Do You Pay Taxes on 401k After 65?

A 401(k) is an employer-sponsored retirement savings plan that allows employees to contribute a portion of their wages to an individual account. A common question for those over age 65 is how these funds are taxed. The tax treatment of a 401(k) is not determined by reaching a specific age, but by the act of taking a distribution from the account.

Taxation of 401(k) Withdrawals

The tax implications of 401(k) withdrawals depend on whether you hold a Traditional or Roth 401(k). These account types have fundamentally different tax structures.

With a Traditional 401(k), your contributions are made on a pre-tax basis, lowering your taxable income during your working years. This allows the funds, including any employer match and investment earnings, to grow tax-deferred. When you take withdrawals in retirement, the entire amount is treated as ordinary income and taxed at your prevailing federal income tax rate for that year.

Conversely, a Roth 401(k) is funded with after-tax dollars, so you receive no upfront tax deduction. For a “qualified distribution,” your withdrawals, including all investment earnings, are completely tax-free. To be qualified, a distribution must be made after you reach age 59½, and at least five years must have passed since your first Roth 401(k) contribution.

When you receive a distribution from a Traditional 401(k), federal tax withholding is a consideration. For a lump-sum payment eligible for rollover, your plan administrator is required to withhold a mandatory 20% for federal taxes. For periodic payments, the withholding rate is 10%, but you can adjust this amount by submitting Form W-4R to your plan administrator.

Required Minimum Distributions

The Internal Revenue Service (IRS) requires you to begin taking withdrawals from your Traditional 401(k) once you reach a certain age. These mandatory withdrawals are known as Required Minimum Distributions (RMDs), and their purpose is to ensure deferred taxes are eventually paid. Failure to take these distributions can result in penalties.

Under the SECURE 2.0 Act, the age to begin RMDs is 73 for individuals who reach age 72 after December 31, 2022. Roth 401(k) accounts are not subject to RMDs for the original account owner.

An exception to the RMD rule is the “still working” exception. If you are still employed past age 73 and are not a 5% owner of the company, you can delay RMDs from your current employer’s 401(k) plan until you retire. This exception does not apply to IRAs or 401(k)s from previous employers, which still require RMDs.

The RMD amount is calculated annually by dividing your account balance as of December 31 of the preceding year by a life expectancy factor found in the IRS’s Uniform Lifetime Table. For example, a 74-year-old with a $500,000 401(k) balance would have a life expectancy factor of 25.5, resulting in an RMD of approximately $19,608 for the year. If you fail to withdraw the full RMD amount, the IRS can impose a penalty of 25% of the shortfall, which may be reduced to 10% if corrected in a timely manner.

State Income Tax Considerations

Beyond federal obligations, the tax treatment of your 401(k) withdrawals is also subject to state-level income tax laws. These rules vary considerably depending on your state of residence at the time of withdrawal.

Some states impose no income tax, meaning your 401(k) distributions are not subject to state-level taxation, though federal taxes still apply. This makes them an attractive option for retirees.

Other states with an income tax still provide favorable treatment for retirement income. This can include a complete exemption for 401(k) withdrawals or partial exemptions and deductions up to a certain income threshold.

Finally, a number of states fully tax 401(k) withdrawals as ordinary income, mirroring the federal treatment. In these locations, your distributions are added to your other income and taxed at the state’s marginal income tax rates.

Interaction with Social Security Benefits

Withdrawals from your Traditional 401(k) can influence the taxability of your Social Security benefits. The income from these distributions can increase your overall income to a level where a portion of your Social Security benefits becomes subject to federal income tax.

This relationship is based on a figure the IRS calls “combined income” or “provisional income.” It is calculated by taking your adjusted gross income (AGI), which includes your taxable 401(k) distributions, adding any nontaxable interest, and then adding one-half of your Social Security benefits for the year.

If your combined income exceeds certain thresholds, a portion of your Social Security benefits will be taxable. For a single filer, if your combined income is between $25,000 and $34,000, up to 50% of your benefits may be taxable. If your combined income is over $34,000, up to 85% of your benefits may be taxable. For those married filing jointly, the thresholds are $32,000 to $44,000 for the 50% inclusion and over $44,000 for the 85% inclusion.

For example, consider a married couple filing jointly with $30,000 in Social Security benefits and $20,000 in other income. Their combined income is $35,000 ($20,000 AGI + $15,000 of SS benefits), making a portion of their Social Security taxable. If they take a $15,000 401(k) distribution, their AGI rises to $35,000, and their combined income becomes $50,000, causing up to 85% of their benefits to be taxed.