Do you get double taxed on a 401k withdrawal? (2024)

Do you get double taxed on a 401k withdrawal?

Do you pay taxes twice on 401(k) withdrawals? We see this question on occasion and understand why it may seem this way. But, no, you don't pay income tax twice on 401(k) withdrawals. With the 20% withholding on your distribution, you're essentially paying part of your taxes upfront.

No, you aren't paying taxes twice. Tax withheld is just an estimated advance payment of your taxes. The final tax amount can only be determined when you fill out your tax return. If too much tax was withheld, you'll receive a refund; otherwise, there'll be a tax due.

Once you begin receiving distributions from your 401(k), you'll owe income taxes on the funds. Some 401(k) plans will automatically withhold 20% to pay for taxes, however, you'll want to check with your plan provider to see how your 401(k) works.

The easiest way to borrow from your 401(k) without owing any taxes is to roll over the funds into a new retirement account. You may do this when, for instance, you leave a job and are moving funds from your former employer's 401(k) plan into one sponsored by your new employer.

Traditional IRAs and 401(k)s work differently: You get an upfront tax break when you contribute but then owe taxes on your withdrawals during retirement. And those withdrawals are taxed as ordinary income, possibly pushing you into a higher tax bracket in retirement.

This is where the rule of 55 comes in. If you turn 55 (or older) during the calendar year you lose or leave your job, you can begin taking distributions from your 401(k) without paying the early withdrawal penalty.

State and local governments may also tax 401(k) distributions. As with the federal government, your distributions are regular income. The tax you pay depends on the income tax rates in your state. If you live in one of the states with no income tax, then you won't need to pay any income tax on your distributions.

Convert the account into an individual retirement account. Start cashing out via a lump-sum distribution, installment payments, or purchasing an annuity through a recommended insurer.

Withdraw the money as cash.

This can be a costly choice since withdrawals of cash are subject to taxes and penalties. Leaving your money in a tax-advantaged retirement account preserves the tax benefits and can help with tax-deferred growth potential over time.

The “Rule of 55” and early retirement

Known as the Rule of 55, this allows you to withdraw money from your 401(k) penalty-free if you leave your job or are laid off during the year in which you turn 55, or later.

What is the best tax strategy for 401k withdrawal?

Deferring Social Security payments, rolling over old 401(k)s, setting up IRAs to avoid the mandatory 20% federal income tax, and keeping your capital gains taxes low are among the best strategies for reducing taxes on your 401(k) withdrawal.

Are 401k Withdrawals Considered Income for Social Security Purposes? They're not income on which you'd have to pay Social Security taxes. Social Security only considers earned income, such as a salary or wages from a job or self-employment.

401k contributions are made pre-tax. As such, they are not included in your taxable income. However, if a person takes distributions from their 401k, then by law that income has to be reported on their tax return in order to ensure that the correct amount of taxes will be paid.

Do you pay taxes twice on 401(k) withdrawals? We see this question on occasion and understand why it may seem this way. But, no, you don't pay income tax twice on 401(k) withdrawals. With the 20% withholding on your distribution, you're essentially paying part of your taxes upfront.

As you pull money out, you'll owe income taxes on the funds. Some 401(k) plans will automatically withhold 20% or so of your account to pay for taxes.

You Can Lower Your Taxable Income

“For example, if you contribute the maximum allowed to your 401(k), you're effectively lowering your taxable income for that year. This reduction can drop you into a lower tax bracket, potentially leading to a larger refund.

Using retirement savings to pay off debt is a decision that should not be taken lightly. It's true that paying off high-interest debt can save you money in the long run, but you also have to consider the potential loss of future investment growth in your retirement account.

Social Security tax FAQs

Social Security income can be taxable no matter how old you are. It all depends on whether your total combined income exceeds a certain level set for your filing status. You may have heard that Social Security income is not taxed after age 70; this is false.

At what age can you withdraw from a 401k without paying taxes?

You can begin withdrawing money from your 401(k) without facing the penalty once you reach age 59½. But the IRS makes a special allowance to help workers who, whether by necessity or choice, retire a few years earlier.

Money pulled from your take-home pay and put into a 401(k) lowers your taxable income so you pay less income tax now. For example, let's assume your salary is $35,000 and your tax bracket is 25%. When you contribute 6% of your salary into a tax-deferred 401(k)— $2,100—your taxable income is reduced to $32,900.

Consider a simple strategy to potentially reduce what you pay in taxes, in retirement: Take an annual withdrawal from every account based on that account's percentage of overall savings.

The IRS allows individuals to cash out their 401k and roll it over to an IRA without penalty and without the cashed-out amount being subject to taxation. You can also close out a 401k without penalty when you leave your job if you are at least 55 years old, but taxes will apply to the amount you withdraw.