Are 401(k) dividends taxable? If so, what is the 401(k )capital gains tax rate for someone in your financial situation? And when do you pay taxes on 401(k) dividends? If you are getting ready for retirement and wondering if you'll need to pay taxes on all those dividends you receive in your growing 401(k) account, you need comprehensive answers to such questions.
The short answer is yes. However, there is no tax on dividends in the years you receive them. Dividends are a portion of a company's profit, paid out to investors in amounts based on the number of company shares they own.
If something comes up and you need to withdraw the dividends or other income in your 401(k) early, you'll pay regular taxes plus an additional 10 percent penalty tax. It helps to understand the IRS rules concerning 401(k) account taxation as you strategize the best way to utilize your retirement assets to minimize taxes.
Read More: Who Must File Income Taxes?
401(k) Plans: A Deeper Look
A 401(k) plan is a type of tax-deferred retirement plan that your employer sponsors. The plan allows you to put money into the account before it's taxed; you receive your paycheck minus the contributed funds each pay period.
In many companies, employers also match a percentage of your contributions. For example, your employer could match 50 percent of your contributions up to a limit of six percent of your pay.
Your money grows tax free until retirement, and once you initiate a dividend withdrawal, you'll pay taxes on the amount of withdrawals at your then-current marginal tax rate. Your company's benefits administrator will provide you with a monthly statement so you can track your 401(k) investment activity.
Exploring Types of Dividends
Many 401(k) plans have a defined set of mutual funds in which they invest your money, and the funds may or may not pay dividends. Dividends are typically classified as qualified or unqualified.
For qualified dividends, you'd pay a lower capital gains tax rate if you had received the dividends outside of a tax-deferred account. When you receive dividends inside your 401(k), however, you lose this tax advantage, and you'll pay your regular tax rate on any dividend income.
When stocks within your mutual funds pay dividends, the funds typically reinvest the cash to purchase more shares for your account and you don't have a choice in the matter. If you hold individual stocks in your 401(k), you'll pay your regular 401(k) dividend tax whether or not you reinvest in more shares.
However, regardless the type of dividend, you are not responsible for paying any taxes on it until the funds are withdrawn from your 401(k).
Read More: Form 1040: What You Need to Know
Taking 401(k) Withdrawals
Regardless of the amount of dividend income you receive in your 401(k), you'll never pay taxes on it until you start withdrawing money from your account. Once you reach age 59 1/2, the IRS lets you withdraw your money without penalty; any earlier, and you'll pay a 10 percent penalty to the IRS on top of regular taxes.
A 401(k) account, like all employer-sponsored tax-deferred retirement plans, requires you to take withdrawals once you retire. However, as long as you keep working for the employer who sponsors your 401(k) plan, you can put off taking distributions even if you're older than age 72.
Tax Form 1099-DIV: Dividends and Distributions
By Jan. 31st of each year, you'll typically receive a 1099-DIV form for any dividends received in your non-tax-deferred accounts.
Since 401(k) dividends do not have any tax effects until you withdraw the money upon retirement, you won't receive any 1099-DIV forms for this account and you also won't need to add any dividend information to your tax return for your 401(k) account.
But, when you do go to take distributions, you should receive an IRS Form 1099-R if you receive $10 or more in distributions from a retirement account. Form 1099-R is used to report these distributions and you must include this income on your federal income taxes.
- Investor.Gov: Dividend
- IRS: Retirement Topics - Exceptions to Tax on Early Distributions
- IRS.Gov: 401(k) Resource Guide - Plan Sponsors - General Distribution Rules
- Northwestern Mutual: 401(k) Basics: When It Was Invented and How It Works
- Nasdaq: Qualified vs. Unqualified Dividends
- IRS.Gov: Retirement Plan and IRA Required Minimum Distributions FAQs
- IRS.Gov: About Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
Cynthia Gaffney has spent over 20 years in finance with experience in valuation, corporate financial planning, mergers & acquisitions consulting and small business ownership. She has worked as a financial writer for online finance publications since 2011, including eHow Money, The Motley Fool, and Sapling.com. She has also edited for several online finance publications, including The Balance, Opposing Views:Money, Synonym:Money, and Zacks.com. A Southern California native, Cynthia received her Bachelor of Science degree in finance and business economics from USC.