Does Tennessee Tax 401k Distributions?
Understand how Tennessee's unique tax structure affects your 401k withdrawals and the important distinction between state and federal tax obligations for retirees.
Understanding the tax implications of 401(k) distributions is a component of retirement planning. For those residing in Tennessee, navigating state-specific tax rules is a concern. This analysis provides clarity on how the state treats income from these retirement accounts, helping residents prepare for their financial future.
Tennessee’s State Tax Structure
Tennessee is one of a handful of states that does not levy a broad-based state income tax. This means that income from salaries and wages is not subject to state taxation. For many years, the state did have a specific, narrow tax on certain types of investment income.
This levy, known as the “Hall Income Tax,” applied only to specific interest and dividend income, not to wages or retirement plan distributions. However, this tax was fully repealed, and as of January 1, 2021, Tennessee no longer taxes individuals on any type of income. This repeal eliminated a common source of confusion for retirees who may have previously dealt with this limited tax.
Taxation of 401k and Other Retirement Plans
Because Tennessee does not have an individual income tax, distributions from 401(k) plans are not taxed at the state level. Retirees can withdraw funds from their 401(k) accounts without incurring any state tax liability, a significant financial benefit. This favorable tax treatment is not limited to just 401(k)s.
The state’s policy extends to other common retirement savings vehicles as well. Withdrawals from traditional IRAs, Roth IRAs, 403(b) plans, and both public and private pensions are also not subject to Tennessee state income tax.
Remember Your Federal Tax Obligations
The absence of a state income tax in Tennessee has no bearing on federal tax responsibilities. The Internal Revenue Service (IRS) operates under a separate system, and its rules for retirement income remain fully in effect. Distributions from traditional, pre-tax 401(k) plans are considered ordinary income by the federal government and must be reported on your annual tax return.
These withdrawals are taxed at the individual’s applicable federal income tax rate for that year. Furthermore, if you take a distribution from your 401(k) before reaching age 59½, you may be subject to a 10% early withdrawal penalty on top of the regular income tax.