How Taxes Work on Your 401(k) Contributions and Withdrawals

You pay taxes on 401(k) money, but the timing depends on which type of account you have

A traditional 401(k) lets you contribute money before taxes are taken out of your paycheck, which lowers your taxable income in the year you contribute. You do not pay federal income tax on that money until you withdraw it in retirement. A Roth 401(k) works the opposite way: you contribute after-tax dollars, so you pay taxes now, but withdrawals in retirement are tax-free. Most employers offer one or the other, and some offer both.

The tax bill arrives when you take the money out, not when you put it in. That is the core difference between the two types, and it shapes your entire tax picture for retirement.

Key Takeaways

• Traditional 401(k) contributions reduce your taxable income this year, but you owe federal income tax on every dollar you withdraw in retirement.
• Roth 401(k) contributions are made with after-tax money, so withdrawals in retirement are completely tax-free as long as the account has been open at least five years.
• If you withdraw money before age 59½, you typically owe income tax plus a 10 percent penalty on the amount withdrawn, with limited exceptions.
• Your employer may match your contributions, and that match is always taxed as ordinary income when you withdraw it, regardless of whether you chose traditional or Roth.
• Required minimum distributions force you to withdraw a set amount each year starting at age 73, and you owe income tax on those withdrawals from a traditional 401(k).

How traditional 401(k) taxes work during your working years

When you contribute to a traditional 401(k), your employer deducts the money from your paycheck before calculating your federal income tax. If you earn $60,000 and contribute $7,000 to a traditional 401(k), you only report $53,000 as taxable income to the IRS. That $7,000 sits in your account and grows tax-free while you work.

Your employer sends your contribution information to the IRS on Form 5498, which shows how much you put in each year. The IRS uses this to verify that your taxable income was correctly reduced. You do not owe any tax on the growth inside the account—whether it comes from interest, dividends, or investment gains—as long as the money stays in the 401(k).

What happens when you withdraw from a traditional 401(k)

Every dollar you withdraw from a traditional 401(k) is taxed as ordinary income in the year you take it out. If you withdraw $50,000 in a single year, that $50,000 is added to your other income for that year, and you pay federal income tax on the total at your regular tax rate. Your 401(k) provider will withhold a percentage of the withdrawal automatically—usually 20 percent—and send it to the IRS, but that withholding may not cover your full tax bill.

If you withdraw before age 59½, you also owe a 10 percent early withdrawal penalty on top of the income tax, unless you meet a narrow exception. The IRS allows penalty-free withdrawals for reasons like disability, a series of substantially equal payments, or certain hardships defined in the tax code. A hardship withdrawal for medical bills or to prevent eviction may avoid the penalty, but you still owe the income tax.

Roth 401(k) contributions and tax-free withdrawals

A Roth 401(k) reverses the tax timing. You contribute money that has already been taxed—your employer takes it from your paycheck after taxes are calculated. This means your taxable income does not go down in the year you contribute. However, the money grows tax-free inside the account, and when you withdraw it in retirement, you owe no federal income tax on the withdrawal itself.

The catch is the five-year rule: your Roth 401(k) must have been open for at least five years before you can withdraw earnings tax-free. If you open a Roth 401(k) at age 58 and try to withdraw at age 60, you can take out your contributions penalty-free, but the earnings are taxed and penalized. Once you turn 59½ and the account has been open five years, all withdrawals—contributions and earnings—are tax-free.

Employer matching and how it gets taxed

When your employer matches your 401(k) contribution, that match is always treated as a traditional contribution for tax purposes, even if you chose a Roth 401(k). Your employer's match reduces your taxable income in the year it is made, and you owe income tax on it when you withdraw it. This is true regardless of whether the match goes into a traditional or Roth bucket.

Some employers allow you to split your contributions between traditional and Roth, but the match itself cannot be Roth. This means if you contribute $10,000 to a Roth 401(k) and your employer matches $5,000, you have $10,000 in the Roth side (tax-free on withdrawal) and $5,000 in the traditional side (taxable on withdrawal).

Required minimum distributions and mandatory tax bills

Starting at age 73, the IRS requires you to withdraw a minimum amount from your traditional 401(k) each year, whether you need the money or not. This amount is calculated using your account balance and your age, and it increases each year. You owe income tax on every dollar of the required minimum distribution.

Roth 401(k)s are subject to required minimum distributions too, but the withdrawals are tax-free. Some people convert a traditional 401(k) to a Roth before age 73 to avoid required distributions, though the conversion itself triggers a large tax bill in the year it happens. If you have both types of accounts, you calculate the required minimum distribution based on the combined balance, but you can take it from either account.

State income tax on 401(k) withdrawals

Federal income tax is only part of the picture. Most states also tax 401(k) withdrawals as ordinary income, using the same rate they apply to wages. A few states—including Florida, Texas, and Wyoming—do not tax income at all, so retirees in those states owe no state tax on 401(k) withdrawals. Others, like California and New York, tax withdrawals at the same rate as earned income.

If you move to a different state after you retire, your tax bill may change. Some states tax only the portion of your withdrawal that came from contributions made while you lived there. This matters most if you worked in a high-tax state and retired to a low-tax state, or vice versa.

Frequently Asked Questions

Do I owe taxes on my 401(k) if I do not withdraw it?

No. You owe no tax on money that stays in your 401(k), whether it is in a traditional or Roth account. The tax bill arrives only when you withdraw. However, starting at age 73, you must withdraw a minimum amount each year from a traditional 401(k), and that withdrawal is taxable.

What if I withdraw from my 401(k) at age 55?

You owe income tax on the withdrawal plus a 10 percent early withdrawal penalty, unless you separated from your employer in the year you turned 55 or later. This exception, called the Rule of 55, lets you avoid the penalty if you left your job at 55 or older. You still owe the income tax. Roth 401(k)s have the same rule but also require the account to be five years old.

Can I avoid taxes by rolling my 401(k) to an IRA?

A direct rollover from a 401(k) to a traditional IRA does not trigger taxes—the money moves directly between accounts. However, if you take a distribution and deposit it yourself within 60 days, your employer withholds 20 percent for taxes. A rollover to a Roth IRA is treated as a conversion and creates a tax bill in the year you do it.

Do I owe taxes on investment gains inside my 401(k)?

No. Investment gains, dividends, and interest earned inside a 401(k)—whether traditional or Roth—are not taxed while the money is in the account. For traditional 401(k)s, you pay tax on the gains when you withdraw. For Roth 401(k)s, the gains are never taxed.

What happens to my 401(k) taxes if I die?

Your beneficiary inherits the account and owes income tax on withdrawals from a traditional 401(k), just as you would have. Roth 401(k) withdrawals remain tax-free for your beneficiary. The rules for how quickly your beneficiary must withdraw the money depend on their relationship to you and when you died.