24 Jul Are 401(k) withdrawals double-taxed?

Q. I am going to retire at age 65 in January 2020. I have two 401(k)s from two different companies. How much will I be taxed every time I pull $12,000 a year out? My financial adviser said at age 62, if I withdraw I would be taxed 10 percent each time. But when I do my taxes the next year, that’s considered income and will be taxed again, correct?
— Taxed

A. There are a couple of items in your question that are unclear, so we’re going to start from scratch.

First, let’s review how 401(k)s are taxed.

The key point to remember is 401(k) distributions are taxed as “ordinary income,” said Michael Maye, a certified financial planner and certified public accountant with MJM Financial in Gillette.

He said the tax liability or taxes you owe will depend on your tax bracket, and in particular, what your marginal tax rate is during the tax year in which a 401(k) distribution is taken.

“The marginal tax rate is simply the tax rate applied to the next dollars of incremental income for a taxpayer,” Maye said.

He said as long as you are over 59 1/2 years old, age has no direct impact on the federal income taxes you owe on a 401(k) distribution.

The key determinant is your marginal tax rate. But maybe you’re asking about the 10 percent early withdrawal penalty from 401(k)s taken prior to 59 1/2 years of age? That might be part of your confusion.

You said you’re also concerned that you will be taxed twice on the distributions, but Maye said that’s not the case.

The contributions you made to the account were made with pre-tax dollars. Then, when you begin 401(k) distributions, you can elect to have both federal and state income taxes withheld, Maye said.

“When the taxpayer gets their tax return prepared they will get a credit for any taxes withheld from their 401(k) distributions,” Maye said. “Remember when you get your taxes prepared during January to April of each year, it is for the prior tax year.”

Maye recommends you ask your accountant to run a tax projection in 2020 prior to taking the 401(k) distribution to assess what the actual incremental tax liability would be.

“Remember there is a good chance we will have tax law changes between now and 2020,” Maye said.

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This post was first published in July 2017.