How to Minimize 401(k) Withdrawal Taxes
A 401(k) is designed as a long-term retirement plan, but you can withdraw money from it at any time. Like other retirement plans, money withdrawn from a 401(k) is taxable as ordinary income, and there is an additional 10 percent penalty you must pay if you take the money before you turn 59 1/2. With careful planning, there are ways to minimize the taxes you must pay on your 401(k) distribution.
Other People Are Reading
Instructions
-
-
1
Minimize your withdrawal amount. The most obvious way to minimize your 401(k) withdrawal taxes is to take as small amount as possible out of your account. You are only taxed on the amount you withdraw, so you can directly control the size of your tax bill.
-
2
Wait until you are over the age of 59 1/2. While you will still have to pay ordinary income tax on your 401(k) distribution, if you wait until you turn 59 1/2, you can avoid the additional 10 percent penalty that the IRS levies on premature distributions.
-
-
3
Take withdrawals during low-income years. Generally speaking, the higher your income, the higher your tax rate, so if you can wait to take a 401(k) withdrawal until a year when you earn less other income, then you will pay less tax on the same size withdrawal.
-
4
Take a 401(k) loan. A 401(k) loan allows you access to up to 50 percent of the value of your account, but as it is a loan, it is not considered a distribution. Thus, you do not have to pay tax on the amount you borrow from your 401(k). Be aware though that if you leave your employer for any reason, your 401(k) loan must be usually paid back within 60 to 90 days or else the outstanding balance of the loan will be considered taxable income.
-
5
Rollover your 401(k) distribution. If you can replace the money in your 401(k) within 60 days of distribution, then the replacement will be considered a rollover, and you will not have to pay tax on the amount you withdrew. In essence, you will simply be borrowing from your 401(k) for 60 days. The IRS allows this once per year.
-
1
References
- Photo Credit A young woman holding a pen, doing her taxes image by Christopher Meder from Fotolia.com
