrawals are taxed. Roth accounts work differently, as you invest with after-tax money and don’t pay taxes on the money you take out.

If you are concerned about entering a higher tax bracket in future years or triggering higher Medicare premiums, especially when Required Minimum Distributions start at 73, consider converting the account to a Roth IRA. This could be done by rolling over the money to a Roth IRA when you leave your job.

While this has tax consequences, as you will be taxed on the converted funds, you can be strategic about when you do a conversion. You may want to convert small amounts at a time to stay in a lower income tax bracket or plan your conversion for a year when your income is low.

Keep in mind that a five-year rule applies after a conversion. That is, if you withdraw any earnings within five years of moving the money into your Roth, you may owe taxes on the withdrawal. However, you can withdraw your contributions without taxes or penalties at any time.

If you already rely on your 401(k) to provide income, or will in the coming five years, a conversion may not work for you.

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Plan withdrawals strategically

Don’t just start withdrawing money from your retirement accounts. You need to be strategic about withdrawals. Otherwise, you could face much higher taxes if you have to withdraw a lot of money once Required Minimum Distributions (RMDs) begin.

Some experts recommend exhausting taxable accounts first while allowing tax-deferred accounts like a 401(k) to keep growing. However, depending on how much money you have coming from other sources and how much your RMDs will be, it may be better to take regular withdrawals from multiple accounts throughout retirement.

For example, you could withdraw enough from your 401(k) each year to stay below the 22% tax bracket while supplementing this income with non-taxable distributions from a Roth or a whole life insurance policy if you have one. This way, you can minimize the total taxes you owe by always staying in the lowest possible tax bracket.

Make strategic investments

If you are taking more money out of your 401(k) than you need to support yourself because you don't want a bigger tax bill later, you can use your distributions to buy tax-free investments that help your money keep growing but that allow you to avoid a large IRS bill.

This could be a critical strategy if you withdraw more than the amount you'd take out at a safe 4% withdrawal rate to try to avoid large RMDs and a tax bump later.

Municipal bonds can be a good option because interest earned on "muni" bonds is exempt from federal taxes and sometimes from state and local taxes. Buying some "muni" bonds could also allow you to move your portfolio out of equities to become more conservative as you enter your 60s and are in your prime retirement years.

Regardless of your situation, we recommend that you consult a financial planner or other qualified professional who can help you develop a tax-efficient strategy. This includes choosing a safe withdrawal rate from your 401(k) so you don't drain your account too quickly and ensure that you keep more of your money instead of sending it to the government.