About Withholding on Retirement Withdrawals

We’re seeing several questions from people about 401(k) or retirement plan withdrawals from which income taxes have been withheld.

Folks appear to be under the impression that once they’ve had taxes withheld on distributions from their 401(k)s or retirement plans, they’ve "already paid taxes" on the withdrawals and don’t need to report the withdrawal or the income tax on their tax returns… "I’ve already paid the tax on this; why do I have to pay it again?"

Here’s the straight talk on this situation: in general, when a 401(k) or 403(b) plan pays a distribution to you, the federal government requires that 20% of the distribution is withheld from the distribution for income taxes. This is just like the federal income tax withheld from your W-2… it’s kind of an "advance payment" on the income taxes that will be due on the taxable income you’re getting as a result of the withdrawal. There are certain exceptions from this withholding rule, like when you receive payments over time or when it’s a distribution due to hardship.

Your withdrawal gets taxed at your regular income tax rate, not at 20%. This means that if you have a lot of other income, or if that withdrawal was a lot of money, you’re very likely in a higher tax bracket than 20%: could be 25%, 28%, 33% or higher. The distribution gets added to your other income, then your income tax is figured on the total taxable income (after deductions). Your withholding, including the 20% withheld from the withdrawal, reduces your taxes due along with the withholding from any other sources like W-2s. You’ll see that 20% included on line 64 of Form 1040 along with any other withholding.

By the way, a 401(k) or 403(b) plan is required to withhold 20% if it is not a direct trustee-to-trustee transfer (rollover with code "G" on Form 1099-R). If it’s a distribution from an IRA,there is no requirement that income taxes be withheld. Also, states may have withholding requirements as well.