The taxes you owe on the withdrawals you take in retirement from your 401(k) account depend on the types of contributions you've made to the retirement account, as traditional pre-tax and Roth 401(k) contributions are taxed differently upon withdrawal.
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If you withdraw pre-tax contributions, and any associated earnings, you'll owe federal (and possibly state) income taxes on that amount. In addition, withdrawing pre-tax contributions, and any associated earnings, from your 401(k) account before you're 59½ may result in a 10% additional federal tax on your withdrawals (although there are certain exceptions to thisFootnote 1).
"Remember that any funds you take out today may ultimately reduce the opportunity for your retirement nest egg to grow on a tax-deferred basis."
— Bill Hunter, Director, Personal Retirement Strategy and Solutions, Bank of America
If you have a Roth 401(k) account and take a qualified withdrawal of your contributions and any associated earnings — which generally requires that you're age 59½ or older, with five years passing since January 1 of the year you made your first Roth contribution — you won't have to pay federal income taxes on that amount. Remember: If you withdraw any earnings associated with your Roth contributions when either of the qualified withdrawal requirements have not been satisfied, federal (and possibly state) income taxes will apply. Also, a 10% additional federal tax may apply if earnings are withdrawn prior to reaching age 59½, unless an exception applies.
There's an additional possible tax consequence for 401(k) withdrawals: When you reach age 72,
Footnote 2 the tax laws require you to make annual withdrawals known as
required minimum distributions (RMDs), unless you are still working for the employer where your 401(k) account is held. If you fail to withdraw your RMDs or withdraw too little, an additional 50% federal income tax on the amount required to be withdrawn, but which was not withdrawn, may apply.
These are all reasons to avoid taking money out of your retirement accounts before the age of 59½ if possible. There's at least one other: Remember that any funds you take out today may ultimately reduce the opportunity for your retirement nest egg to grow on a tax-deferred basis.