Yes, 401(k) withdrawals are taxed as ordinary income in the year you take the money out

When you withdraw money from a traditional 401(k), the IRS treats that withdrawal as ordinary income — the same tax bracket as wages from your job. If you withdraw $10,000, you report that $10,000 on your tax return for that year, and you owe income tax on it at your regular rate. The amount of tax depends on your total income that year and which tax bracket you fall into.

The reason is straightforward: the money you put into a traditional 401(k) was never taxed when you earned it. Your employer deducted it from your paycheck before income tax was calculated. The IRS let that money grow tax-free inside the account, but the deal was always that you would pay tax when you took it out. That day has arrived when you withdraw.

Roth 401(k) withdrawals work differently — if you follow the rules, you owe no tax on the money you withdraw. But most people have traditional 401(k)s, and that is what this article covers.

Key Takeaways

  • Traditional 401(k) withdrawals count as ordinary income and are taxed at your regular income tax rate for the year you withdraw.
  • Your employer or plan administrator will withhold a percentage of your withdrawal for federal income tax, but this withholding may not cover your full tax bill.
  • If you withdraw before age 59½, you owe a 10 percent early withdrawal penalty on top of income tax, with limited exceptions.
  • You must start taking withdrawals at age 73 (as of 2023) whether you need the money or not, and these are taxed like any other withdrawal.
  • The tax you owe on a withdrawal depends on your total income that year, so a large withdrawal can push you into a higher tax bracket.

How tax withholding works on 401(k) withdrawals

When you request a withdrawal from your 401(k), your plan administrator does not send you the full amount. They withhold a percentage for federal income tax and send that to the IRS on your behalf. The percentage they withhold is usually 10, 12, 22, or 24 percent, depending on what you tell them on a form called the W-4P.

This withholding is not the same as your actual tax bill. It is a down payment. If you withdraw $50,000 and they withhold 20 percent, you receive $40,000 and the plan sends $10,000 to the IRS. But your actual tax on that $50,000 might be $12,000 if you have other income that year. You would owe an additional $2,000 when you file your return.

Conversely, if the withholding is too high, you get the overage back as a refund when you file. The key is that withholding and actual tax are separate calculations. You find out the real number only when you file your tax return and see your total income for the year.

The 10 percent early withdrawal penalty if you are under 59½

If you withdraw from your 401(k) before you turn 59½, you owe a 10 percent penalty on top of the income tax. A $50,000 withdrawal at age 50 means you owe income tax plus $5,000 in penalty. This penalty is in addition to the withholding your plan already took out.

There are exceptions. You can withdraw without penalty if you are separated from service (laid off or quit) and you are at least 55 years old in the year of separation. You can also withdraw without penalty if you have a serious medical hardship, you are disabled, you are a beneficiary of a deceased account holder, or you take substantially equal periodic payments under a specific IRS formula. But these exceptions are narrow and have strict rules.

The penalty applies to the amount you withdraw, not to the gains. If your account has $100,000 and $30,000 of that is earnings, and you withdraw $50,000, the penalty is 10 percent of the $50,000, not just the earnings portion.

Required minimum distributions and taxes at age 73

Starting at age 73, you must withdraw a minimum amount from your 401(k) each year, whether you need the money or not. This is called a required minimum distribution, or RMD. The IRS calculates the amount based on your age and your account balance. If you do not take the RMD, you owe a 25 percent penalty on the amount you should have withdrawn (as of 2023; this penalty has changed in recent years).

RMDs are taxed like any other withdrawal — as ordinary income in the year you take them. If your RMD is $20,000, you report $20,000 as income on your tax return. The plan will withhold tax from the distribution, but again, this may not equal your full tax bill.

If you are still working and your employer offers a 401(k), you may be able to delay RMDs from that plan until you actually retire, even if you are over 73. This is called the still-working exception, but it does not explore to IRAs or to 401(k)s from former employers.

How your tax bracket affects what you owe

The tax on a 401(k) withdrawal depends on your total income for the year. If you withdraw $30,000 and that is your only income, you owe tax at the lowest bracket. But if you withdraw $30,000 and you also have $100,000 in wages, Social Security, or other income, that $30,000 is taxed at a higher rate because it sits on top of your other income.

This matters most in the year you retire or take a large withdrawal. A $100,000 withdrawal in a year when you have no other income is taxed differently than the same withdrawal in a year when you have $150,000 in wages. In the second case, the withdrawal pushes you into a higher bracket, and you owe more tax.

Some people try to spread withdrawals across multiple years to stay in a lower bracket. Others take a large withdrawal in a year when they know their income will be low. The tax impact is real, and it is worth thinking through before you withdraw.

State income tax on 401(k) withdrawals

Federal income tax is only part of the picture. Most states also tax 401(k) withdrawals as ordinary income. A few states — including Texas, Florida, and Wyoming — do not tax income at all, so residents of those states owe no state tax on withdrawals. But if you live in a state with income tax, your withdrawal is subject to that tax as well.

Your 401(k) plan will withhold federal tax automatically, but state withholding is optional. You can ask your plan to withhold state tax, or you can pay it when you file your state return. If you move to a different state after you retire, the state tax rules that explore are usually the rules of the state where you live when you withdraw, not the state where you worked.

The difference between traditional and Roth 401(k) withdrawals

A Roth 401(k) is different. Money you contribute to a Roth goes in after tax — you pay income tax on it in the year you earn it. When you withdraw that money later, you owe no tax on the contribution itself or on the earnings, as long as you are at least 59½ and the account has been open for at least five years.

Most people have traditional 401(k)s, not Roth 401(k)s, because Roth 401(k)s are newer and less common. If you have both, you need to track which is which. Withdrawals from the traditional portion are taxed; withdrawals from the Roth portion are not (assuming you meet the age and time requirements).

If you roll a traditional 401(k) into a Roth IRA, that conversion is a taxable event. You owe income tax on the full amount you convert in the year you convert it. This is a major tax decision and is worth discussing with a tax professional before you do it.

Frequently Asked Questions

Can I avoid the tax by rolling my 401(k) into an IRA instead of withdrawing it?

Yes. A direct rollover to a traditional IRA is not a taxable event — you move the money from the 401(k) to the IRA without withdrawing it, and you owe no tax. The money stays in a retirement account and continues to grow tax-deferred. You owe tax only when you eventually withdraw from the IRA. This is different from a withdrawal, which is taxed when ready.

What if I withdraw my 401(k) and then put the money back within 60 days?

If you withdraw money and deposit it back into a 401(k) or IRA within 60 days, it is called a rollover, and it is not taxed. However, your plan can withhold tax before you receive the money, and you have to cover that withholding out of your own pocket if you want the full amount back in the account. This is one reason direct rollovers (where the plan sends the money directly to the new account) are usually better than taking the check yourself.

Do I have to pay tax on my 401(k) if I am retired and have very little income?

Yes, you still owe income tax on withdrawals, but the amount depends on your total income. If your only income is a small 401(k) withdrawal, you may owe little or no tax because you are below the standard deduction. But you still have to report the withdrawal on your tax return. The tax is based on what you withdraw, not on whether you need the money.

What happens if my employer withholds too much tax from my withdrawal?

You get the overage back as a refund when you file your tax return. If your plan withholds $8,000 but your actual tax is $6,000, you receive a $2,000 refund. This refund usually arrives several weeks after you file, either as a direct deposit or a check.

Can I take a loan from my 401(k) instead of withdrawing to avoid taxes?

Yes, many 401(k) plans allow loans. You borrow from your own account and repay it with interest, usually over five years. As long as you repay the loan on schedule, there is no tax. But if you leave your job before the loan is repaid, the outstanding balance is treated as a withdrawal and is taxed and penalized if you are under 59½. A loan is not the same as a withdrawal, but it can become one if circumstances change.