Retirement

Paying Tax Later Doesn't Always Mean Paying Less

How 401(k)s are taxed

One of the most important things to remember about your 401(k) is this: The balance you see isn’t how much you’ll have available for retirement. The reason? Taxes.

Tax breaks on contributions

As a retirement plan, 401(k)s are popular because they are tax-advantaged in the short term. Your contributions during the year are excluded from your earnings and will only be taxed on withdrawal, meaning you can lower your tax bill now and not worry about it for years to come. 

Many employers offer a 401(k) match as an added benefit, too. They’ll match your actual contributions up to a pre-determined limit by putting the money into your retirement account.

Sounds good so far. But what happens in the long term, when you withdraw funds from the plan?

Taxes on withdrawals

Distribution from your 401(k) is taxed as ordinary income, like earnings from employment. Your tax bill will depend on your age and income level. While many people expect to be in a lower tax bracket by the time they retire, this doesn’t always happen, particularly as retirees typically have less deductions. 

Taking 401(k) distributions could push you into a bracket where your Social Security benefits become taxable. If your income is high enough, your monthly Medicare premiums could also go up. Unfortunately, IRS prescribes minimum distribution amounts once you reach 72 — so you’ll have limited control over how much to withdraw.

The bottom line? 401(k)s have pros and cons. There could be more tax efficient ways for you to save for retirement. Talk to your financial professional to find out more.

Pub11500  2022-136198 Exp. 4/24

Share |

Have A Question About This Topic?

Thank you! Oops!

Related Content

Toddlers to Teens: The Lesson of Money

Toddlers to Teens: The Lesson of Money

Money is a central part of everyday life as an adult. We spend time most days earning it, we need it for survival, and we want it for fun and entertainment.

The Business Cycle

The Business Cycle

How will you weather the ups and downs of the business cycle?

Infographic: Personal Finances Are Like A Game of Golf

Infographic: Personal Finances Are Like A Game of Golf

What's the Secret Behind a Great Golf Game and Personal Finances? What do golf and personal finances have in common? A lot of things, but the key is confidence. And how do you become confident, exactly? Well, it starts with the basics and builds from there, so you can navigate tricky conditions and overcome unexpected hazards, whether on the green or in life.