How Are 401k Withdrawals Taxed?

Understand 401k withdrawal tax before you take a distribution.

One of the main benefits of a 401k plan is that contributions and earnings grow tax-deferred. No matter how much money you earn in your 401k, you won’t have to worry about paying taxes on those gains until you take a distribution. In the case of a Roth 401k, you might be able to avoid taxes altogether. However, a traditional 401k withdrawal is generally taxable. Some 401k distributions trigger additional penalties as well. Here’s a look at what to know before taking a distribution from a 401k.

How Are 401k Withdrawals Taxed?

With a few exceptions, distributions from 401ks are taxed as ordinary income. However, if you were born before 1936 and you take out your distribution as a lump sum, you might benefit from special taxation.

You can also avoid tax if you roll over your distribution into another tax-advantaged plan, such as an IRA or another 401k plan. If you don’t complete the rollover within 60 days of your distribution, however, the rollover becomes fully taxable, the same as an ordinary distribution.

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401k Early Withdrawal Penalty

If you take money out of your 401k before you turn age 59.5, you might face an additional tax of 10 percent for taking an early distribution. Some exceptions apply to this rule, including a 401k early withdrawal for one of the following reasons:

  • Payments to a beneficiary
  • Payments due to a qualifying disability
  • Payments due to an IRS levy
  • Payments to satisfy a qualified domestic relations order
  • Payments made after separation from service after age 55

401k Taxes vs. Roth 401k Taxes

A Roth 401k carries different tax characteristics than a traditional 401k. With a Roth 401k, you don’t benefit from a tax deduction on your contributions. However, qualified distributions are tax-free. A qualified distribution is one taken at least five years after an initial contribution and when the account holder is at least age 59.5, has died or becomes disabled.

Related: The Best Roth IRA Accounts

When Can I Take a 401k Distribution?

In most cases, you can’t access the money in your 401k until you turn age 59.5 unless the plan terminates, you die or become disabled or if you leave your job for any reason after age 55, which is known as “separation from service.” Some plans do allow for loans of up to 50 percent of the vested value of your account, up to $50,000. However, if you don’t pay that money back, the outstanding balance is treated as a taxable distribution.

Once you turn 59.5, you’ll be required to take at least a minimum amount from your 401k every year. This minimum required distribution is also fully taxable when taken from a traditional 401k plan.

Your plan might also allow for hardship distributions, which can only be used to meet an immediate and heavy financial need. If allowed, hardship distributions are subject to ordinary income taxation, just like any other withdrawal. They’re also subject to the 10 percent early withdrawal penalty, if applicable.

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