Taxes on retirement account withdrawals

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Q. I’ve put $100,000 into my 401( k) and it’s worth $140,000 now. If I take out $30,000, I’m taking out part of my contributions. Do I have to pay taxes on any of this because I already paid taxes on the first $100,000?
— Unsure

A. Taxes can get complicated when you start taking funds from retirement accounts.

Let’s first assume you’re not talking about a 401(K) plan that has a Roth feature.

Typically, the contributions made to a 401(K) plan are done on a pre-tax basis, said Laurie Wolfe, a certified public accountant with Lassus Wherley in New Providence.

This means that you are not paying income taxes on the earnings you use to make the contribution — though you will pay Social Security taxes on this, Wolfe said.

It is possible to contribute to a 401(K) on an after-tax basis if the plan allows. This is not typical, especially in light of the availability of Roth contributions.

Any monies you take out of a 401(K), if all contributions were made on a pre-tax basis, are fully taxable at ordinary income tax rates, Wolfe said. Further, if you are under the age of 59 1/2, you will pay a 10 percent early withdrawal penalty unless you meet certain exceptions. More on that in a moment.

If you actually do have some after-tax contributions, Wolfe said, any distribution would be pro-rated between any pre-tax and after-tax contributions you made and any earnings associated with those contributions.

“You can’t dictate that you only want to withdraw after-tax contributions,” she said. “Only the earnings on the after-tax contributions are taxed on distribution. The earnings on the pre-tax contributions plus the pre-tax contributions themselves are fully taxable.”

Alternatively, Wolfe said, you may have made contributions to a 401(K) with a Roth feature.

These types of contributions are made on an after-tax basis.

“The use of the Roth feature requires the employer to put those contributions into a separate account from any contributions you made to a regular, non-Roth, account,” Wolfe said. “Generally, if you are at least 59 ½ years old and have participated in the Roth feature for at least five years, then any distribution from this account is not taxed.”

But if you don’t meet these requirements, the earnings portion of your Roth account would be subject to a 10 percent penalty tax unless one of the penalty exceptions applies. The distribution of the Roth 401(k) contribution portion is not subject to the 10 percent penalty tax, Wolfe said.

She said in general, the 10 percent penalty tax does not apply to the taxable portion of a distribution if the distribution is made (1) after attainment of age 59 ½; (2) after termination of employment when attaining age 55, (3) upon death or disability, (4) after termination of employment and payable in substantially equal installments over your lifetime, or (5) to pay for deductible medical expenses.

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NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.