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TAXES
MARCH 19, 2021

How are 401(k) account withdrawals taxed?

Answered by
Ben Storey
Director, Retirement Thought Leadership
Bank of America
The taxes you owe on the withdrawals you take in retirement from your 401(k) plan 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.
Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
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) plan account before you're 59½ may result in a 10% additional federal tax on your withdrawals (unless an exception appliesFootnote 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."
— Ben Storey, Director, Retirement Thought Leadership, 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first Roth contribution (or Roth conversion, if earlier) — you won't have to pay federal income taxes on the earnings withdrawn. 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 Also, a 10% additional federal tax may apply if earnings are withdrawn prior to reaching age 59½, unless an exception applies.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 (or age 70 1/2 if you attained such age prior to January 1, 2020),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) plan 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fail to withdraw your RMDs or withdraw too little, an additional 50% federal income tax on the amount required to be withdrawn, but which was not withdrawn, may apply.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.
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Footnote 1 For employer-sponsored retirement plans such as a 401(k) plan, one of the exceptions to the age 59½ rule includes distributions taken after a separation from service that occurred on or after the year in which you turn age 55.

Footnote 2 If you own more than 5% of the business sponsoring the plan, then you must begin receiving distributions by April 1 of the year after the calendar year in which you reach age 72 (age 70½ if you attained such age prior to January 1, 2020), even if you are still working for the employer.

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