Is a 401(k) Withdrawal Taxed at the Same Rate as Earned Income?

Is a 401(k) Withdrawal Taxed at the Same Rate as Earned Income?
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If you choose to withdraw funds from your 401(k) account, those funds will be taxed the same rate as your earned income. Experts advise against taking an early withdrawal from your 401(k), as this could impact your financial security in your golden years. However, if you need money and have exercised all other options, this may be your only choice. It’s important to understand the taxes and potential penalties you’ll face for an early withdrawal prior to taking action.

401(k) Withdrawal Taxes and Penalties

The minimum age to withdraw funds from your 401(k) without facing a penalty fee is 59 1/2 years of age. You'll be charged a 10 percent penalty fee for taking money from your account prior to reaching retirement age, and you'll also have to pay taxes on the funds. While retirement may seem far off to you now, it's important to start planning early, as withdrawing funds early puts you at risk of jeopardizing your future financial security.

Eligible Hardships

There are a few exceptions to the 10 percent penalty fee imposed by the IRS for early withdrawals from your 401(k) fund. While you’ll still be taxed on the money, qualifying hardships can make you eligible to withdraw money from your account to pay for expenses including purchasing your first home, financing the costs of a sudden disability and paying for higher education expenses. After taking a hardship withdrawal from your account, you’re typically not eligible to contribute to your 401(k) for a period of six months.

401(k) Taxes

Your 401(k) contributions are deducted from your paycheck on a pretax basis. You don't have to pay taxes on your savings until you withdraw the money. Your deductions will be taxed at the same rate as earned income. Contributing to your 401(k) can actually lower the amount you pay in taxes each paycheck, as the deduction lowers your amount of taxable income.

401(k) Loan

Some 401(k) plans allow you to take out a loan, which can serve as another option when you’ve spent your emergency fund and have few other options. Typically, you’re able to take out a loan for half the vested amount in your account or a maximum of $50,000. The term of the loan is usually five years, and you’ll have to pay yourself back with interest. If you lose your job, you’ll be forced to pay the loan back within a 60-day period.