Do I Need to File My 401(k) on Taxes?

Understanding the tax obligations associated with your 401(k) is essential for effective financial planning. Both traditional and Roth 401(k)s offer unique tax advantages that influence how they are reported on your taxes.

Traditional 401(k) Taxable Distributions

Traditional 401(k) plans are funded with pre-tax dollars, which reduces your taxable income in the year contributions are made. However, withdrawals are considered ordinary income and subject to federal income tax, with rates ranging from 10% to 37% based on IRS tax brackets for 2024.

Required Minimum Distributions (RMDs) must begin by April 1 of the year after you turn 73, as mandated by the SECURE Act 2.0. Failure to take the RMD can result in a penalty of 25% of the amount not withdrawn. Staying on schedule with RMDs is critical to avoid penalties.

Roth 401(k) and Qualified Distributions

Roth 401(k) plans are funded with after-tax dollars, meaning taxes are paid upfront. Qualified distributions from a Roth 401(k) are tax-free, making them advantageous for those expecting higher tax rates in retirement.

For a distribution to qualify as tax-free, the account must have been held for at least five years from the first tax year of contribution. Additionally, the distribution must occur after age 59½, due to disability, or upon the account holder’s death.

Additional Tax on Early Withdrawals

The IRS applies a 10% penalty on early withdrawals from retirement accounts like 401(k)s if taken before age 59½.

Certain exceptions exist, such as withdrawals for medical expenses exceeding 7.5% of adjusted gross income or in cases of permanent disability. Penalty-free withdrawals are also allowed under qualified domestic relations orders (QDROs) during divorce proceedings.

Documentation for Reporting

Proper documentation is key to managing 401(k) transactions. For traditional 401(k)s, Form 1099-R, issued by the plan administrator, outlines total distributions for the tax year. Confirming this information matches your records ensures accurate tax reporting.

For Roth 401(k)s, Form 1099-R is also used. Verify that distribution codes indicate qualified withdrawals to confirm their tax-free status. Keeping detailed account records, including contribution dates and amounts, is essential to support the qualified nature of distributions.

Rollovers and Transfers

Rollovers and transfers help manage 401(k) funds while keeping tax advantages intact. A direct rollover, where funds move directly between retirement accounts, is the most tax-efficient method. For instance, rolling over a 401(k) to an IRA or a new employer’s 401(k) keeps the transaction tax-deferred.

An indirect rollover, where funds are distributed to the account holder before being deposited into another retirement account, requires the full amount to be redeposited within 60 days to avoid taxes and penalties. For example, if $100,000 is distributed and 20% ($20,000) is withheld for taxes, the account holder must deposit the full $100,000 into the new account. Missing the deadline results in the distribution being taxed as income and potentially subject to the 10% early withdrawal penalty if under age 59½.