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- Traditional 401(k) contributions
- Employer contributions and vesting
- Traditional distributions are generally taxable
- Roth 401(k) taxation
- Early distributions and the additional 10% tax
- Loans are not distributions when rules are met
- Direct rollovers and 60-day rollovers
- Withholding is a prepayment
- Required minimum distributions
- Contribution limits and excess deferrals
- Changing jobs and plan choices
- State tax and recordkeeping
- Sources
Key Facts
- Federal level: Traditional pre-tax 401(k) elective deferrals generally avoid current federal income tax but remain subject to Social Security and Medicare taxes.
- Federal level: Traditional 401(k) distributions, including earnings, are generally included in federal taxable income when paid.
- Federal level: Designated Roth 401(k) contributions are made after federal income tax; qualified Roth distributions are generally excluded from gross income.
- Federal level: A taxable distribution before age 59½ can also face a 10% additional tax unless a statutory exception applies.
- Federal level: An eligible direct rollover to another qualified plan or IRA generally defers current income tax and avoids mandatory withholding paid to the participant.
A 401(k) is tax-advantaged, not automatically tax-free. The federal result depends on which account received the contribution, whether the money was pre-tax, Roth, or other after-tax money, how earnings accumulated, and what kind of distribution occurred. State income-tax treatment is a separate question.
Traditional 401(k) contributions
Traditional elective deferrals are generally excluded from current federal taxable income. If an employee earns $70,000 and makes a $5,000 eligible pre-tax deferral, the Form W-2 generally reflects the deferral in the retirement-plan boxes and excludes it from federal income-tax wages, subject to the governing payroll rules.
The deferral still counts as wages for Social Security and Medicare taxes. It also remains part of compensation for several employment and benefit purposes. “Pre-tax” in this context primarily describes current federal income-tax treatment.
Employer contributions and vesting
Employer matching and nonelective contributions generally enter the plan without current federal income tax to the employee. Earnings can then accumulate tax-deferred inside the traditional account.
An employee is always fully vested in employee elective deferrals. A plan may use a vesting schedule for employer contributions. Forfeiting an unvested employer amount after leaving employment is not the same as taking a taxable distribution.
Traditional distributions are generally taxable
A traditional 401(k) distribution is generally ordinary income to the extent it consists of untaxed contributions and earnings. The plan reports distributions on Form 1099-R, and the federal return reports the gross and taxable amounts in the applicable retirement-income fields.
A distribution is not generally taxed at a special 401(k) rate. It joins the recipient’s other taxable income and is subject to the brackets and rules for that tax year. A large lump sum can therefore affect the marginal bracket and income-based deductions, credits, or premiums.
If the account contains employee after-tax contributions that were not designated Roth contributions, part of a distribution may be a nontaxable recovery of basis. Publication 575 explains the allocation rules; a participant cannot ordinarily treat the entire payment as basis first.
Roth 401(k) taxation
Designated Roth contributions are included in current gross income. The plan separately accounts for Roth contributions and earnings. A qualified distribution from the designated Roth account is excluded from gross income.
A qualified Roth distribution generally must occur after the five-tax-year participation period and after the participant reaches age 59½, becomes disabled, or dies. A nonqualified Roth distribution generally includes a proportionate share of contributions and earnings; the contribution portion is not taxed again, while the earnings portion can be taxable and may face the additional tax.
Early distributions and the additional 10% tax
The taxable portion of a retirement-plan distribution before age 59½ is generally subject to a 10% additional tax unless an exception applies. Income tax and the additional tax are separate: an exception to the additional tax does not necessarily exclude the distribution from ordinary income.
Potential exceptions include distributions after separation from service during or after the year the participant reaches age 55, distributions due to total and permanent disability, certain substantially equal periodic payments, qualified domestic relations orders, specified medical expenses, and several newer limited-purpose exceptions. Each has its own statutory conditions.
A plan’s permission to take a hardship distribution does not itself create an exception to the 10% additional tax. Hardship is a plan-distribution rule; additional-tax exceptions are federal tax rules.
Loans are not distributions when rules are met
A compliant 401(k) loan is generally not taxable when issued. Federal rules limit the amount and repayment period, and the plan must permit loans. A principal-residence loan can have a longer repayment period than the usual five years.
A loan can become a deemed distribution after a default or other failure. A plan loan offset when employment ends or the plan terminates has separate rollover timing rules. A deemed distribution or offset can produce taxable income and potentially the 10% additional tax.
Direct rollovers and 60-day rollovers
An eligible rollover distribution transferred directly from a 401(k) to an eligible retirement plan generally is not currently included in income. A direct rollover also avoids the 20% mandatory federal withholding that generally applies when an eligible rollover distribution is paid to the participant.
When the payment is made to the participant, completing a full rollover within 60 days can require replacing the amount withheld from other funds. Amounts not timely rolled over are generally taxable, and the additional tax can apply.
A rollover from a traditional 401(k) to a Roth IRA or designated Roth account is a conversion. Previously untaxed amounts are generally included in gross income for the conversion year even though the movement is a rollover.
Withholding is a prepayment
Federal withholding from a 401(k) distribution is credited on the recipient’s return. It is not the final tax calculation. Mandatory 20% withholding commonly applies to eligible rollover distributions paid to the participant, while other payments can use different withholding elections or default rates.
A Form 1099-R reports the gross distribution, taxable amount when determined, distribution code, and federal tax withheld. Readers reviewing that reporting system can also consult the general guide to Form 1099 information returns.
Required minimum distributions
Traditional 401(k) balances are generally subject to required minimum distribution rules beginning at the applicable statutory age. A current employer’s plan may permit a still-working exception for a participant who is not a 5% owner, but the plan and ownership rules matter.
Beginning in 2024, designated Roth accounts in employer plans are not subject to lifetime required minimum distributions for the account owner. Beneficiary distribution rules remain separate.
Required minimum distributions are not eligible rollover distributions. Failing to take the required amount can produce an excise tax, with possible reduction or waiver under the governing correction rules.
Contribution limits and excess deferrals
The 2026 basic elective-deferral limit is $24,500, or compensation if lower. The aggregate limit applies across traditional and designated Roth elective deferrals, not separately to each account.
Age-based catch-up contribution rules can permit additional deferrals. Excess deferrals require timely correction; leaving an excess uncorrected can cause the same amount to be taxed in more than one year.
Changing jobs and plan choices
After employment ends, available choices can include leaving money in the former plan, rolling it to a new employer plan or IRA, or taking a distribution, subject to plan terms and account size. The tax result differs from the investment, fee, creditor-protection, and access consequences.
A summary plan description identifies the plan’s available distributions, loans, Roth feature, vesting schedule, and administrative procedures. Federal tax law sets boundaries, but it does not require every plan to offer every permitted option.
State tax and recordkeeping
Federal exclusion or inclusion does not establish state income-tax treatment. States can differ in their treatment of contributions, rollovers, retirement distributions, and basis.
Useful records include Forms W-2 and 1099-R, plan statements separating traditional, Roth, and after-tax sources, rollover confirmations, contribution and basis history, loan documents, and beneficiary records. Records become especially important when an account contains more than one tax source.
Sources
- IRS 401(k) Plans
- IRS 401(k) Plan Overview
- IRS Publication 575, Pension and Annuity Income
- IRS Designated Roth Account
- IRS Topic 558, Additional Tax on Early Distributions
- IRS Retirement Plan Contributions
- IRS Required Minimum Distributions
- IRS Rollovers of Retirement Plan Distributions
- USAGov State and Local Taxes
