How will a 401(k) withdrawal impact my taxes at year-end?
I am 63 years old and am receiving Social Security benefits. If i withdraw money from my 401k (which will have the mandatory 20% deducted) will I owe additional tax at year end?
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Assuming the withdrawal is going to be spent and not rolled over to another retirement account, a partial withdrawal from your Traditional 401(k) will be treated as taxable income when you file your taxes next year. The amount the 401(k) provider deducts and sends to the IRS will also be counted as a prepayment of your taxes for the year, similar to how withholdings worked while working.
Whether you owe additional taxes or will get some of the 20% back will depend on your marginal tax bracket when you file your taxes. If your highest tax bracket is above 20% when you file taxes, you will owe the difference. While if you highest tax bracket is below 20%, you will potentially receive the difference as a tax refund next April.
An Example
Assume you were withdrawing $10,000 from your 401(k), the withdrawal was subject to income taxes (read more below), and you were subject to the 20% mandatory withholding. $2,000 of the $10,000 would be sent to the IRS. Leaving you with $8,000.
When you prepare your taxes early next year, you would find out your highest marginal tax bracket, including the $10,000 of income from the withdrawal. If your marginal tax bracket was 22%, then you would owe an additional 4% of the $10,000; or $400.
Conversely, if your marginal tax bracket was 12%, then you would have overpaid your taxes by 8% of the $10,000; or $800. On your taxes, you would be credited with the $800 overpayment and could receive it as part of your refund, depending on your exact tax situation.
Account Type Matters
Other considerations which could impact the tax situation is the nature of the 401(k) account. If the money is held in a ROTH portion of the 401(k), then you may not owe any taxes and would not have 20% deducted. If the withdrawal is from after-tax contributions to your 401(k), then you have the ability to subtract the appropriate basis from the gains which would lower your tax liability.
A Final Consideration
If you are rolling the withdrawal over to another retirement account, you should consider working with a fiduciary & fee-only financial advisor. There are multiple ways to make this rollover happen, and the most common way consumers roll over their retirement accounts results in an unnecessary 20% IRS withholding.