When thinking about 401(k) plans, most people focus on growing their accounts through contributions and investments. But it’s important to understand what happens when you spend your money. For example, how much tax do you pay on 401(k) withdrawals, and how can you get that money without paying taxes?
These questions are essential for almost anybody planning for retirement. The rules are similar for other retirement plans, including 403(b), TSP, IRA, and 457 accounts—although there may be differences specific to certain plans.
Continue reading below, or get similar information from this video.
How Much Tax Do You Pay?
Withdrawals from pre-tax retirement accounts are treated as ordinary income. As a result, taking money out of those accounts is similar to receiving a paycheck from your job.
Withdrawals from a 401(k) plan may result in several types of tax, and you need to understand all of them:
- Income tax: You may owe federal and state income tax when using money from pre-tax retirement accounts or withdrawing earnings from after-tax accounts.
- Penalty tax: You could owe additional taxes for early withdrawals, generally before age 59 ½.
- Withholding: Your 401(k) may be required to withhold 20% of the amount you withdraw. That is a deposit on the year’s tax liability, and you might end up owing more or getting a refund.
That said, you might not end up owing any taxes, depending on the situation. Adjustments to your income can reduce or eliminate taxes, and several strategies can help. More on that below.
Is This a Taxable Event?
As you plan your withdrawal, it’s important to be specific about what type of withdrawal we’re talking about.
- Rollovers: If you move the money from your workplace plan to another retirement account, it’s generally not a taxable event if you do a direct rollover. That might be the case when moving assets from your 401(k) to an IRA.
- Distributions: When you take money out of a retirement account, you may owe taxes. That might happen when you withdraw money and spend it.
Income tax is usually due when you withdraw pre-tax funds (which have never been taxed) from a retirement account. Taxable distributions can include the following:
- Money you contribute out of your pay on a pre-tax basis
- Funds your employer deposits into your account (matching or profit-sharing, for example)
- Growth on pre-tax money
- Earnings in after-tax accounts
That income is generally treated as ordinary income, so you pay at whatever tax rate you’re in when you withdraw money. It’s similar to earning money from work—you typically owe income tax on those earnings.
Remember that you might owe state income taxes as well as federal income tax. However, some states exclude some or all of your retirement income from state-taxable income, easing the burden a bit.
Your Tax Bracket
Your tax rate depends on your income. The higher your income (from all sources—not just withdrawals), the higher your tax bracket. You can find up-to-date tax brackets online, but it’s important to know how these brackets work.
People often assume that all of their income is taxed at their highest tax bracket, or their marginal tax rate. That’s not the case.
For federal income tax, you often pay at several different tax rates. For example, in 2023:
- Your first $11,000 of income as a single filer ($22,000 for married filing jointly) is taxed at the lowest rate of 10%.
- The next $33,375 ($67,450 for MFJ) is taxed at the next rate of 12%.
- And so on.
Example: Your income is $85,000, putting you in the 22% tax bracket as a single filer for 2023. You take a distribution from your 401(k), and you’re 60 years old. How much tax will you pay?
- If you withdraw up to $15,000 or so, you’d still be in the 22% tax bracket. So, a $15,000 distribution would add $3,300 to your tax liability for the year.
- If you withdraw more than that, the excess would be taxed at the next bracket up (24%).
Things get especially interesting as the amounts grow. If you earn $85,000 and you withdraw $125,000 to pay off a loan, you’d find yourself in the 32% tax bracket for 2023. Again, not all of your income is taxed at that bracket, but for the portion that is, you only keep $680 of every $1,000 you withdraw.
Ultimately, it’s important to look at all of your income and the amount of your expected withdrawal before doing anything. With that information, you can estimate your tax bracket(s) and the cost of taking withdrawals.
The good news is there may be ways to limit how much you pay in taxes when withdrawing from retirement accounts.
Why Your Income Matters
Your tax bracket—and the amount you pay in income tax—isn’t the only thing to consider when you take distributions. Depending on your situation, it may be wise to consider:
- A high income can cause some (or more) of your Social Security income to be included in your taxable income. As a result, you keep less of that income (it goes from potentially tax-free to taxable).
- Income above certain levels may require that you pay higher premiums for Medicare or Marketplace health insurance.
- The higher your income, the less likely you are to qualify for various tax credits, deductions, assistance programs, and more.
Understanding taxes on 401(k) withdrawals can be complicated. There are at least two pieces to make sense of:
- What you actually owe the IRS for the year
- Any taxes that are withheld from your distribution
The amount you owe the IRS depends on your income, deductions, and other aspects of your tax return. You can’t know what that amount is until you complete your tax return—which doesn’t happen until after year-end. To some degree, your distribution will likely increase the amount you owe.
There’s also the question of withholding.
Tax withholding is money that goes to the IRS as an advance payment or deposit on your tax liability for the year. Withholding can happen at the time of your distribution, but it’s probably not the exact amount you actually owe.
You typically get a refund if you end up paying too much through withholding. But if you don’t withhold enough, you generally owe taxes. You could even owe underpayment penalties if you don’t withhold enough.
Because of the potential consequences, it’s important to make a reasonable estimate of the amount you’ll eventually owe on your distribution.
Mandatory or Optional?
When you take a cash withdrawal from a 401(k) plan, the plan must withhold 20% of the gross amount. So, if your distribution is $10,000, the 20% mandatory withholding would be $2,000, and you would receive $8,000 net.
You’re generally allowed to have more withheld, if you choose. Again, this withholding is a deposit on your taxes, and you might owe more, get a refund, or offset taxes you owe for other income sources.
For most people, mandatory tax withholding is a surprise. They want all of the money available quickly, and they don’t realize that they can only access 80% of the funds in their 401(k).
There may be a few instances when you can avoid mandatory withholding:
- Hardship distributions are not eligible for rollover, so they are not subject to mandatory tax withholding (but the distribution is still likely taxable).
- Direct rollovers to another eligible retirement account are not taxable.
- Required minimum distributions (RMDs) are not eligible for rollover so there is no mandatory 20%, although there might be a default withholding rate you can opt-out of.
- Periodic payments (at least annual) lasting for at least one year may be exempt from mandatory withholding. Consult with your plan administrator and tax expert for complete details.
If you want to spend money from your 401(k) and you’re no longer working for that employer, you can potentially avoid mandatory withholding by moving the assets to an IRA. Then, you can choose the amount of withholding (if any) from your IRA distributions. That strategy takes extra time and requires that you’re able to roll to an IRA, but it may be helpful.
Early Withdrawal Penalty
In addition to income tax, you might have to pay an early withdrawal penalty to the IRS when taking withdrawals from a 401(k). That can happen when you remove money before age 59 ½.
Several exceptions allow you to avoid the penalty, so research those carefully if you’re taking early distributions. And be aware that different workplace plans work differently. For example, a 457 plan would not have an early withdrawal penalty, while a 401(k) plan would.
But if you leave your job at age 55 or later, you can withdraw from that job’s 401(k) or 403(b) plan without an early withdrawal penalty—if you meet certain requirements. In particular, you must take funds from the 401(k) related to the job you left at 55 or later.
There are other wrinkles to be aware of when it comes to early withdrawal penalties, so be sure to triple-check for additional opportunities and risks.
Do You Have to Pay Taxes After Age 65 (or 59 ½)?
Your age can affect how much you pay in taxes. Again, the early withdrawal penalty usually applies to those under the age of 59 ½. After that age, you still have to pay federal income tax on withdrawals in most cases, but the penalty goes away.
The same is true after age 65. Distributions are considered ordinary income, and you typically have to pay federal income tax on those withdrawals. In some cases, your state might not tax withdrawals from retirement accounts, or a certain amount might be excluded, so research your state’s rules.
When Do You Owe Taxes on 401(k) Withdrawals?
Assuming you take a taxable distribution, you owe taxes for the year in which you take a distribution. For example, if you withdraw funds in 2024, the tax impact would be on your 2024 taxes. For most people, you pay those taxes by April of the following year (April of 2025, in this case). But remember that you might need to pay estimated taxes to avoid underpayment penalties, and your plan might also withhold taxes when you take the distribution.
How to Get 401(k) Money Without Paying Taxes
There are several ways to avoid or reduce taxes on retirement plan withdrawals. Some of the strategies below might not be available to you—and there might be additional solutions not shown here—but it’s worth exploring your options.
Important: None of these solutions are perfect, but there might be a “good enough” strategy that can help you save some money. Beware of solutions that sound too good to be true.
If your annual income is low enough, you might not owe taxes on distributions. That could happen if your deductions (such as the standard deduction) reduce your income to a point where you don’t owe income taxes.
You can even get strategic about keeping your income low. For example, if you need money and you can plan ahead, you might pull some of the funds out in the current year and wait until January (or later) of the following year to take the rest. By splitting the distributions, you might be able to keep your income low enough.
From a bigger-picture perspective, you might plan to withdraw money from pre-tax accounts before you’re required to. For instance, when you have years with a low income, you might take withdrawals even if you don’t need the money yet. Why let a 0% tax rate go to waste?
Qualified Charitable Distribution (QCD)
If you’re charitably minded, you can give money directly to a tax-qualified charity from your IRA. When done properly, that donation is not included in your income, even though you pull funds out of a retirement account.
If you’re going to donate money anyway, it’s worth investigating this option. You’ll reduce your tax burden, and by skipping the tax payment, you leave more money available for your favorite charity.
However, QCDs are not available from 401(k) plans. You must use an IRA with this strategy, so you would need to roll funds out of your 401(k) plan first. There are other restrictions, including maximum limits and age requirements, so check with a tax professional if you’re considering this option.
If you have assets in Roth accounts, distributions might be tax-free. You already paid income tax on your contributions, but you need to be mindful of earnings in Roth accounts.
When pulling from a Roth IRA, you get to take your regular contributions back out first. That money is free of taxes and penalties, but any earnings in the account might be taxable.
With 401(k) plans, your Roth distribution may come out pro-rata, meaning you’ll include some earnings in every distribution—you don’t get to take the most tax-favored dollars out first.
So, it’s critical to see if you can take a “qualified distribution” from your plan. A qualified distribution generally requires that you’ve had the account open for five years or more and you’re over age 59 ½. Death and disability may also qualify.
The opportunity for Roth 401(k) might not matter if you spent your life contributing pre-tax dollars. But if you’re planning ahead, this could be helpful later.
Of course, with Roth-type money, you pay the taxes when contributing, so you ultimately have to pay taxes at some point—when the money goes in or when it comes out.
When you borrow from your 401(k), you don’t owe taxes as long as you repay the loan on time. However, if you don’t repay, any unpaid amount may be treated as a distribution subject to taxes and penalties.
With loans, you need to be careful about leaving your job or losing a job. You might be required to repay the outstanding loan balance when you stop working for your employer. But you might not have the funds available to pay off the loan—that’s why you borrowed in the first place.
In some cases, it’s possible to offset the loan amount by contributing to an IRA later, but those rules can be complicated. And again, you need a lump sum of money to cover the loan balance.
Avoid 20% Withholding Tax
Paying 20% on a 401(k) withdrawal can be problematic if you need all the money in your account immediately. But again, 401(k) plans are often required to withhold that amount when you take a cash distribution. So, what if you want to get 100% of your account balance, or what if you expect to pay taxes at a rate that’s significantly lower than 20%?
If you want access to your money without paying taxes first, you can roll your 401(k) balance over to an IRA before taking a distribution. With IRAs, you have more control over tax withholding, and you can often choose to have nothing withheld—or select 0% withholding.
There are at least two potential caveats to this strategy:
- You will most likely owe taxes on that money at some point. By avoiding tax withholding, you’re only delaying the payment. This can also lead to underpayment penalties in some cases.
- You’ll need to move the assets to an IRA first. That takes time, including processing time and any hold times before you can withdraw money from your IRA.
Avoiding Penalty Taxes
If you need money before age 59 ½, there may be several ways to get pre-tax retirement money with no penalty taxes. However, you may still owe income tax on your withdrawal. By skipping the penalty tax, you can at least ease the burden somewhat.
- Rule of 55: If you leave your job at age 55 or later, you may qualify for an exception as described above. That age may go lower for public safety workers.
- SEPP 72(t): If you take substantially equal periodic payments (SEPPs) from your pre-tax accounts, you can begin distributions before age 59 ½ without penalty. But that strategy can be rigid and complicated, and mistakes result in retroactive taxes.
- 457 plans: When you have a governmental 457(b) plan, you should be able to take withdrawals at any age without the early distribution penalty.
- Other exceptions? The IRS has several additional rules that allow you to dodge penalty taxes, so it’s worth researching any opportunities.
- Wait until 59 ½: It might not be possible, but if you can wait or find alternative funds to draw from, you might avoid the 10% penalty. That’s probably easiest when you’re already in your late 50s.