What Percent of a 401(k) Is Taxed?

A 401(k) plan offers a tax-advantaged way to save for retirement, but understanding how these accounts are taxed can be complex. There is no single “percent” that applies to all 401(k) distributions; instead, taxation depends on several factors, including the type of 401(k) plan and when withdrawals occur. While contributions and earnings benefit from tax advantages during the accumulation phase, the money becomes subject to taxation, typically upon withdrawal.

Understanding 401(k) Taxable Events

The taxation of a 401(k) plan hinges on whether it is a traditional or Roth account, with different rules governing contributions and investment growth. Traditional 401(k) contributions are made on a pre-tax basis, deducted from your gross income before taxes. This reduces your current taxable income, providing an immediate tax benefit. Funds within a traditional 401(k), including employer contributions and investment earnings, grow tax-deferred. Taxes become due when the money is withdrawn in retirement.

Contributions to a Roth 401(k) are made with after-tax dollars, meaning they do not reduce your current taxable income. You pay taxes on the money before it enters the account. Qualified withdrawals of both contributions and earnings from a Roth 401(k) are entirely tax-free in retirement.

Investment earnings, such as gains, interest, or dividends, accumulate tax-deferred within both traditional and Roth 401(k) accounts. For traditional plans, these earnings and original contributions are taxed upon distribution. For Roth accounts, these earnings can be withdrawn tax-free if the distribution meets specific qualification criteria. The distinction lies in when the tax liability is incurred: at contribution for Roth or at withdrawal for traditional.

How 401(k) Withdrawals Are Taxed

The tax treatment of 401(k) withdrawals varies significantly based on the plan type and distribution timing. Traditional 401(k) withdrawals are taxed as ordinary income in the year received. The amount withdrawn is added to your other taxable income, potentially affecting your overall tax liability. The tax rate applied depends on your individual income tax bracket at the time of distribution.

For Roth 401(k) accounts, qualified withdrawals are tax-free. To be qualified, the account must have been open for at least five years, and the withdrawal must occur after you reach age 59½, become disabled, or on account of your death. Meeting these conditions allows both contributions and accumulated earnings to be withdrawn without federal income tax.

Withdrawals from a 401(k) before age 59½ are generally considered “early” and are subject to an additional 10% federal penalty tax on the taxable portion. Exceptions to this penalty include distributions due to total and permanent disability, separation from service at age 55 or older, certain emergency expenses up to $1,000 per year, or distributions for victims of domestic abuse.

Required Minimum Distributions (RMDs) are mandatory withdrawals from traditional 401(k)s. The SECURE 2.0 Act increased this age to 73 starting in 2023, and it will further increase to 75 by 2033. Failure to take the full RMD by the deadline can result in a penalty, generally 25% of the amount not distributed, though it can be reduced to 10% if corrected within two years.

Determining Your Applicable Tax Rate

The percentage of your 401(k) withdrawal that is taxed is not a flat rate, but determined by your overall financial situation in the year of withdrawal. The United States employs a progressive tax system, meaning different portions of your income are taxed at different rates. When you take a withdrawal from a traditional 401(k), that amount is added to your other income for the year, such as wages, pensions, or Social Security benefits. This combined income determines your total taxable income, which then places you into specific marginal tax brackets.

Marginal tax brackets mean that only the portion of your income within a particular bracket is taxed at that bracket’s rate. For example, if a 401(k) withdrawal pushes your total income into a higher bracket, only the amount exceeding the lower bracket’s threshold is taxed at the higher rate. Your total income from all sources influences which tax brackets apply to your 401(k) distributions, potentially leading to a higher effective tax rate.

Various deductions and credits can reduce your taxable income, lowering the effective tax rate on your 401(k) distributions. The standard deduction reduces your taxable income by a fixed amount, while itemized deductions allow you to subtract specific expenses. Tax credits directly reduce the amount of tax you owe, providing a dollar-for-dollar reduction in your tax liability.

Tax Reporting and Withholding

When you receive a distribution from your 401(k), your plan administrator reports this to you and the Internal Revenue Service (IRS). This reporting is done on Form 1099-R, detailing the gross amount, taxable amount, and any federal or state income tax withheld. You can expect to receive this form by January 31 following the calendar year of the distribution.

Federal income tax is typically withheld from 401(k) distributions, similar to wage withholding. For eligible rollover distributions, a mandatory 20% federal income tax withholding applies. For nonperiodic payments not eligible for rollover, the default withholding rate is 10% unless you elect a different rate using Form W-4R. You can adjust your withholding to manage your tax liability throughout the year, aiming to avoid a large tax bill or refund.

State income tax rules on 401(k) distributions vary significantly across the United States. Some states do not tax retirement income, while others tax it fully or partially. Depending on your state of residence, your 401(k) distributions may be subject to state income tax in addition to federal taxes.