February 8, 2023

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10 Ways to Reduce Your 401(k) Taxes This Year

2 min read

If you have a traditional 401(k), you will have to pay taxes when you take a 401(k) distribution. That 401(k) money is subject to ordinary income tax. The amount you pay is based on your tax bracket, and if you’re younger than 59½, add a 10% early withdrawal penalty in most cases. That could put your tax rate in the top 37% bracket.

You could look at a Roth 401(k) or a Roth IRA to pay taxes now rather than later, but we wanted to know how financial professionals help clients minimize their tax burden on a standard 401(k) distribution. We asked, and they gave us some tips on reducing your taxable burden and avoiding the 20% mandatory withholding. Read on to find out how you can benefit right now.

Key Takeaways

  • Certain strategies exist to alleviate the tax burden on 401(k) distributions.
  • Net unrealized appreciation and tax-loss harvesting are two strategies that could reduce taxable income.
  • Rolling over regular distributions to an IRA avoids automatic tax withholding by the plan administrator.
  • Consider delaying plan distributions (if you are still working) and Social Security benefits or borrowing from your 401(k) instead of actually withdrawing funds.
  • The CARES (Coronavirus Aid, Relief, and Economic Security) Act provided some tax relief in 2020 to those with retirement accounts, including 401(k)s, impacted by the coronavirus outbreak. Much of those benefits have since expired.

How Are 401(k) Distributions Taxed?

Distributions from your 401(k) are taxed as ordinary income, based on your yearly income. That income includes distributions from retirement accounts and pensions and any other earnings. As a result, when you take a 401(k) distribution, it is important to be aware of your tax bracket and how the distribution might impact that bracket. Any 401(k) distribution you take will increase your yearly earnings and could push you into a higher tax bracket if you’re not careful.

There is a mandatory withholding of 20% of a 401(k) withdrawal to…

2022-06-06 05:05:23

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