How Does a 401k Work When You Retire? Key Rules and Considerations for US Expats

This article explains how a 401(k) works when you retire. It covers the fundamental aspects of 401(k) plans, including distribution options, taxation, rollovers to IRAs, and the potential use of annuities, as well as the key considerations that may apply when retiring abroad.

When Can You Access Your 401k?

You can begin withdrawing from your 401(k) at age 59½ without incurring the IRS early-withdrawal penalty. Distributions before this age may be treated as early withdrawals and subject to a 10% federal penalty on the withdrawn amount. This charge would be levied in addition to any applicable federal (and potentially state) income tax payable on the withdrawal.

However, the IRS allows penalty-free (but still taxable) withdrawals before age 59½ under specific circumstances. Common examples include:

• Permanent disability or terminal illness (subject to IRS definitions and medical certification).
• Domestic abuse (subject to statutory limits and documentation requirements).
• Certain losses resulting from a federally declared disaster.
• Qualified active-duty reservist service (generally for deployments of 180 days or more after September 11, 2001).

Eligibility criteria, withdrawal limits, and documentation requirements vary by exception and by plan. Not all 401(k) plans permit access to these exceptions.

A particularly notable exception is the “Rule of 55.” If you separate from your employer in or after the calendar year you turn 55, you may withdraw from that employer’s 401(k) without incurring the 10% early-withdrawal penalty. This exception does not apply to IRAs or to 401(k)s held with previous employers.

The list of penalty exceptions is extensive, so it is recommended that you review the relevant IRS guidance or seek professional advice to determine whether you qualify.

Reaching age 59½ only signifies that you are allowed to take distributions, not that you must do so. You may decide to defer withdrawals so that your 401(k) funds remain invested for a longer period.

This approach may be particularly appealing to individuals with additional income sources who wish to extend tax-deferred growth or coordinate withdrawals with broader retirement and tax planning.

What Should You Do With Your 401k When You Retire?

The majority of 401(k) plans offer flexibility in how benefits can be accessed in retirement. You may generally choose between several methods, most notably:

• Withdrawing a single lump-sum amount.
• Establishing a fixed schedule of withdrawals (for example, monthly or quarterly).
• Taking ad hoc withdrawals as needed.

No method is universally superior, and each approach involves trade-offs that should be assessed carefully.

For example, taking a lump-sum distribution may provide immediate liquidity, but it can expose you to several significant risks, including:

1. A substantial tax bill in the year of withdrawal.
2. An increased risk of depleting retirement assets too quickly.
3. The loss of future tax-deferred investment growth.

For these reasons, many retirees choose to draw income gradually, aligning withdrawals with expected spending needs and overall retirement objectives.

A commonly cited guideline is the “4% withdrawal rule,” where you withdraw 4% of your portfolio in the first year of retirement and then adjust that amount annually in line with inflation, rather than by a fixed percentage.

This approach is intended as a general planning framework rather than a guarantee and may not be suitable in all market conditions or time horizons.

Alternatively, some retirees prefer fixed-dollar or fixed-percentage withdrawals that are aligned with current and anticipated expenses, particularly where income needs vary over time.

Your 401(k) withdrawal strategy can have long-term consequences for both sustainability and taxation, especially when combined with other income sources such as Social Security or retirement income taxed abroad. As a result, many individuals choose to seek professional advice when structuring withdrawals.

For a personalised withdrawal strategy, consult our experts at Titan Wealth International. Our professional advisers will assess your financial circumstances and needs to provide a strategy that effectively integrates your 401(k) into a broader retirement and cross-border financial plan.

Coordinating 401(k) Withdrawals With Social Security

The timing of your 401(k) withdrawals can directly affect how much of your Social Security benefits are subject to tax.

Under US rules, the taxation of Social Security depends on your “combined income,” which includes taxable retirement account distributions from sources such as traditional 401(k)s and IRAs.

Drawing heavily from a traditional 401(k) in the same years that you begin receiving Social Security benefits may increase the proportion of those benefits subject to tax.

Depending on your combined income, up to 50% or 85% of Social Security benefits may become taxable at the federal level. In contrast, some retirees choose to draw more heavily from retirement accounts earlier in retirement or stagger income sources over time.

For US expats, these decisions may be further complicated by how Social Security benefits are taxed in the country of residence and whether treaty provisions apply.

While some US tax treaties provide relief or exclusive taxing rights, others do not address Social Security explicitly. Coordinating income sources can therefore play an important role in managing overall tax exposure.

How Are 401k Distributions Taxed?

Roth 401(k) Distributions

Roth 401(k) plans operate differently from traditional 401(k)s and can play an important role in retirement planning, particularly for individuals who expect to remain in higher tax brackets or retire abroad.

Contributions to a Roth 401(k) are made with after-tax dollars. As a result, qualified withdrawals of both contributions and earnings are generally tax-free, provided two conditions are met:

• You are at least age 59½ at the time of the withdrawal.
• At least five years have passed since your first Roth contribution to the plan.

If either condition is not satisfied, the earnings portion of a withdrawal may be subject to income tax and, in some cases, the 10% early-withdrawal penalty.

A significant change introduced under the SECURE 2.0 Act is that, from 2024 onwards, Roth 401(k)s are no longer subject to required minimum distributions (RMDs) during the account holder’s lifetime.

Previously, Roth 401(k)s were treated like traditional 401(k)s for RMD purposes, which often led retirees to roll them into Roth IRAs to avoid mandatory withdrawals.

This alignment with Roth IRAs means Roth 401(k)s can now be used more effectively as a long-term tax-planning tool. For retirees who do not need immediate income, Roth balances may be left invested for longer, potentially supporting later-life spending, legacy planning, or uneven income needs across retirement.

For US expats, Roth 401(k)s require additional consideration. While the US generally treats qualified Roth withdrawals as tax-free, many non-US tax authorities do not recognise the Roth structure and may tax distributions differently.

The availability of treaty relief varies by jurisdiction and may depend on whether the relevant tax treaty explicitly addresses Roth-type accounts or how the income is characterised locally.

As a result, Roth 401(k) withdrawals that are tax-free in the US may still be partially or fully taxable in your country of residence, making careful cross-border tax planning essential.

Traditional 401(k) distributions

Traditional 401(k) distributions are typically taxed as ordinary income, reflecting the fact that these plans are funded with pre-tax contributions and benefit from tax deferral during the accumulation period.

Upon taking withdrawals, the taxable portion of any distribution is added to your income for the year and taxed at your marginal federal income tax rates. State income tax may also apply, depending on your circumstances.

It is not possible to eliminate US federal income tax on traditional 401(k) withdrawals, although there are strategies for managing the timing and overall level of taxation.

For instance, you may convert some or all of your traditional 401(k) balance to a Roth account, most commonly via a rollover to a Roth IRA, before or early in retirement.

Since Roth accounts are funded with after-tax dollars, you would pay income tax on the amount converted in the year of conversion, but the funds may then grow and be withdrawn tax-free under Roth rules, provided the distribution is qualified.

To ensure tax-free distributions from a Roth account, you must satisfy the conditions for a qualified distribution, including:

1. Being over age 59½.
2. Making the withdrawal at least five years after the initial Roth contribution or conversion.

It is crucial to compare the income tax payable on traditional 401(k) withdrawals with the tax cost of a Roth conversion to determine whether this strategy is appropriate for your situation.

Such decisions are highly individual and are often best assessed with professional tax advice, particularly when retiring abroad.

US Withholding Tax on 401(k) Distributions

When you take distributions from a 401(k), the plan administrator is generally required to withhold US federal income tax at source under IRS withholding rules. The amount withheld depends on how the distribution is taken.

For periodic payments, withholding is typically calculated using IRS withholding tables, similar to payroll income. By contrast, eligible rollover distributions paid directly to you as a lump sum are generally subject to mandatory 20% federal withholding, regardless of your actual tax liability.

This withholding applies even if you live outside the United States. Importantly, withholding is not the same as the final tax owed. It represents a prepayment of tax that is reconciled when you file your US tax return.

For US expats, this can create cash-flow challenges, particularly if treaty relief, foreign tax credits, or deductions reduce the ultimate tax due. In practice, excess withholding can usually only be recovered by filing a US federal income tax return for the relevant year.

How Do Required Minimum Distributions (RMDs) Work?

Although you are allowed to defer withdrawals from a traditional 401(k), you may not do so indefinitely. The IRS requires you to begin taking required minimum distributions (RMDs) once you reach a specified age.

The current starting age for required minimum distributions (RMDs) is 73. Under the SECURE 2.0 Act, this will increase to age 75 for individuals born in 1960 or later, with the change taking effect from 2033.

In practical terms, the year you reach age 73 is generally the first year for which an RMD applies, meaning you must begin withdrawing at least a minimum amount from your traditional 401(k) so that the IRS can tax previously deferred income.

Your first RMD may be delayed until 1 April of the following year, although doing so would result in two RMDs being taxable in that year.

The main exception applies if you continue working beyond the applicable RMD age. If you are still employed by the company sponsoring the 401(k) and do not own more than 5% of the company, you may delay RMDs from that employer’s plan until the year you actually retire. This exception does not apply to IRAs or to 401(k)s held with former employers.

Your RMD amount is calculated based on your account balance and life expectancy factors published by the IRS. Specifically, the prior year-end account balance is divided by the applicable life expectancy factor from the IRS Uniform Lifetime Table.

For example, at age 76, the current Uniform Lifetime table assigns a life expectancy factor of 23.7. If your 401(k) balance was $300,000 on 31 December of the previous year, your RMD for the current year would be:

It is crucial to calculate the RMD accurately and ensure the withdrawal is made by the required deadline.

Failure to do so may result in a penalty equal to 25% of the RMD shortfall, which can be reduced to 10% if the error is corrected and reported to the IRS within the applicable correction period.

Should You Roll Over Your 401k After Retirement?

If you wish to obtain greater flexibility in accessing and managing your retirement funds, you may decide to roll over your 401(k) into an individual retirement account (IRA).

Doing so may also be sensible if you wish to consolidate multiple accounts and invest in a wider range of assets, subject to the investment options and rules of the receiving IRA provider, including:

• Stocks
• Bonds
• Mutual funds
• ETFs
• Annuities

You may generally select between two types of IRAs for your rollover:

Annuities can also be purchased within an IRA following a rollover. Certain income annuities may provide predictable lifetime income, which can be appealing for retirees seeking longevity protection or stable cash flow while living abroad. However, annuities involve insurer credit risk, fees, and reduced liquidity, and their tax treatment depends on how the annuity is structured.

Rolling over to a traditional IRA does not eliminate RMD obligations. You will remain subject to RMDs once you reach the applicable starting age. Conversely, Roth IRAs are not subject to required minimum distributions during the account holder’s lifetime, which can be an important consideration for retirees who do not need immediate income.

The IRS does not permit rollovers from Roth 401(k)s to traditional IRAs. In addition, the primary factor when deciding between a traditional IRA rollover and a Roth IRA conversion is your tax position at the time of the rollover and in future years.

If you are currently in a high tax bracket, converting to a Roth IRA may be less appropriate because the rollover amount would generally be taxable in the year of conversion.

In such circumstances, a rollover to a traditional IRA may be preferable, allowing you to defer taxation until distributions are taken.

Using Annuities as Part of a 401(k) or IRA Strategy

Some retirees choose to use annuities as part of their overall retirement income strategy, either within a 401(k) plan where permitted or more commonly within an IRA following a rollover.

Income annuities are designed to provide a predictable stream of payments, often for life. This can be appealing for retirees who value stable cash flow, wish to reduce reliance on market performance, or want to manage longevity risk in later years.

However, annuities also involve important trade-offs. They may limit access to capital, involve insurer credit risk, and carry higher fees than traditional investment portfolios. The suitability of an annuity depends on factors such as total retirement assets, other income sources, expected spending needs, and life expectancy.

For US expats, it is also essential to understand how annuity income will be taxed locally and whether it is treated differently from pension or investment income under local tax rules or applicable tax treaties.

What To Consider If You Are Managing a 401k as an Expat

If you reside abroad or plan to retire outside of the United States, you should consider three key aspects of 401(k) management:

1. Access to funds.
2. State Tax Considerations.
3. Local and double taxation.
4. Currency exchange risk.

Access to Funds

Some 401(k) plan providers impose restrictions on accounts held by non-US residents. These restrictions may include limits on transactions, investments, or distributions, and policies vary significantly by plan and custodian.

In some cases, providers may restrict new investments, limit withdrawals, or impose additional administrative requirements once an account holder becomes non-resident.

While some plans continue to service accounts for non-residents, others may require the account to be transferred or distributed after relocation abroad. In limited cases, a plan may require you to close or roll over your 401(k) after you move overseas.

As a result, many US expats choose to roll over their 401(k) into an IRA held with a brokerage that accommodates international clients. Doing so can offer greater continuity and ease of management, whereas leaving funds in an employer-sponsored plan may become impractical if the provider does not support overseas account holders.

State Tax Considerations for US Expats

In addition to federal taxation, some US states may continue to tax 401(k) distributions depending on your prior residency and how state ties were severed.

While many states cease taxation once residency is clearly broken, others apply more stringent residency or domicile tests. As a result, certain former residents may remain subject to state income tax on retirement distributions even after moving abroad.

Whether state tax applies depends on factors such as your former state of residence, the timing and permanence of your departure, and whether ongoing connections to the state remain.

State tax exposure can materially affect the net value of your retirement income and should be reviewed as part of the planning process.

Local and Double Taxation

American citizens are subject to US federal income tax on their worldwide income, regardless of where they live.

As a result, the IRS will continue to tax your 401(k) withdrawals even if you reside overseas. At the same time, your country of residence may also tax the same income, creating a risk of double taxation.

To address this, the United States has entered into income tax treaties with many countries. These treaties allocate taxing rights between jurisdictions and may provide relief through mechanisms such as foreign tax credits, reduced withholding rates, or, in limited cases, exemptions.

However, treaty outcomes vary significantly by country and by treaty. Relief from double taxation often depends on how retirement income is classified under the relevant treaty and whether credit relief is available in practice.

For example, under the US-France tax treaty, private retirement income is generally taxable in the country of residence. However, the United States continues to tax its citizens regardless of residence. In practice, this means double taxation is typically mitigated through foreign tax credits rather than outright exemptions, and outcomes depend on individual circumstances.

Treaty treatment varies widely by jurisdiction, and some treaties do not address US retirement accounts explicitly. Professional advice is therefore essential before relying on treaty relief.

Currency Exchange Risk

Your 401(k) is denominated in US dollars, while your living expenses may be in another currency. Fluctuations in exchange rates can therefore affect the real value of your withdrawals and may increase income volatility over time.

You may consider whether and how to manage currency risk as part of your broader retirement strategy. However, rolling over a 401(k) directly into a foreign pension scheme is generally not permitted under US tax rules without triggering a taxable distribution.

If you withdraw your 401(k) balance and attempt to transfer the proceeds into a non-US retirement vehicle, the IRS will generally treat this as a fully taxable distribution and may impose an early-withdrawal penalty if you are under age 59½.

To maximise retirement income and manage cross-border risks effectively, it is advisable to seek professional guidance tailored to your country of residence and overall financial circumstances.