How Is a 401(k) Taxed? Contributions, Withdrawals, and RMDs

A 401k is taxed one of two ways depending on the type of contributions you make. Traditional 401k contributions come out of your paycheck before federal income tax, grow tax-deferred, and are taxed as ordinary income when you withdraw them in retirement. Roth 401k contributions are made with money that has already been taxed, and qualified withdrawals — including all investment growth — come out entirely tax-free. Withdrawals taken before age 59½ generally trigger an extra 10% penalty on top of any income tax owed.¹

Traditional Contributions: Tax Now or Tax Later

When you contribute to a traditional 401k, your employer routes the money into the plan before calculating federal income tax withholding. Those dollars never appear as taxable wages on your Form W-2.² Earn $70,000 and defer $10,000, and you report $60,000 in taxable wages that year. The tax on that $10,000 is not forgiven; it is postponed until you take the money out.

Social Security and Medicare taxes work differently. Your employer still withholds FICA (6.2% for Social Security and 1.45% for Medicare) on your full salary, including the portion you defer.³ The traditional 401k tax break applies to income tax only.

Inside the account, dividends, interest, and capital gains accumulate without annual tax. You pay ordinary income tax on the full amount — original contributions and investment growth alike — when it leaves the plan.

Roth Contributions: Tax Now, Tax-Free Later

Roth 401k contributions go the other direction. The money is taxed as regular wages before it reaches the plan, so your reportable income for the year is not reduced.⁴ The trade-off is at the back end: qualified distributions, including every dollar of investment growth, are free of federal income tax.

A distribution qualifies for tax-free treatment when two conditions are both met: at least five years have passed since your first Roth contribution to the plan, and you are at least 59½ (or the distribution is due to disability or death).⁵ Pull money out before satisfying both, and the earnings portion can be taxable.

How Your Employer Match Is Taxed

Employer matching dollars have traditionally gone into a pre-tax bucket inside the plan, even for employees making Roth contributions. That means the match and its earnings are taxed as ordinary income at withdrawal, the same way traditional money is. Since 2023, plans have had the option of letting employees receive matching contributions as designated Roth contributions, in which case the match is included in your gross income for the year it lands in your account.⁶ Not every employer offers the Roth match, so confirm the treatment with your plan administrator.

How Withdrawals Are Taxed in Retirement

Once you reach 59½, you can take money out of a 401k without any early withdrawal penalty. Traditional distributions get added to your other income for the year — wages, pension payments, Social Security — and taxed at your marginal rate. For 2026, federal income tax brackets on that income range from 10% on the first $12,400 of taxable income for single filers up to 37% on income above $640,600.⁷

A single large withdrawal can move you into a higher bracket. If your other income already sits near the top of the 22% bracket, a sizable distribution can push part of it into the 24% bracket. Spreading withdrawals across several years is one way to blunt that effect.

Distributions are not subject to Social Security or Medicare tax. You already paid FICA on the money when you earned it, so retirement withdrawals face only income tax. Your plan administrator reports each distribution to the IRS on Form 1099-R, which you receive after year-end and use to complete your return.⁸

The Mandatory 20% Withholding on Direct Payments

If a taxable distribution is paid to you rather than rolled over, the plan administrator must withhold 20% for federal income tax, even if you intend to redeposit the money into another retirement account yourself.⁹ The withholding does not apply to direct rollovers, where the plan sends the funds straight to another qualified plan or IRA.

Rollovers

Moving your 401k balance into an IRA or another employer’s plan lets you keep the money tax-deferred. A direct rollover (trustee-to-trustee) is the cleanest route: nothing is withheld and no tax is owed.¹⁰

With an indirect rollover, the check comes to you with 20% already withheld. You then have 60 days to deposit the full original amount into another qualified account, which means covering the withheld 20% out of your own pocket. Redeposit only what you received, and the withheld portion is treated as a taxable distribution — plus a 10% penalty if you are under 59½.¹⁰

The 10% Early Withdrawal Penalty

Take taxable money out of your 401k before age 59½ and you owe a 10% additional tax on top of the regular income tax.¹ Pull $20,000 at age 45 in the 22% bracket and you would owe about $4,400 in income tax plus a $2,000 penalty, losing close to a third of the withdrawal.

The penalty is reported on Form 5329. If the plan administrator already coded the distribution correctly on your 1099-R, Form 5329 may not be required, but you do need it any time you claim an exception.¹

Exceptions That Waive the Penalty

Several situations remove the 10% penalty even though the distribution is still taxed as ordinary income:¹

Leaving your job during or after the year you turn 55 (age 50 for qualifying public safety employees of state or local governments), for distributions from that employer’s plan.
Total and permanent disability.
Distributions to a beneficiary after the account holder’s death.
A series of substantially equal periodic payments taken at least annually over your life expectancy using an IRS-approved method.
Unreimbursed medical expenses exceeding 7.5% of your adjusted gross income.
Payments to a former spouse under a qualified domestic relations order.
Certain distributions to qualified military reservists called to active duty.
Up to $22,000 for losses from a federally declared disaster.
Up to $5,000 per child for qualified birth or adoption expenses.
Distributions after a physician certifies a terminal illness.
Up to the lesser of $10,000 or 50% of the account for domestic abuse victims (distributions after December 31, 2023).
One distribution per year up to $1,000 for emergency personal or family expenses (available since 2024).

Not every exception that applies to IRAs applies to 401k plans. The separation-from-service rule at 55, for example, is available only in employer plans, not IRAs.

When a 401k Loan Becomes Taxable

Many plans let you borrow from your own account, generally up to the lesser of $50,000 or 50% of your vested balance, with a five-year repayment window (longer if the loan is for a primary residence).¹¹ A loan in good standing is not a distribution and is not taxed.

Trouble starts when the loan defaults. Miss required payments, leave your job with an unpaid balance, borrow beyond the legal limit, or fall outside a qualifying repayment schedule, and the outstanding amount is treated as a taxable distribution. Ordinary income tax applies to the full unpaid balance, and if you are under 59½, the 10% penalty stacks on top.¹²

If you leave an employer with an outstanding loan, you can avoid the tax by rolling the unpaid balance into an IRA or another eligible retirement plan by the due date (including extensions) of your federal return for the year the loan is treated as a distribution.¹¹

Required Minimum Distributions After 73

A traditional 401k cannot sit untouched forever. Required minimum distributions begin at age 73, with the amount calculated by dividing your prior year-end balance by a life expectancy factor from IRS tables.¹³ Under SECURE 2.0, the starting age moves to 75 for people born in 1960 or later, effective in 2033.

If you are still working past 73 and do not own 5% or more of the sponsoring company, you can delay RMDs from that employer’s plan until the year you actually retire. The exception applies only to your current employer’s 401k, not to old 401k accounts or traditional IRAs.¹³

Missing an RMD is expensive. The excise tax is 25% of the shortfall, dropping to 10% if you correct the mistake within two years by taking the missed amount and filing a corrected return.¹³ Your very first RMD can be pushed to April 1 of the year after you turn 73, but that forces two taxable RMDs into the same calendar year, which can lift you into a higher bracket.

State Income Tax

Federal treatment is only half the story. Most states with an income tax treat 401k distributions as taxable, though some states with no income tax do not tax retirement withdrawals at all, and others offer partial exclusions tied to age or total income. Rates on retirement income range from 0% to over 13% in the highest-tax states. Because the rules vary significantly, check your state tax agency’s guidance or a tax professional for how your distributions will be treated where you live.

1
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
2
Internal Revenue Service. Topic No. 424, 401(k) Plans
3
Internal Revenue Service. Retirement Plan FAQs Regarding Contributions
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Internal Revenue Service. Retirement Plans FAQs on Designated Roth Accounts
5
Internal Revenue Service. Roth Account in Your Retirement Plan
6
Internal Revenue Service. SECURE 2.0 Act Changes Affect How Businesses Complete Forms W-2
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Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
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Internal Revenue Service. About Form 1099-R
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Internal Revenue Service. 401(k) Resource Guide – Plan Participants – General Distribution Rules
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Internal Revenue Service. Rollovers of Retirement Plan and IRA Distributions
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Internal Revenue Service. Retirement Topics – Plan Loans
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Internal Revenue Service. Fixing Common Plan Mistakes – Plan Loan Failures and Deemed Distributions
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Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs