When you take a 401(k) distribution, you will have to pay taxes if you have a traditional 401(k). Ordinary income tax applies to the money in your 401(k). The amount you pay is determined by your tax rate, plus a 10% early withdrawal penalty if you’re under the age of 59 1/2. This could push you into the top tax bracket of 37%.
To reduce your tax burden, attempt to keep your taxable income at a lower tax rate when taking 401(k) withdrawals. To prevent falling into the next tax bracket with a higher tax rate, you can take distributions up to the highest limit of your tax bracket.
Start Borrowing Instead Of Withdrawing From A 401(K)
Some plans allow you to borrow money from your 401(k) account. If that’s the case, you might be able to borrow money from your account, invest the funds, and create a steady income stream that lasts beyond your repayment of the loan.
The IRS typically enables you to borrow up to 50% of your vested loan balance — up to $50,000 — with a five-year payback period. In this situation, you don’t have to pay any taxes or a 10% penalty on the payout. Instead, you must repay this sum in at least quarterly installments during the loan’s term. This strategy has investment risk, before taking such a huge step, you should consult with a financial expert.
Avoid Early Withdrawal Penalty
If you withdraw money from your traditional IRA before turning 59 1/2, you’ll be hit with a 10% early withdrawal penalty, on top of the income tax owed on each withdrawal. You may be eligible for a penalty-free 401(k) withdrawal if you quit your present employment at age 55 or later.
However, depending on your tax bracket, the payout will be subject to ordinary income tax. To be eligible for a penalty-free distribution, an employee must have left their employer. If you use the money for specific purposes such as a significant medical bill, college costs, or a first home purchase, you are eligible to avoid the early withdrawal penalty.
Defer Taking Social Security
If you have taken a 401(k) withdrawal, you should contemplate deferring your Social Security benefits to keep your taxable income in a lower tax bracket. Taking both distributions at the same time raises your taxable income and, therefore increases your income tax bill.
You can postpone claiming social security payments until you are 70 years old if your 401(k) withdrawals are sufficient to fulfill your needs. This technique not only reduces 401(k) withdrawal taxes, but it also boosts your Social Security payments. This technique works if you wait until you reach full retirement age, which is between 65 and 67 years old to start receiving Social Security benefits.
Resolve Your Tax Bills
If you’ve found yourself in a nasty mess with the IRS, take a deep breath. For taxpayers who may have difficulty paying off an excessive amount of tax debt, there’s a new and improved relief program that consolidates many major relief programs into a one-size-fits-all assistance program. Any issues regarding back taxes, unfiled years, or any other tax-related problems may be solved through one program; the IRS Fresh Start Program!
How Simple Is Qualifying?
Considering that the Fresh Start Program is a federal program, you would think meeting the qualifications may be very difficult, but really, it’s a lot simpler and quicker than you think. Take the following steps in order to find out if you are eligible in as little as 3 minutes.
- Fill out some basic information about yourself and your back taxes here.
- Have a representative reach out to you to discuss your eligibility.
- Go through the enrollment process and finally reduce or eliminate your tax liabilities.