Are you planning your retirement in Phoenix, AZ? A 401(k) is one of the most common forms of retirement accounts, but many people don’t fully understand how taxes work with a 401(k). If you want to minimize the taxes you pay and make the most of your retirement account, read on to learn what you need to know about a 401(k) and taxes.
How are contributions taxed?
One of the primary considerations when it comes to a 401(k) and taxes are how contributions are taxed. A key benefit to this type of retirement account is that it’s tax deferred, but your overall contribution limit for each year is $19,500. You won’t pay income taxes on the money you contribute to your account, since it’s taken out of your paycheck before income taxes are totaled. You also won’t pay income taxes on any growth you see from your 401(k) investments—taxes are deferred until you withdraw funds. You don’t need to deduct contributions on your tax return. Your employer will report your total income after contributions are taken into account.
How are distributions taxed?
Distributions are any withdrawals made from a 401(k) after you’ve retired. By opening a 401(k), you’ve chosen to defer taxes, and distributions are taxed as regular income. You’ll pay regular income tax rates on the amount you withdraw. Many people find that it’s best to take distributions gradually, since withdrawing the entire amount in your 401(k) can push you into a higher tax bracket for the year.
State and local governments in Phoenix, AZ may also tax your distributions. They look at 401(k) distributions as regular income, and the tax you pay depends on your state income tax rate.
How are early withdrawals taxed?
The earliest you should withdraw money from your 401(k) is when you reach 59.5 years old. If you withdraw before that, you pay a penalty of 10 percent of the amount you withdraw. In some circumstances, the penalty can be waived. If you’re in desperate financial circumstances, such as facing unexpected medical expenses, or if you’re disabled, you won’t have to pay a penalty. Talk to your fiduciary advisor to learn more about the special circumstances that remove the penalty fee.
Are employer contributions taxed?
The IRS treats employer contributions in the same way as your personal contributions. While you won’t pay taxes while the money is in your account, you will when it comes time to withdraw the money. One great benefit of receiving employer contributions to your 401(k) is that you don’t pay payroll taxes on any amount the employer puts into your account. It also doesn’t count toward the overall $19,500 contribution limit.
Understanding how taxes work with a 401(k) helps you make the most of your retirement in Phoenix, AZ. While you can administer these plans yourself in some cases, it’s always smart to work with a trusted fiduciary advisor who has your best interests at heart. Contact Fiduciary Advisors, LTD. to gain a thorough understanding of tax implications for your 401(k).