If I switch jobs to a lower tax bracket right before I retire, do I save on 401k taxes?

Question

I'm curious about how your withdrawal tax bracket is determined for your 401k

Here are the scenarios:

A) Let's say I am making $100,000-$200,000 per year for my whole career with a Traditional 401k. I don't remove anything from it before age 59.5. At that age, I retire. How much--or in what bracket--would the 401k withdrawals be taxed?

B) Just like scenario A, let's say I am making $100,000-$200,000 per year for my whole career with a Traditional 401k. Around age 58, I switch jobs and start making $30,000 per year. I retire at age 59.5 again. How much--or in what bracket--would the 401k withdrawals be taxed? Is it the same or different as scenario A?

In other words: how is your retirement/401k tax bracket determined?

Answer 1

Your tax bracket is determined by your total taxable income in a given year, where money drawn from a traditional-style deferred-tax 401k or IRA is taxable income. (Money drawn from a Roth account was taxed before deposit and is not taxed when withdrawn after the relevant date.)

Your recent salary history has no effect on this, except salary in the same year -- and there is no advantage to be gained by taking a deliberate pay cut for its own sake.

Answer 2

Your prior earnings have absolutely no bearing on the taxes due on 401k disbursements. Your 401k disbursements are considered income in the tax year in which they are received; whether or not you earn or otherwise acquire additional income. There's no telling what tax brackets and rates will look like that far in the future. But, if your total income including your 401k disbursements is $200,000 you'll likely owe more taxes than if your total was $30,000 including disbursements.

I will say though, if you could choose to make $200,000 per year or $30,000 per year with all other factors being equal you choose $200,000 every time. Even if you pay more in taxes, you will have more net income.

Now, some pension plans will take in to account either your last year's income, or an average of some number of years income in determining your benefit amount. That's a whole different discussion and will be specific to your pension plan.

Answer 3

Assuming your only income is withdrawals from the 401k, the thing that determines the tax rate on your 401k withdrawals is how much money you draw out of the 401k in a single tax year. The money counts as income when you take it out. If you withdraw $100,000 from the 401k in a single year, you'll be in a higher tax bracket than if you withdraw only $30,000 in that year, but your earnings in previous years are irrelevant.