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Taxes on 401(k) and IRA Withdrawals
The rates are the same, but the amount of money that is taxed depends on whether you made pre-tax or after-tax contributions to your accounts.
By Kimberly Lankford, Contributing Editor, Kiplinger's Personal Finance
May 8, 2008
Is that true when you withdraw your money at retirement that you pay less tax for a traditional IRA than a 401(k)?
The tax rates are the same, but the amount of money that is taxed may be different depending on whether your made pre-tax or after-tax contributions.
The great thing about traditional IRAs and 401(k)s is that the earnings are tax-deferred. You don't have to pay taxes on dividends, capital-gains distributions or profits when you sell the investments as long as you don't withdraw the money from the account. When you finally do take the money in retirement, it is taxed at your income-tax rate, which can be from 10% to 35% depending on your income. After you retire, your income-tax rate is likely to be lower than it was when you were working.
But the portion of your withdrawals that is taxed may be different for your 401(k) than it is for your traditional IRA. If you've only made pre-tax contributions to the account -- which is the case for many 401(k) participants -- then the entire amount you withdraw will be taxed. But if you've made any non-deductible contributions -- common for IRA participants with income above the cut-off for deductibility -- then you'll owe taxes only on the earnings from those contributions, but not the contributions themselves.
If you withdraw money from several traditional IRAs to which you made both tax-deductible and non-deductible contributions, then the portion that escapes taxes is based on the ratio of non-deductible contributions to the total balance in all of your IRAs. See The Taxing Side of IRA Conversions for more information.
And if you have any Roth IRAs, the tax calculation becomes much easier. Your Roth withdrawals are 100% tax-free as long as you're at least age 59½ and have had a Roth for at least five years.
For more information about retirement-savings withdrawals, see How to Tap Your Retirement Accounts and Planning Your Retirement Tax Strategy.
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Reader Comments (6)
Posted by: retiree at 05/09/2008 02:40:40 PM
If you take a withdrawal from a company plan and you are 55 and retired, you are taxed at your income rate, but do not pay the 10% penlty. if you put it in a IRA the age is 59 1/2. Wise to make your withdrawal before rolling it over to a IRA. This is a mistake that many make.
Posted by: JD at 06/28/2008 03:31:59 PM
Common fallacy, and a big mistake. Your income tax rate is likely to be much higher when you retire than it is now. Two reasons: First, tax rates historically go up, and as our country becomes more socialist this is sure to continue. Second, when you are retired, you have no more deductions. Your kids are gone, your house is probably paid off, you have no pre-tax retirement account contributions, etc. You may have lower gross income, but without deductions, your taxable income is much higher.
Posted by: Ed Young at 02/02/2010 01:12:29 AM
I have some 48,000 in an IRA. I am 70 and will be 71 in October of 2010. What is the tax bite if I transfer the full amount to a checking for savings account.
Posted by: Sadie at 05/27/2010 09:37:30 AM
What a nightmare I have created but with 5 yrs prior to 70 1/2, I should have time to correct. Just where to begin with monies not taxed via former employer & rolled over to traditional IRA many years ago; monies moved from one account to another over the years. But the big question is what about those monies deposited for self-employed hubby (no 401K, etc.), in traditional IRA with far too many mutual funds, etc. solely by a single broker, now aligned with BofA, in panic we cashed out 3/2009 for far less than valued and temporarily sitting in money market. For example: How does one make withdrawals, paying tax on $1 basis when value is only $.25 as am aware losses are not accounted for with IRAs? Totally confused!
Posted by: richard furuta at 06/20/2010 02:00:45 PM
I want to buy property in California. Want to put down payment of $50,000. Money will have to come from IRA or Annuity. I am 63 years old. Will I have to add this amount to income at tax time? I am retired.
Posted by: Carolyn at 07/06/2010 04:27:50 PM
I will turn 70 in May of 2011. When do I make my first withdrawal from my IRA accounts without owing taxes for two years.