When you withdraw money from your 401(k) account before retirement age (59 ½), you’ll have to pay taxes on the amount you withdraw. The amount of tax you pay will depend on your tax bracket and the type of 401(k) account you have. If you have a traditional 401(k) account, your withdrawals will be taxed as ordinary income. If you have a Roth 401(k) account, your withdrawals will be tax-free if you meet certain criteria. However, if you withdraw money from a Roth 401(k) account before age 59 ½, you may have to pay a 10% early withdrawal penalty.
401(k) Withdrawal Tax Basics
When you withdraw money from your 401(k), you may have to pay taxes on the amount you withdraw. The amount of tax you owe will depend on several factors, including your age, the type of withdrawal you make, and your income.
Types of 401(k) Withdrawals
- Qualified withdrawals: Withdrawals made after you reach age 59½ are typically subject to ordinary income tax.
- Early withdrawals: Withdrawals made before you reach age 59½ are subject to ordinary income tax plus a 10% early withdrawal penalty.
- Roth 401(k) withdrawals: Withdrawals from a Roth 401(k) are typically tax-free if certain requirements are met.
Tax Rate on 401(k) Withdrawals
The tax rate on 401(k) withdrawals depends on your ordinary income tax bracket. For 2023, the federal income tax brackets are as follows:
Filing Status Taxable Income Tax Rate Single $0 – $11,850 10% Single $11,851 – $44,725 12% Single $44,726 – $89,450 22% Single $89,451+ 24% In addition to federal income taxes, you may also have to pay state income taxes on your 401(k) withdrawal.
Avoiding Taxes on 401(k) Withdrawals
There are a few ways to avoid or reduce taxes on 401(k) withdrawals:
- Wait until you reach age 59½ to withdraw funds. This will help you avoid the 10% early withdrawal penalty.
- Rollover your 401(k) to an IRA. This will allow you to defer paying taxes on your 401(k) until you withdraw funds from the IRA.
- Make qualified withdrawals. Qualified withdrawals are those made after you reach age 59½, are used for certain expenses, or are made as part of a systematic withdrawal plan.
Tax Rates for Traditional vs. Roth 401(k)s
Traditional 401(k)s
Traditional 401(k) contributions are made pre-tax, meaning they are deducted from your paycheck before taxes are calculated. This lowers your taxable income and reduces the amount of taxes you owe in the year you make the contribution. However, when you withdraw money from a traditional 401(k) in retirement, it is taxed as ordinary income. The tax rate you pay will depend on your income tax bracket at the time of withdrawal.
- 10% tax bracket: 0%
- 12% tax bracket: 10%
- 22% tax bracket: 12%
- 24% tax bracket: 22%
- 32% tax bracket: 24%
- 35% tax bracket: 32%
- 37% tax bracket: 35%
Roth 401(k)s
Roth 401(k) contributions are made post-tax, meaning they are made after taxes have been calculated. This means you don’t get a tax break in the year you make the contribution. However, when you withdraw money from a Roth 401(k) in retirement, it is tax-free, provided you meet certain requirements.
Table: Tax Treatment of Traditional and Roth 401(k)s
Traditional 401(k) Roth 401(k) Contributions Pre-tax Post-tax Taxation of earnings Tax-deferred Tax-free Taxation of withdrawals Taxed as ordinary income Tax-free if certain requirements are met Early Withdrawal Penalties and Exceptions
If you withdraw money from your 401(k) before reaching age 59½, you may have to pay a 10% early withdrawal penalty in addition to income taxes on the amount withdrawn. However, there are some exceptions to this penalty, such as:
- Withdrawals to pay for qualified medical expenses
- Withdrawals to pay for education expenses (up to $10,000 per year)
- Withdrawals to buy or build a first home (up to $10,000 per lifetime)
- Withdrawals to pay for disability expenses
- Withdrawals to pay for certain other expenses, such as unreimbursed medical expenses or funeral expenses
If you qualify for one of these exceptions, you may still have to pay income taxes on the amount withdrawn, but you will not have to pay the 10% early withdrawal penalty.
Tax on 401(k) Withdrawals
The amount of income tax you will pay on a 401(k) withdrawal depends on your tax bracket. The following table shows the 2023 federal income tax brackets for single filers:
Taxable Income Tax Rate $0 – $10,275 10% $10,276 – $41,775 12% $41,776 – $89,075 22% $89,076 – $170,050 24% $170,051 – $215,950 32% $215,951 – $539,900 35% $539,901 or more 37% For example, if you are in the 22% tax bracket and you withdraw $10,000 from your 401(k), you will pay $2,200 in income taxes on the withdrawal.
It is important to note that you may also have to pay state income taxes on your 401(k) withdrawal. The amount of state income tax you will pay will depend on the tax laws of your state.
How Much is the Tax on 401(k) Withdrawals?
The amount of tax you pay on 401(k) withdrawals depends on several factors, including your age, the type of withdrawal you make, and your income. In general, you will pay income tax on any withdrawals you make from your 401(k) account, and you may also have to pay a 10% early withdrawal penalty if you are under age 59½.
Minimizing Taxes on 401(k) Withdrawals
- Delay withdrawals until you are age 59½. This will help you avoid the 10% early withdrawal penalty.
- Withdraw only as much as you need. Withdrawals are taxed as ordinary income, so taking out more than you need can mean paying more in taxes.
- Consider a Roth 401(k). Roth 401(k)s are funded with after-tax dollars, so you do not have to pay income tax on withdrawals in retirement.
- Make sure you understand the tax implications of different types of withdrawals. There are several different types of 401(k) withdrawals, each with its own tax implications. Be sure to understand the tax implications of each type of withdrawal before you make a decision.
Thanks for sticking with me through this deep dive into the world of 401k withdrawals and taxes. Now that you have a clearer picture, you can make informed decisions about when and how to access your retirement savings. Keep in mind that tax laws can change, so it’s always a good idea to consult with a qualified financial advisor or tax professional to stay up-to-date. Until next time, keep investing wisely and making the most of your retirement savings.