Does a 401(k) Count as Income?

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Whether a 401(k) counts as income depends on the type of account and when you’re accessing the money. Traditional 401(k) contributions are made with pre-tax dollars, so they aren’t considered taxable income at the time you contribute, but you will owe income tax when you withdraw the funds in retirement.

On the other hand, Roth 401(k) contributions are made with after-tax dollars, so qualified withdrawals are generally tax-free and don’t count as income later on.

How 401(k) Contributions Affect Your Taxable Income

Understanding whether your 401(k) contributions count as income depends on the type of account you have. Here’s a breakdown of how it works:

• Traditional 401(k) contributions. These are made with pre-tax dollars, meaning your contributions reduce your taxable income for the year. You’ll pay income taxes later when you withdraw the money in retirement.
• Roth 401(k) contributions. These are made with after-tax dollars. They don’t reduce your taxable income in the year you contribute, but qualified withdrawals are tax-free in retirement.
• Employer matching contributions. These don’t count as income when they’re deposited into your account. However, you will pay taxes on the employer match portion when you withdraw those funds in retirement.

Are 401(k) Withdrawals Considered Taxable Income?

As with contributions, the type of 401(k) plan determines whether withdrawals are counted as income.

• Traditional 401(k). Withdrawals are taxed as ordinary income in retirement.
• Roth 401(k). Qualified withdrawals, those taken after age 59½ and after the account has been open for at least five years, are tax-free
• Early withdrawals. Taxed as income plus a 10% early withdrawal penalty if taken when younger than 59½, unless one of a handful of rare exceptions applies.

Are 401(k) Loans Taxable or Counted as Income?

Taking a loan from your 401(k) doesn’t count as income, as long as you repay it on time. Most 401(k) plans allow you to borrow from your account and repay the amount, with interest, within a set period (typically five years). As long as you follow the repayment terms, the loan is not considered taxable income.

However, if you default on the loan or leave your job and fail to repay the remaining balance, the unpaid amount is treated as a distribution. That means it becomes taxable income and may also trigger a 10% early withdrawal penalty if you’re under age 59½.

Do 401(k) Contributions Affect Your Adjusted Gross Income (AGI)?

Yes, but it depends on the type of 401(k) you have.

• Traditional 401(k) contributions. These reduce your adjusted gross income (AGI) because they’re made with pre-tax dollars. Lowering your AGI can reduce your overall tax bill and may help you qualify for certain income-based tax credits or deductions.
• Roth 401(k) contributions. Roth 401(k) contributions are made with after-tax dollars, so they do not lower your AGI. While they won’t reduce your current tax bill, qualified withdrawals in retirement are tax-free.

Does 401(k) Income Affect Social Security or Medicare?

While 401(k) funds can impact your overall tax picture, their effect on Social Security and Medicare depends on how and when the money is used:

• 401(k) contributions. These do not count as earned income for Social Security purposes and have no effect on your Social Security benefits.
• 401(k) withdrawals. Distributions are not subject to Social Security payroll tax. However, they do count toward your taxable income, which can affect your Medicare premiums, particularly if your income pushes you into a higher bracket for Income-Related Monthly Adjustment Amounts (IRMAA).

Does 401(k) Income Affect Unemployment or Government Assistance?

Whether a 401(k) impacts your eligibility for unemployment benefits or other social programs depends on how the funds are used:

• 401(k) contributions. These do not affect your eligibility for unemployment benefits. Since they’re not considered income, they won’t reduce your benefit amount.
• 401(k) withdrawals. Distributions may be counted as income for needs-based programs like Medicaid or ACA health insurance subsidies. This can potentially reduce your benefits or disqualify you, depending on the program’s income limits.

How to Reduce Taxes on 401(k) Withdrawals in Retirement

While 401(k) plans offer tax-deferred growth during your working years, withdrawals in retirement are generally taxed as ordinary income. That makes smart tax planning essential to preserving more of your savings. Here are a few strategies to help reduce your tax burden:

• Withdraw gradually to stay in a lower tax bracket. Taking only what you need can help you avoid pushing yourself into a higher income tax bracket.
• Consider Roth conversions before retirement. Converting some of your traditional 401(k) funds to a Roth IRA while your tax rate is relatively low can reduce future taxable income.
• Coordinate withdrawals with other income sources. Plan distributions alongside Social Security, pensions, and investment income to better control your taxable income each year.

Bottom Line

Traditional 401(k) contributions are tax-deferred but taxed as ordinary income upon withdrawal. Conversely, Roth 401(k)s are funded with money that has already been taxed, so they’re tax-free upon withdrawal. When working, choose a plan type that aligns with your current and projected future tax brackets. In retirement, consider taking traditional withdrawals gradually to maintain a low tax rate.

Work with a tax professional to create a withdrawal strategy that minimizes your taxable income in retirement.

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