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Taxes and the 401k Withdrawal

401k withdrawalIf you take a 401k withdrawal and the money in the 401k was deducted from your taxable income, you’ll be taxed on the funds you withdraw. Depending on the circumstances, you may also be subject to a penalty. There’s a lot of confusion about how the taxation works – and the taxation and penalties can be different depending upon the circumstances.

Taxation of the 401k Withdrawal

When you take a distribution of pre-tax money from a 401k plan, the amount of the 401k withdrawal that is pre-tax will be included in your income and will be taxed at your marginal income tax rate in that year.

Unless you meet one of the exceptions noted in the article 16 Ways to Withdraw Money From Your 401k Without Penalty, your 401k withdrawal will also be subject to a 10% early withdrawal penalty.

For example – if you have a 401k plan at a former employer and you are 45 years of age, unless your 401k withdrawal meets one of the exceptions, taxation would work like this for a $50,000 401k withdrawal:

Taxable Income before withdrawal $60,000
Tax (assumes MFJ) $8,072.50
Effective Tax Rate 13.45%
401k Withdrawal $50,000
Other taxable income $60,000
Total taxable income $110,000
Tax (assumes MFJ) $23,836.75
Effective Tax Rate 21.67%
Penalty (10%) $5,000
Total Tax and Penalty $28,836.75
Total Effective Tax Rate 26.22%

Nothing really dramatic about the first part, it’s just more taxable income and you’ve likely grown to understand the effect of the graduated tax schedule. But what will likely open your eyes is the fact that this $50,000 was actually taxed at a rate of 41.53%! Your 401k withdrawal of $50,000 resulted in $20,764.25 in taxes and penalties, so in effect you only “net” $29.235.75 from this withdrawal. Almost makes a payday loan look cheap by comparison.

On the other hand, if you met one of the exceptions (such as being age 59½ or older, the penalty would not apply. The effective tax rate on the 401k withdrawal is 10% less, at only 31.53%.

Mandatory Withholding

Another thing you need to understand about your 401k withdrawal is the mandatory withholding. Unless your 401k withdrawal is a direct rollover to another plan (such as an IRA), part of a Series of Substantially Equal Periodic Payments (SOSEPP, or 72t option), is a Required Minimum Distribution or a hardship distribution, there is a requirement for the administrator to withhold 20% from the 401k withdrawal.

This 20% is sent to the IRS and will be included as part of your withholding and estimated tax payments that will apply against your tax when you file. If the withholding was too much, you’ll get a refund of the extra withholding, just as you do from extra withholding or estimated payments.

Here’s a continuation of the previous example to illustrate withholding:

401k Withdrawal $50,000
Mandatory Withholding (20%) $10,000
Other Withholding (from W4 wages) $9,000
Total Withholding $19,000
Total Tax and Penalty (from prior) $28,836.75
Amount You Owe $9,836.75

As you can see, even though the mandatory withholding from the 401k withdrawal is substantial, it’s not enough in many cases to cover the tax and penalties from the withdrawal.

58 Comments

  1. SandraNo Gravatar says:

    I’m 44 I quit and am jobless, I felt like I had to empty my 401k due to no credit. I had around 39000. I received 29000 after withholding the first part. How much should I set aside for taxes at end of year. I thought voya was taking out 15% and I would just have to pay 10% at end of the year.

    1. jblankenshipNo Gravatar says:

      That’s going to depend on your overall income for the year. You’ll need to add your other income to the total 401k withdrawal and calculate the tax requirement from there. Don’t forget that you’ll also owe 10% penalty ($3,900) on the 401k early withdrawal.

  2. JCNo Gravatar says:

    I’m 61 and getting ready to withdraw $50K. I’m aware of the 20% mandatory penalty but what will be the additional taxes and when do they have to be paid?

    1. jblankenshipNo Gravatar says:

      The 20% you’re referring to is not a penalty – it is withheld to cover the potential taxes. When you take a withdrawal from your 401k you must add the withdrawal amount (the gross amount, including the withheld 20%) to your other income for the year. That will determine how much tax you will owe. If it’s more than the 20% withheld, you must pay additional; if it’s less, you’ll get a refund.

      Since you’re over age 59 1/2 there are no penalties on the withdrawal.

  3. M GuptaNo Gravatar says:

    I am expat and contributing to 401K and plan to go back early next year Jan/Feb 2018. My taxable income will be negligible in 2018. Can I withdraw my 401K as I understand my tax bracket will low. Pls confirm. Also will I have to pay the 10% penalty as I will be moving back to my home country and will not be returning.

    1. jblankenshipNo Gravatar says:

      Yes, you can withdraw your funds – but some (or all) of the matching funds from your employer may not be available to you if you’ve only been employed by this employer for a short time. You will be taxed on the withdrawal, but if you have no other US income for the year you might get away without tax on the funds (at the very least, low tax). There will be the 10% penalty unless you meet one of the exceptions.

  4. Cee JayNo Gravatar says:

    Hi Mr. Blankenship. I was injured at work, receiving workers comp until recently. I cannot work and need money for bills, etc,. Can I withdraw from my 401k? I am 50 years old with no income right now. Thank you!

    1. jblankenshipNo Gravatar says:

      It’s going to be up to your 401k administrator. If you’re disabled, this is a possible exception against the penalty, but you’d still owe the tax. See the article 16 Ways to Withdraw Money From Your 401k Without Penalty for more exceptions.

  5. Ron HopkinsNo Gravatar says:

    I am 71 and 7months, still working and contributing to my 401 (about 30,000), do I have to withdraw funds now since I am still working and contributing?

    1. jblankenshipNo Gravatar says:

      Not if you’re still working as of the end of this calendar year, as long as you’re not a 5% or more owner of the business that you work for.

  6. Thomas BrownNo Gravatar says:

    I am 61 years old and still employed by the same company. Can I withdraw my entire amount ? I am buried in credit card debt and want to pay it off.

    1. jblankenshipNo Gravatar says:

      That’s a question for your plan administrator. If I had to guess I would say it’s unlikely – but ask them, you may find out differently.

  7. FreemanNo Gravatar says:

    Do you have to meet certain criteria to pull money from a 401k plan if you still work for the company the plan is with?

    1. jblankenshipNo Gravatar says:

      Yes, your 401k administrator should have the details for you.

  8. MarciaNo Gravatar says:

    My brother is currently incarcerated and I (I have power of attorney) need to encase his 401k, how do I go about doing same?

    1. jblankenshipNo Gravatar says:

      I don’t know what you mean by “encase his 401k”. If you can provide more details I’ll try to help.

  9. Ethel BernalNo Gravatar says:

    I have recently gotten laid off from my job. I am 56 years old. In order to make ends meet I will need to withdraw a portion from my 401k. My plan does not allow withdrawl so I will need to roll it over. My question is, can I withdraw a portion of it to pay bills and roll over the remaining amount?

    1. jblankenshipNo Gravatar says:

      Yes, that’s perfectly acceptable. Taking the withdrawal before it’s rolled over will allow you to avoid the penalty for early (pre 59 1/2) withdrawal as well.

      1. Bryan WNo Gravatar says:

        Really? Does he avoid the penalty because he was laid off? I have the same situation and am planning to withdraw all but $5500 (annual max contribution to Roth IRA). Does this mean 20% but no penalty?

        1. jblankenshipNo Gravatar says:

          The reason for leaving the job isn’t important – layoff, retirement, etc., all work for that exception to the penalty, as long as you are age 55 or older when you leave the job.

  10. JoshuaNo Gravatar says:

    Is it normal to be penalized more than the amount you had? I’m 31 and only just started 401k last year. I had 200 in it. Now on my taxes they are penalizing me 400. Is this normal? I switched jobs in August and at my new job I had to wait until the new year to enroll and with only 200 in there the former job didn’t give me any other option but to cash it out.

    1. jblankenshipNo Gravatar says:

      That doesn’t sound right – but without looking at your tax return I can’t say for sure what is happening. The penalty should only be 10% of the amount withdrawn. There would be tax on the amount withdrawn as well, but that would be at your normal tax rate, still nothing that could double your penalty/tax.

      1. JoshuaNo Gravatar says:

        That’s what I thought. A relative does my taxes and they used 2 different sites and both came back the same. Would you recommend I take it for review? She just submitted them yesterday.

        1. jblankenshipNo Gravatar says:

          Yes, I think it makes sense to have someone look over your documents and the return to make sure it’s all done properly.

  11. Bill ClintonNo Gravatar says:

    My wife will quit her job this year. She has a 401k With Principal. She also turns 55 this year. Principal is pushing us to rollover her 401k into one of their managed accounts. If I understand it right if we do that we no longer can access here 401k without paying the 10% penalty until she turns 59 1/2? Even though we have no plans for the money I still do not want to lock it up for 4 years. If I understand it right I want to leave her money with Principal and I can access it without the 10% penalty and once she turns 59.5 we can do whatever we want with it?

  12. Bryan BNo Gravatar says:

    I am under the understanding that I can get a hardship withdraw for a down payment on a home as my primary residence. I am a first time home buyer. Does this exclude me from the 10% penalty? I am under 59 1/2. Also, can I split the disbursement? 1/2 loan and 1/2 withdraw?

    1. jblankenshipNo Gravatar says:

      These are questions for you to ask your 401k administrator.

      Generally a withdrawal from a 401k for home purchase is not one of the exceptions to the 10% penalty.

  13. joeNo Gravatar says:

    I am 57, unemployed, and want to start withdrawing from my 401k using SOSEPP. do I need to withdraw for 5 years, or is SOSEPP no longer binding once I reach 59 and a half

    1. jblankenshipNo Gravatar says:

      Once you start a SOSEPP you must continue it for the longer of 5 years or until you reach age 59 1/2. So in your case it would be five years.

      Did you leave the employer on or after your 55th year? If so, you should have access to the funds without penalty and without the restrictions of a SOSEPP.

  14. daiquan HallNo Gravatar says:

    I need to borrow $875.00 from my 401k , how much would i have to owe back?

    1. jblankenshipNo Gravatar says:

      That depends on the interest rate and how long you stretch out your payback. Talk to your 401k administrator to get more information.

  15. Katie MartinezNo Gravatar says:

    Hi, I am 591/2 years old. I recently left my job and would like to begin withdrawing from my 403b plan. My advisor at the company where I have my money says that I have to pay a 20% fund tax on any money that I take out. Is that correct? Why can’t I just take the money out and count it as income when I file taxes and pay any taxes I owe then? Thanks, Katie

    1. jblankenshipNo Gravatar says:

      The 20% withholding is a hard and fast rule. You could avoid that requirement by rolling over your 403b plan into an IRA, and then you can take distributions from the IRA with no withholding (or any amount of withholding you deem to be appropriate).

  16. LizNo Gravatar says:

    I currently have over 40,000 in retirement account from a previous job. I want to take a portion out and put the other portion in a IRA. I’m under 59, and wanted to know the best route to take to avoid major penalties. I really need some of my money but not all of it. I was going to take some and invest it into a small business. I also have a retirement account at my new job. Any advice would be helpful. Thanks in advance.

    1. jblankenshipNo Gravatar says:

      If you meet one of the exceptions (see this article for details) then you may avoid the penalty on your withdrawal or a portion of the withdrawal.

  17. mickiNo Gravatar says:

    hi im 60 years old i want to use my 401k to buy a house i earn 60000 a year and my 401k is 60000 what do i need to do and what would i pay on that tax or any penalties

    1. jblankenshipNo Gravatar says:

      You need to ask your 401k administrator how you can access the funds. Regarding the tax, any amount that you withdraw from the account will be taxed as ordinary income – added to your other earnings for the year. Since you’re over age 59 1/2, there would not be any penalty on the withdrawal.

  18. […] the withdrawal, and if you do not meet one of the exceptions, a penalty as well. See the article Taxes and the 401k Withdrawal for more details about how the taxation […]

  19. ManZaarNo Gravatar says:

    I am getting ready to move from one job to another. I have 17K in my 401K and I have an outstanding loan of $4500. I would like to move my money to an IRA account just before/after I leave my current company while taking about 5K in cash to assist in some financial hardships. What would the best option be to avoid fees & penalties? Will the will I be taxed as income on both the $4500 loan & $5K withdrawal? I wonder how hard that hit would be…

    -Washington State resident, 25 years old.

    1. jblankenshipNo Gravatar says:

      Unless you meet one of the exceptions, you will owe 10% penalty ($950) plus ordinary income tax on the $9,500 – your loan plus the withdrawal – at whatever your income tax rate is.

  20. davidNo Gravatar says:

    hi, how about if am no longer a US resident, do i still have to pay penalty and taxes on it? thank you

  21. Tula FoxNo Gravatar says:

    Hello,
    I am a first time buyer and I would like to use my 401k savings as down payment. Doing little research, I’ve found contradicting information. Some say, no penalties or taxes are due when using for a down payment on a home for a first time buyer, other say 10% taxes and other taxes,etc..
    I am 38, so I do not qualify for any age exemptions.

    Thanks!

    1. Tula FoxNo Gravatar says:

      So, the question is: What would be correct? no penalties or taxes(exempt) because I am a first time buyer, or the usual penaties and taxes?

    2. jblankenshipNo Gravatar says:

      401k funds are not allowed an exemption from penalties for first-time home purchase. If you are no longer working for the company you could rollover your 401k account to an IRA, and then use the first-time homebuyer exemption for a withdrawal. Either way there will be taxes to pay – and if you don’t qualify for an exemption you will also owe the 10% penalty.

  22. MVHNo Gravatar says:

    Hi – I am planning to quit my present job to start a small business. My 401K has about $35,000 and my 401K loan has about $5,000 balance left. I am in Utah. what would my estimated taxes and penalty be if I withdrew all of the amount in the 401K?

    1. jblankenshipNo Gravatar says:

      If you’re under age 59 1/2 you’ll have a penalty of 10% plus whatever additional tax is calculated. To find the amount of tax you would add the amount of the withdrawal to your ordinary income and figure the tax.

  23. EsetelNo Gravatar says:

    I recently fell on hard times after having a major illness. My mother recently retired and wants to help me out by giving me the $20,000 from her 401k; however I know there are heavy penalties that comes with that. However; instead of crawling into more debt I’m wondering if this is this is the better option along with repaying my mother back all the money with all the fees. Could you give me an idea of what fees I will be facing.
    She is 60 years old and roughly have 750,000 in her 401k

    1. jblankenshipNo Gravatar says:

      It’s not a bad idea – there would not be any penalties for your mother withdrawing funds from her 401k. She’s over age 59 1/2 and has retired from her job. There will be taxes on the withdrawal, but how much depends on your mother’s other income. You could calculate what the tax increase is from the withdrawal and add that amount to the amount that you will pay her back – that would be the “upright” thing to do, since the withdrawal has cost her extra taxes.

      This option is better than some other options, such as payday loans, credit card debt and the like.

  24. Dee McNealyNo Gravatar says:

    I work for a small company. Doing a loan from my 401k is not an option. I would like to take 5000.00 from my 401k. I have 45,000.00 in my 401k now. I am single with no dependents and have always gotten a refund on my taxes. Can you give me an idea of what I would be facing?

    1. jblankenshipNo Gravatar says:

      If you’re still working for the company and under age 59.5 it’s likely that you will not be allowed to take a withdrawal. If you somehow qualify for a withdrawal you can expect to pay ordinary income tax and 10% penalty on the withdrawal. If your ordinary income tax is 25% for example, the taxes and penalties would amount to $1,750.

  25. michelleNo Gravatar says:

    i am 30 years old and i have a 401k plan with my old company i no longer work for and going through hard times trying to buy a house can i withdraw my money if i havent worked for them in 5 years ? and how do i look into it i dont even know where to being i really forgot all about it until i was just sent papers on it thank you

    1. sraskieNo Gravatar says:

      Hi Michelle,

      The answer to your question is yes. However, carefully consider the tax consequences. If you take the money from your old 401k, you will have to pay ordinary income taxes AND an additional 10% penalty since you are under age 59.5.

  26. N. WoodsNo Gravatar says:

    My company closed and I have a $30,000 401k to consider on what I should do with. My husband had major surgery earlier this year, which we have paid most of the bills however due to this surgery he was out of work for 4 1/2 months causing a large debt of just living expenses. Can you roll part of your 401k into an IRA and take a tax hit on only part of your money? Something else I was considering is that I have an eleven year old and would like to put a 1/3 into a college fund.

    1. jblankenshipNo Gravatar says:

      Yes, you can rollover part of the 401k and take part out in cash. You will owe tax on the part taken in cash, and if you’re under 59 1/2 years of age and you do not meet one of the criteria for an exception, you will also have a 10% penalty for early withdrawal on the cashed out portion.

  27. Steven WassnerNo Gravatar says:

    I am not clear on one aspect. I believe that even after I retire I can still transfer money from my 401K to a Roth IRA and of course, that money will be taxed. My question is, will that transfer be counted as part of my minimum distribution? In other words, can I take money from a 401k that I don’t need for living expenses pay tax on it and roll it over into a Roth IRA that can sit for years without necessitating a withdrawal?

    1. jblankenshipNo Gravatar says:

      Unfortunately, no. RMD funds cannot be rolled over or converted into any other IRA account, including Roth IRA.

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