Taxes on early 401k withdrawal

July 27, 2012 3:12 PM

Is 401k withdrawal income the same as McDonalds income?

Let's say I'm under 55 and my only income for a given tax year is an early 401k withdrawal of $5000, with the rest of my living expenses taken from a savings account. Am I correct in thinking that as far as the IRS is concerned, I "earned" $5000 that year, and would be taxed accordingly (same standard deductions as if it were wage income, etc), aside from the 10% penalty?

Does the picture get any more complicated if this is done for several years in a row?

posted by mpls2 to Work & Money (6 answers total)

For 401(k)s, yes, the $5000 would be taxable income, subject to the standard deduction and the 10% penalty.

For IRAs and some other policies, you can do "substantially equal periodic payments" to avoid early-withdrawal penalties before retirement, but that does not apply to 401(k)s.
posted by saeculorum at 3:31 PM on July 27, 2012 [1 favorite]

That said, 401(k) withdrawals are not subject to Social Security taxes or Medicare taxes, as it is not earned income (also, the money that went into the 401(k) paid Social Security and Medicare taxes, as 401(k)s only shelter your income from federal taxes).
posted by saeculorum at 3:32 PM on July 27, 2012

No, payroll taxes are paid on earned income when you earned it, even if it goes into a 401(k). When you take the money out of the 401(k), you pay income tax, not payroll tax.
posted by phoenixy at 3:33 PM on July 27, 2012

It depends if you were contributing pre or post tax money to the 401k to begin with. Some 401k programs let you put post-tax income into them, which means you have already paid income tax on the principal and will not have to pay it when you withdraw it. You will still need to pay income tax on the interest you earned. If all your contributions were pre-tax, then you have to pay income tax on all of it.
posted by soelo at 8:06 AM on July 28, 2012 [1 favorite]

soelo is referring to the distinction between a Traditional 401(k), which is tax-deductible on the money going in, and taxed on the money going out, and a Roth 401(k), which is taxed on the money going in, but untaxed on the money going out.

She is correct about that - I had naively assumed a Traditional 401(k) plan. Roth 401(k)s are still uncommon, and they just started existing in 2006, but that is something to consider.
posted by saeculorum at 10:08 AM on July 28, 2012

No, I am not talking about Roths exclusively. My traditional 401K is administered through Fidelity (is employer provided and not Roth) but allows you to contribute either post- or pre-tax money. I don't know how common that is, but we've had the option for at least 15 years.
posted by soelo at 7:32 AM on July 30, 2012