RMDs refer to the minimum amounts that a retirement plan account owner must withdraw annually starting at age 73 (as of the current rules in 2024). This rule applies to 401(k) accounts, among other types of retirement accounts like IRAs. The IRS sets the RMD rules to ensure that retirement funds are eventually taxed. The specific amount to withdraw each year is calculated based on the account balance at the end of the previous year and a life expectancy factor provided by the IRS.

When you withdraw funds from a traditional 401(k), the amount you withdraw is generally considered taxable income. This means that the withdrawals will be taxed at your current income tax rate. If you withdraw before age 59½, you may also incur an additional 10% early withdrawal penalty, unless an exception applies. However, Roth 401(k) accounts have different tax implications; qualified withdrawals from these accounts are generally tax-free.

Sequence of returns risk is the risk that the order of investment returns will negatively impact the value of an account, particularly during the withdrawal phase in retirement. For a 401(k), this means that if you experience poor investment returns early in retirement, it can significantly reduce the amount of money you have available in later years, even if the average returns over time are reasonable. This risk is critical because negative returns combined with withdrawals can deplete the account more quickly than if those same negative returns occurred later.