Vanguard Says the Typical 401(k) for Workers Over 65 Holds About $88,000. Taking It as a Lump Sum the Year You Retire Can Hand a Quarter of It to the IRS
Cashing out a 401(k) the year you retire sounds straightforward until ordinary tax brackets, a vanishing deduction, and bad timing all collide in the same return. The math reveals a surprisingly large slice of that nest egg disappears before the…
This post may contain links from our sponsors and affiliates, and Flywheel Publishing may receive compensation for actions taken through them.
A 65-year-old who empties an $88,000 401(k) the year he retires can owe the IRS about $21,396 on it. It totals to 24.3% of the account, gone before the money reaches his checking account.
Standard tax rules drive this result. The bill comes from ordinary brackets, a deduction that phases out and bad timing all hitting in the same tax year.
What Vanguard’s $88,000 Number Really Measures
Vanguard’s How America Saves 2026 puts the typical 401(k) for workers over 65 at about $88,000. “Typical” means the median: half of all participants had balances above the median, and half had balances below. The median across all ages was $44,115, while the average reached $167,970.
For many retirees, $88,000 may be the largest single check they receive. Under IRC Section 402(a), every pre-tax dollar counts as ordinary income in the year it’s paid out.
How an $88,000 Cash-Out Becomes a $21,400 Tax Bill
Assumptions use 2026 tax figures. He’s a single filer who turns 65 in 2026, retires midyear after earning $80,000 in wages, hasn’t claimed Social Security, claims the standard write-off and has an all-pretax 401(k).
His deductions include the standard write-off of $16,100, plus the age-65 add-on of $2,050. The new One, Big, Beautiful Bill senior deduction of up to $6,000 shrinks by 6% of modified AGI above $75,000.
| 2026 line item | Keep the 401(k) | Cash it out |
|---|---|---|
| Adjusted gross income | $80,000 | $168,000 |
| Standard deduction | $16,100 | $16,100 |
| Age-65 add-on | $2,050 | $2,050 |
| Senior deduction | $5,700 | $420 |
| Taxable income | $56,150 | $149,430 |
| Federal income tax | $7,065 | $28,461.20 |
Brackets work like fill lines. For 2026, single filers pay 12% on income above $12,400, 22% above $50,400 and 24% above $105,700. His wages already reach into the 22% bracket. The lump sum fills the rest of that bracket and then goes well into 24%.
Meanwhile, the extra income nearly wipes out his senior deduction. That makes each added dollar cost more than the bracket rate alone suggests.
Why the 20% Withholding Still Leaves an April Bill
Under IRC Section 3405(c), a plan must withhold 20% from any eligible rollover distribution paid directly to you. Here that’s $17,600. That leaves him $3,796 short, due with the 2026 return filed in 2027. An underpayment penalty may apply if other withholding doesn’t meet safe-harbor tests.
Two other rules don’t affect him. The 10% early-withdrawal penalty under Section 72(t) doesn’t apply to him because he’s past 59½. Ten-year averaging on Form 4972 is off the table too, since it covers only people born before January 2, 1936.
Everything above is federal tax. Most states tax the distribution as well, though some partly or fully exempt retirement income.
Your Other Income Decides Whether You Pay 12% or 24%
Same retiree, same $88,000, different timing. Say he does a direct rollover into an IRA, delays Social Security and withdraws $44,000 in each of 2027 and 2028. Using 2026 brackets, his taxable income is $19,850 each year and his tax is $2,134. That saves about $17,128 versus the cash-out.
The lump sum causes trouble in other places too. Medicare sets 2028 Part B and D premiums from 2026 MAGI, and $168,000 clears the first IRMAA tier. A retiree already collecting Social Security has a further problem: the extra income can make up to 85% of benefits taxable.
Three Moves Before You Sign the Distribution Form
- Request a direct rollover. A trustee-to-trustee transfer to an IRA causes no withholding and no tax until you take out the money.
- Draw it down during the gap years. The years between your last paycheck and Social Security or required minimum distributions are when the 12% bracket is cheapest to fill (the same window we sized up for Roth conversions in a free guide here). The senior deduction runs through 2028.
- Split it across tax years. If you need cash, take part in December and the rest in January to put two standard deductions to work.
Two items to watch: the 2027 Social Security COLA is tracking toward 3.3%, and the IRS usually releases next year’s brackets in the fall. Both affect room in the 12% bracket. Since this decision can’t be reversed once the check is cut, run the numbers with a CPA or fiduciary advisor before you choose a payout.
Contact [email protected] for any questions or corrections.
Vilma Rios is a tax professional and tax content contributor with more than 15 years of experience in tax and accounting. She specializes in federal tax research, tax education, and translating complex tax rules into clear, practical information for individuals, families, and small-business owners.
Vilma is a Content Tax Contributor II with the National Association of Tax Professionals (NATP), where she contributes to tax education and professional content. She has also presented tax information through webinars, including Spanish-language tax education, and has appeared on Telemundo 47 discussing tax topics and helping viewers understand important tax-filing requirements.
Her experience also includes tax and accounting work, tax research, IRS-related matters, and public tax education. While in college, Vilma volunteered in an IRS-sponsored tax assistance program and was recognized for her community service by local and state officials.
Known as “Your Tax Geek,” Vilma is passionate about making taxes easier to understand and helping people navigate an increasingly complex tax system.
