What Are the Taxes on a 401k Withdrawal After 65?

A 401(k) is a workplace retirement savings account with tax advantages. For individuals over age 65, withdrawals are not subject to the 10% early withdrawal penalty. The primary consideration for any distribution is the impact of income tax, which depends on the type of 401(k) account and your total income in the year of the withdrawal.

Fundamental Tax Treatment of Withdrawals

The tax treatment of a 401(k) withdrawal depends on whether the account is a Traditional or Roth 401(k). With a Traditional 401(k), contributions are pre-tax, lowering your taxable income during your working years. When you withdraw funds after age 65, the entire amount, including contributions and investment earnings, is treated as ordinary income.

There is no special tax rate for 401(k) distributions; the money is added to your other income for the year and taxed at federal income tax rates. For example, if you have $40,000 in other income and take a $25,000 withdrawal, your total taxable income becomes $65,000. This amount is then taxed according to the federal income tax brackets for that year.

In contrast, withdrawals from a Roth 401(k) can be entirely tax-free because contributions are made with after-tax dollars. For a withdrawal to be a tax-free “qualified distribution,” two conditions must be met. First, the account owner must be at least 59.5 years old, and second, at least five years must have passed since the first contribution was made to the account.

If both conditions are satisfied, neither the contributions nor the investment earnings are subject to federal income tax upon withdrawal. The five-year clock starts on January 1 of the year you made your first contribution.

Most states also levy an income tax on Traditional 401(k) withdrawals, treating the money as regular income. State rules vary, as some states have no income tax, while others offer specific exemptions for retirement income. Retirees should verify their local tax regulations to understand the full impact of their withdrawals.

Understanding Required Minimum Distributions (RMDs)

The Internal Revenue Service (IRS) requires individuals to take a Required Minimum Distribution (RMD) from their retirement accounts each year after reaching a certain age. These rules ensure the government receives tax revenue on funds that have grown tax-deferred. RMD rules apply to Traditional 401(k)s but, as of 2024, no longer apply to Roth 401(k) accounts for the original owner.

The starting age for RMDs has changed due to the SECURE 2.0 Act. The age to begin taking RMDs was raised to 73 for individuals born between 1951 and 1959. The law further increases the RMD age to 75 for those born in 1960 or later. Be aware that older resources may reference previous starting ages of 72 or 70.5.

An RMD is calculated by dividing the 401(k) account balance from December 31 of the prior year by a life expectancy factor from the IRS’s Uniform Lifetime Table. For example, an individual aged 75 has a life expectancy factor of 24.6. If their 401(k) balance was $500,000, their RMD would be $20,325 ($500,000 divided by 24.6).

Failing to take the full RMD amount by the deadline results in a penalty. The SECURE 2.0 Act reduced this penalty to 25% of the amount that was not withdrawn. If the mistake is corrected in a timely manner, the penalty may be further reduced to 10%.

An exception to RMD rules exists for those still employed. If you continue to work for the employer that sponsors your 401(k) and do not own more than 5% of the company, you can delay RMDs from that plan until you retire. This “still working” exception applies only to the 401(k) of your current employer; RMDs are still required from IRAs and 401(k)s held with previous employers.

Managing the Tax on Your Withdrawals

Taxes on 401(k) withdrawals can be handled through withholding. For an “eligible rollover distribution,” such as a lump-sum payment made directly to you, the plan administrator is required to withhold a mandatory 20% for federal taxes.

For periodic payments, like monthly or annual withdrawals, you can choose your withholding amount. You can elect not to have taxes withheld or specify a percentage or flat dollar amount to be withheld. This is done by submitting Form W-4P, Withholding Certificate for Pension or Annuity Payments, to your plan administrator.

If your withholding is not enough to cover your total tax liability, you may need to make quarterly estimated tax payments to the IRS using Form 1040-ES. These payments cover income not subject to withholding. Failure to pay enough tax throughout the year can result in an underpayment penalty.

Withdrawals from a Traditional 401(k) can affect the taxation of your Social Security benefits. The IRS uses “provisional income” to determine if your benefits are taxable, which is calculated by adding your modified adjusted gross income (MAGI), nontaxable interest, and 50% of your Social Security benefits. Since a 401(k) withdrawal increases your MAGI, it can cause more of your Social Security benefits to be taxed. For a single filer, if provisional income is over $34,000, up to 85% of benefits can be subject to income tax.

The timing and size of your withdrawals can be managed to control your tax bracket. A large lump-sum distribution in a single year could push you into a much higher tax bracket. Taking smaller, regular withdrawals over several years can help keep your total annual income in a lower tax bracket, reducing your overall tax burden.