Most 401(k) plans are tax-deferred. This means that you don’t pay taxes on the money you contribute — or on any gains, interest or dividends the plan produces — until you withdraw from the account. Show
That makes the 401(k) not just a way to save for retirement; it’s also a great way to cut your tax bill. But there are a few rules about 401(k) taxes to know, as well as a few strategies that can get your tax bill even lower. Here’s an overview of how 401(k) taxes work, how a 401(k) can affect your tax return and how to pay less tax when the IRS asks for a cut of your retirement savings. » Use our 401k calculatorto see if you're on track for retirement Taxes on 401(k) contributionsContributions to a traditional 401(k) plan come out of your paycheck before the IRS takes its cut. You’ll sometimes hear this referred to as “pre-tax income,” and it means two things: 1) you won’t pay income tax on those contributions, and 2) they can reduce your adjusted gross income. An example of how this works: If you earn $50,000 before taxes and you contribute $2,000 of it to your 401(k), that's $2,000 less you'll be taxed on. When you file your tax return, you’d report $48,000 rather than $50,000. A few other notable facts about 401(k) contributions:
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Taxes on 401(k) withdrawalsIf you withdraw the money early
There are a lot of exceptions. This article has more details, but in a nutshell, you might be able to escape the IRS’s 10% penalty for early withdrawals from a traditional 401(k) if you:
If you withdraw the money when you retireFor traditional 401(k)s, the money you withdraw (also called a “distribution”) is taxable as regular income — like income from a job — in the year you take it. (Remember, you didn’t pay income taxes on it back when you put it in the account; now it’s time to pay the piper.) You can begin withdrawing money from your traditional 401(k) without penalty when you turn age 59½. The rate at which your distributions are taxed will depend on what federal tax bracket you fall in at the time of your qualified withdrawal. A few important points:
Taxes on Roth 401(k) plansSome employers offer another type of 401(k) plan called a Roth 401(k). These savings plans take the opposite approach when it comes to taxation: They’re funded by post-tax income. This means your contributions won’t lower your AGI ahead of tax-filing season. The biggest benefit of a Roth 401(k) is that because you’re paying taxes on your contributions now, you can withdraw the money tax-free later. A few other important notes:
Roth 401(k) vs. traditional 401(k)
7 ways to reduce your 401(k) taxes
Does withdrawal from 401k count as earned income?Withdrawals from 401(k)s are considered income and are generally subject to income tax because contributions and growth were tax-deferred, rather than tax-free.
Does 401k withdrawal affect Social Security income?The simple answer is that any income you receive from your 401(k) or other qualified retirement plan does not affect the amount of Social Security retirement benefits you receive each month.
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