Craig Wear, CFP® explains that a traditional 401(k) balance isn't fully 'yours' because taxes haven't been paid; the IRS will tax withdrawals at unknown future rates and early withdrawals incur income tax plus a 10% penalty. He advises considering Roth accounts or conversions to lock in tax-free growth and urges people to evaluate after-tax take-home from retirement accounts.
You probably already know this, but you don't fully own your 401k. Here's who does. So someone tells me, I got a million bucks in my 401k. I'm thinking, well, great, but how much of that is actually yours? See, when your money is in the traditional 401k, you haven't really paid taxes on it yet. That means that your partner, the IRS is just kind of waiting to take their cut. It's kind of, it'll be time to pay the piper one of these days. And guess what, you, you don't even know how much they're going to take because we don't know what future tax rates are going to be. It's kind of a giant question mark. If you withdraw early, you're going to get hit with income tax and a 10% early withdrawal. And it's like kind of kicking a tax bill down the road without knowing the price tag. You're the general partner and the IRS is kind of the limited partner. So if you want more control, consider tax free growth options like a Roth IRA or a Roth 401K. Or consider doing massive conversions to get out from underneath the control, the IRS or the uncertainty of where tax rates are going to be in the future. And always remember, what's in your 401k isn't really what you're going to walk away with. You got to consider what the after tax portion really is going to be.
