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How to Navigate Your 401(k) Taxes, Contributions, and Potential Losses

Lauren Brown Updated: August 7, 2023 • 5 min read
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Retirement savings, including a 401(k), offer a safety net for your golden years but can also impact your taxes. It is a retirement savings account sponsored by employers. The plan has tax advantages, but that does not mean that there is no 401(k) tax or that distributions from a retirement plan happen without tax consequences. Understanding these aspects can help you manage your financial health while avoiding potential tax surprises. 

401(k) tax on contributions can be a significant part of planning your retirement strategy.

401(k) Contributions and Tax

401(k) tax on contributions can be a significant part of planning your retirement strategy. You may have heard of a 401(k), but how does contributing to this plan affect your taxes? That depends on the type of retirement plan you have. Both the type (traditional or Roth) and the amount you contribute can affect your income tax liability both now and in the future.

Traditional 401(k)

A traditional 401(k) is an employer-sponsored plan where you fund the account directly through your paycheck. This occurs pre-tax because your money goes into the 401(k) before the tax calculation and deduction. The advantage of contributing pre-tax is that it can lower your overall taxable income for the year, which could place you in a lower tax bracket. The benefits are then two-fold since you may be able to lower your tax bill, which has an immediate impact and potentially grow your money through investments in your 401(k), boosting your retirement savings. 

With a traditional 401(k), you pay no tax at the time of contribution, but that does not mean you are entirely off the hook for taxes. These accounts are for tax-deferred savings, not tax-free. This implies that those distributions are taxed when you withdraw from your 401(k). 

Let’s look at an example to better understand the concept of a 401(k) contribution.

Imagine earning $50,000 per year, which sssmeans your taxable income would be $50,000, and you would need to pay tax on that entire amount. If you instead contribute $5,000 of your income to your traditional 401(k), what happens to your taxes then? In this case, your taxable income drops to $45,000 because you do not owe taxes on the amount you contributed. Your taxes are now calculated based on an income of $45,000 instead, and you have $5,000 for investments in your 401(k).

Roth 401(k)

A Roth 401(k) is also an employer-sponsored plan, though contributions work differently than for a traditional 401(k). In the case of a Roth 401(k), your contributions occur post-tax. This means you pay income tax on the money when you earn it and then use it to fund the account. As a result, your taxable income is not reduced by your Roth 401(k) contributions in the year you make them. Instead, you pay tax now and benefit from tax-free withdrawals in retirement.

Both traditional 401(k)s and Roth 401(k)s are tax-advantaged, though the type of account dictates the timing of that tax benefit. Regardless of the account type, the government sets an annual contribution limit for 401(k) plans. The contribution limit for 2023 is $22,500, with the amount likely to increase for 2024. You could face a tax penalty if you contribute more than the maximum, though, so keeping track of how much you add to the account each year can be valuable.

While these are the general concepts behind 401(k) tax on contributions, everyone's financial situation and tax circumstances are unique. Consider consulting with a tax professional or financial advisor for specific guidance.

Tax on 401(k) Withdrawals

The withdrawal counts as regular income for tax purposes, with the rate dependent on your tax bracket at that time. Many retirement plans apply a default withholding rate of 20% for federal taxes on 401(k) distributions unless you specifically choose otherwise.

Like with contributions, the tax implications depend on the type of 401(k) you have. However, this does not always cover the entire tax liability, and you might owe more when you file your taxes. An additional tax bill is more likely when you are in a higher tax bracket. If the withholding tax is more than what you owe, though, you might get a refund when you file your tax return.

How a 401(k) withdrawal affects tax return

Taking money out of your traditional 401(k) plan is not a tax-free event. This means that there is a direct impact on your tax return. Suppose you are no longer working and start taking out money from your retirement plan, this will likely make up a significant part of your taxable income, meaning your tax bracket depends on how much you withdraw from the account. 

Careful planning and consideration can help you manage your 401(k) withdrawals to minimize potential tax impacts. You can also consult a tax professional to ensure you understand the nuances of tax on 401(k) withdrawal requests and the effects on your tax return.

Claiming 401(k) Losses on Tax

You might be able to claim capital losses on your other investment accounts, but the same is not true for your retirement accounts, including your 401(k). The differing tax treatment is because your 401(k) is a tax-deferred retirement account and already receives preferential tax treatment. 

You only pay taxes on the money when you withdraw it, so any losses inside the plan get realized only when you make those withdrawals. If the value of your account drops due to investment losses, you will not be able to claim this loss on your taxes.

Distributions from a Retirement Plan

Asking the question, "Does 401(k) withdrawal count as income?" is key. Since the answer is typically yes, this means that there are likely to be tax implications associated with your withdrawal. The amount you withdraw from your 401(k) is added to your annual income and taxed accordingly.

For example, if you are in the 22% tax bracket and withdraw $10,000 from your 401(k), your tax owed will be $2,200 on that distribution. In this example, you may have 20% tax withheld, which means your bank holds back $2,000 of the $10,000 withdrawal. Since you are in the 22% bracket, you would owe an additional 2% in 401(k) tax when you file your tax return, with the IRS requiring you to pay an additional $200. 


Understanding the implications of 401(k) tax is crucial to effective financial and retirement planning. With every contribution or withdrawal, taxes are a consideration, impacting your taxable income and the money in your pocket. While taxes are inevitable on distributions from a retirement plan, how you prepare for them now and during your golden years is largely under your control. Given the complexity of tax regulations, seeking professional tax guidance can further empower you to make the best financial decisions for your specific situation.



Can you claim 401(k) losses on taxes?

A 401(k) is a tax-advantaged account with different rules than typical investment accounts. You can not claim 401(k) losses on your taxes as the plan has other tax benefits.

Are taxes automatically taken out of 401(k) withdrawal?

Your plan administrator often withholds 20% of your withdrawal to cover 401(k) taxes. You can confirm the withholding amount with your financial institution and often elect to have more withheld at the source. A 20% withholding amount is not always sufficient to cover the entire tax liability, though, especially if you are in a higher tax bracket.

How much federal tax on 401(k) withdrawal?

The federal 401(k) withdrawal tax depends on your income tax bracket. The more income you have, including your 401(k) distribution, the higher your tax rate could be.

Does 401(k) withdrawal count as income?

Yes, 401(k) withdrawals generally count toward your annual taxable income.

Written by Lauren Brown linkedin-icon

Lauren has over a decade of experience in wealth management and financial planning. She is a CFA charterholder and holds a Bachelor's degree in Finance. Lauren has worked with several asset management firms, offering wealth advisory and portfolio management services to high-net-worth clients.