Your 401(k) is taxed when you withdraw money, not when you contribute or invest it

A 401(k) is a retirement account where your employer may match what you contribute, and your money grows without being taxed each year. But the IRS taxes that money when you take it out. The amount you owe depends on what type of 401(k) you have, how old you are, and how long the money has been sitting in the account.

Most people have a traditional 401(k), where contributions reduce your taxable income in the year you make them. When you withdraw, the full amount—your original contributions plus all the growth—is taxed as ordinary income at whatever tax rate applies to you that year. A smaller number of people have a Roth 401(k), where contributions are made with after-tax dollars, but withdrawals in retirement are tax-free if you follow the rules.

Key Takeaways

  • Traditional 401(k) withdrawals are taxed as ordinary income at your current tax rate, while Roth 401(k) withdrawals are tax-free if you are 59½ or older and have held the account for at least five years.
  • If you withdraw before age 59½, you typically owe income tax plus a 10 percent early withdrawal penalty, unless an exception applies such as disability or a hardship withdrawal.
  • At age 73, you must begin taking required minimum distributions (RMDs) from a traditional 401(k), and those withdrawals are fully taxable.
  • Rolling a 401(k) into an IRA when you change jobs lets you keep the tax-deferred growth, but the tax rules on withdrawal remain the same.

How traditional 401(k) taxes work at withdrawal

When you withdraw from a traditional 401(k), your employer sends the money to you and reports the amount to the IRS on a Form 1099-R. That withdrawal is added to your other income for the year, and you pay income tax on it at your ordinary tax rate—the same rate you pay on wages or salary.

If you withdraw $30,000 from your 401(k) in a year when your other income puts you in the 22 percent tax bracket, that $30,000 is taxed at 22 percent, meaning you owe $6,600 in federal income tax on it (before any state or local taxes). Your employer usually withholds a percentage of the withdrawal automatically—often 20 percent—but that withholding may not cover your full tax bill, especially if the withdrawal pushes you into a higher bracket.

You can adjust how much your employer withholds by filling out a Form W-4P with your plan administrator, but most people do not. This means you may owe money when you file your tax return, or you may have overpaid and receive a refund.

Roth 401(k) withdrawals and the five-year rule

A Roth 401(k) works differently. You contribute with money you have already paid income tax on, so your contributions are not deductible. But when you withdraw in retirement, both your contributions and all the growth come out tax-free—if you meet two conditions: you must be at least 59½ years old, and you must have held a Roth 401(k) account for at least five years.

The five-year clock starts on January 1 of the year you first contributed to any Roth 401(k) with your employer, not on the date of each individual contribution. If you opened a Roth 401(k) in 2020 and are now 59½ in 2025, you meet both conditions and can withdraw tax-free. If you are 59½ but opened the account in 2022, you must wait until 2027 to withdraw without owing taxes on the growth.

If you withdraw before meeting both conditions, the growth portion is taxed as ordinary income, and you may also owe the 10 percent early withdrawal penalty. Your contributions themselves can always come out tax-free, but the IRS requires you to withdraw growth first.

Early withdrawal penalties and exceptions

If you withdraw from a traditional 401(k) before age 59½, you owe income tax on the withdrawal plus a 10 percent early withdrawal penalty. On a $20,000 withdrawal, that penalty is $2,000 before you even calculate income tax.

Some situations let you avoid the penalty. Rule 72(t) allows you to take equal periodic payments based on your life expectancy without penalty, even before 59½—but the payments must continue for five years or until you turn 59½, whichever is longer. Substantially equal periodic payments (SEPP) is the formal name, and the IRS publishes tables to calculate the allowed amount each year.

Other penalty exceptions include disability, medical expenses that exceed 7.5 percent of your adjusted gross income, health insurance premiums while unemployed, and a few others. A hardship withdrawal for when ready and heavy financial need (such as preventing eviction or paying medical bills) may be allowed by your plan, but it still triggers income tax and the penalty—the plan straightforward permits the withdrawal, it does not waive the taxes.

Required minimum distributions starting at age 73

At age 73, the IRS requires you to begin withdrawing a minimum amount from your traditional 401(k) each year, whether you need the money or not. This is called a required minimum distribution (RMD). The amount is calculated by dividing your account balance on December 31 of the prior year by a life expectancy factor published by the IRS.

If your balance is $500,000 on December 31, 2024, and the IRS factor for your age is 24.5, your RMD for 2025 is roughly $20,408. That entire amount is taxable as ordinary income. If you do not take the RMD, you owe a penalty of 25 percent of the amount you should have withdrawn (reduced to 10 percent if you correct it within two years).

Roth 401(k) accounts are subject to RMDs during the account holder's lifetime, but Roth IRAs are not. This is one reason some people roll a Roth 401(k) into a Roth IRA after leaving a job—to avoid RMDs in retirement.

Rolling over a 401(k) and tax consequences

When you leave a job, you can roll your 401(k) into an IRA (Individual Retirement Account) at a bank or brokerage. A direct rollover means your employer sends the money straight to the IRA custodian, and you owe no tax or penalty. An indirect rollover means your employer sends you a check, and you have 60 days to deposit it into an IRA yourself. If you miss the important date, the full amount is taxed as ordinary income plus the 10 percent penalty (unless you are over 59½).

Rolling a traditional 401(k) into a traditional IRA preserves the tax-deferred status—the money continues to grow without annual tax, and you pay tax only on withdrawals. Rolling a Roth 401(k) into a Roth IRA keeps the tax-free withdrawal benefit. But you cannot roll a traditional 401(k) into a Roth IRA without triggering a taxable conversion, which means you owe income tax on the full amount in the year you convert.

State and local taxes on 401(k) withdrawals

Federal income tax is only part of the bill. Most states tax 401(k) withdrawals as ordinary income, using the same amount you reported to the IRS. A few states—including Florida, Texas, and Wyoming—do not tax retirement income at all. Others, like Pennsylvania and Illinois, exempt 401(k) withdrawals specifically, even though they tax other income.

If you live in a state with income tax and withdraw $50,000 from your 401(k), you may owe state tax in addition to federal tax. Some people move to a no-tax state after retiring partly for this reason, though you must establish residency there before the move takes effect for tax purposes. Your employer's payroll system should withhold state tax automatically, but you can adjust it with a state Form W-4 if needed.

Frequently Asked Questions

Can I avoid taxes on a 401(k) withdrawal if I roll it into an IRA?

A direct rollover into an IRA does not trigger taxes—the money moves tax-deferred. But you still owe tax when you eventually withdraw from the IRA. Rolling over does not erase the tax bill; it only delays it until retirement.

What happens if my employer withholds too much tax from my 401(k) withdrawal?

The excess withholding is refunded to you when you file your tax return. If you withdraw $30,000 and your employer withholds $6,000, but you only owe $5,000 in tax, you receive a $1,000 refund. You can adjust future withholding by submitting a Form W-4P to your plan administrator.

Do I have to pay taxes on my 401(k) if I never withdraw it?

No, but at age 73 you must begin taking required minimum distributions, which are taxable. If you do not need the money, you still owe income tax on the RMD. The only way to avoid this is to have a Roth 401(k) or roll the balance into a Roth IRA before RMDs begin.

Is the 10 percent early withdrawal penalty the same as income tax?

No, they are separate. If you withdraw $20,000 at age 50 from a traditional 401(k), you owe income tax on the full $20,000 (say, $4,400 at 22 percent) plus a $2,000 penalty, for a total of $6,400 before state taxes.

What if I take a loan from my 401(k) instead of withdrawing?

A 401(k) loan is not a withdrawal, so you do not owe income tax or penalty on the amount borrowed. You repay the loan to your own account with interest. But if you leave your job before repaying, the outstanding balance is treated as a withdrawal and becomes taxable.