What are the tax ramifications due to 401(k) withdrawals.?

Question

I understand that withdrawals are penalized and that taxes are also deducted at the time of the withdrawal. What I'm not sure about is if I still have to include the net portion of the withdrawal on my income taxes. If they have to be included, isn't the same money getting taxed two times? Can someone give me some advice/explanations?

Answer 1

Let's say you contributed $5000 to the 401K. Because that came off of your income pre-tax, no income tax has been paid on that money. That's the gov't's incentive to save for retirement.

As long as that money is under the umbrella of a 401k or IRA, it grows tax-free. Tax is only due on an amount distributed in the year distributed. Also, as a disincentive to taking money out prior to age 59.5, there is a Fed penalty of 10%, & possibly a state penalty, on the distribution.

Now, let's say you take all $5k out in 2007. Tax is due on $5000 because it was never taxed. The law requires 20% to be withheld for Fed Tax, so they will hold $1k and send it to IRS. Part of your confusion is in thinking that withholding is tax. It is not TAX. It is money sent to IRS in anticipation of tax. It is in an account at IRS with your SSN on it. Really not tyhat much different tha an account at a bank except that you can't access the money.

Now here's the trap in this whole thing. Everyonr thinks that the 20% w/holding covers all the tax on the distribution. IT DOES NOT.If you are in the 15% tax bracket and the 10% penalty applies, tax will total 25% but only 20% was withheld. Some states do not require w/holding on distribs of this type so the ambush is even more painful. If you are in a bracket higher than 15%, the hurt is worse still.

Answer 2

You do not include the net on your tax return, you include the gross.

For example, if you cash out a $5000 401k you would only receive $4000 after 20% is withheld. On your return next year, you would report $5000 in income. The $1000 withheld would be credited on page two of the return along with any withholding reported W2s and/or estimated payments.

No, it is not double taxation.

Answer 3

depends if you just borrowed it against yourself all you really do is repay yourself with no penalty however if you didnt it can be a percentage of the amount you borrowed against it