Does Virginia Really Tax 401(k) Distributions? – Avoid This Mistake + FAQs

Virginia taxes 401(k) distributions as ordinary income, just like wages or any other income.

Unlike some states that offer special exclusions for retirement income, Virginia does not provide a unique tax break specifically for 401(k) withdrawals. Key points about Virginia’s treatment of 401(k) income:

• State Income Tax Rates: Virginia’s tax rates range from 2% up to 5.75% of taxable income. (The top rate of 5.75% kicks in at about $17,000 of Virginia taxable income, so most retirees will pay the top rate on at least part of their 401(k) income.)
• “Age Deduction” for Seniors: Virginia offers an Age Deduction for residents 65 and older, which can effectively shelter some retirement income from state tax. If you qualify, you can subtract up to $12,000 from your Virginia taxable income. (The exact deduction may be lower for higher-income seniors; it phases out $1 for each $1 of income over $50,000 single/$75,000 joint.) This deduction isn’t specific to 401(k)s – it’s a general senior income deduction – but it can cover part of your 401(k) withdrawals.
• Social Security is Tax-Free: Virginia does not tax Social Security benefits at all. In fact, if any Social Security is taxed on your federal return, Virginia lets you subtract that amount out of your state income. This means retirees can use Social Security income without increasing their Virginia tax, potentially using it to reduce how much they need to withdraw (and be taxed on) from their 401(k).

Bottom line: Your traditional 401(k) withdrawals will be added to your other income on your Virginia resident tax return and taxed at the state’s normal income tax rates.

For a 65+ retiree, the first $12k or so may be effectively exempt (thanks to the Age Deduction), and Social Security won’t count toward Virginia taxes, but the rest of the 401(k) distribution is fully taxable by the state.

Virginia vs. Other States: Taxation Comparison

How does Virginia’s taxation of retirement income stack up against other states? The table below compares Virginia with a few example states:

In Florida, since there is no state income tax, 401(k) withdrawals aren’t taxed at all at the state level. Pennsylvania is one of a few states that exempt retirement distributions — 401(k), IRA, and pension income is not taxed by Pennsylvania for retirees.

California represents the other extreme: it fully taxes 401(k) withdrawals as regular income, and with California’s high tax brackets (1% up to 13.3% state tax) that can make a big dent.

Virginia falls somewhere in the middle – it taxes retirement income, but its top rate (5.75%) is moderate and it does offer an age-based deduction to soften the blow for seniors.

401(k) Tax Breaks and Exemptions in Virginia

While Virginia taxes retirement account withdrawals, there are a few tax breaks that can reduce the burden:

• Age Deduction for Seniors: Virginia offers an age-based deduction for older taxpayers that can significantly offset retirement income. Taxpayers who are age 65 or older may qualify for a deduction of up to $12,000 from their Virginia taxable income. This deduction applies to all types of retirement income (401(k) distributions, IRA withdrawals, pension income, etc.), effectively making that portion of income tax-free for seniors. For example, a retiree over 65 who withdraws $15,000 from a 401(k) in a year might be able to deduct $12,000 of it, so only $3,000 is subject to Virginia tax. (There are income limits: the $12,000 deduction begins to phase out for higher-income seniors — e.g. singles with adjusted income over $50,000 — so not everyone 65+ will get the full amount. But many middle-income retirees do qualify for the full deduction.) This age deduction is one of Virginia’s key tax breaks for retirees, and it can substantially reduce or even eliminate state tax on 401(k) withdrawals for those who qualify.

• Standard Deduction and Personal Exemptions: Don’t forget that regular tax rules still apply. Both the federal and state standard deductions and any personal exemptions can offset your income, including 401(k) withdrawals. Virginia, for instance, has its own state standard deduction (which has been increasing in recent years) that reduces your taxable income. If your total income in retirement is relatively modest, the standard deduction might cover a lot of it. For example, if a married couple in Virginia has $20,000 of 401(k) withdrawals as their only income for the year, the Virginia standard deduction (let’s say around $17,000 for joint filers in 2023) would make most of that $20,000 not taxable by the state. In combination with the senior age deduction, many retirees find that only a small portion of their 401(k) money is actually taxed by Virginia. (And at the federal level, the standard deduction is even larger — over $27,000 for a senior couple in 2023 — which can zero out federal tax on a modest 401(k) withdrawal as well.)

• Tax-Free Rollovers: If you roll over your 401(k) distribution into another qualified retirement account (such as moving the money from a 401(k) to an IRA or to a new employer’s 401(k)), you can defer taxation entirely. A direct rollover (where the funds go straight from your 401(k) plan to the new IRA/401(k)) is not taxable – neither by the IRS nor by Virginia. Because the money never actually comes to you as a cash distribution, it’s not considered income; it stays in a tax-deferred account. This means you won’t owe taxes until you eventually withdraw the money from that new account. Indirect rollovers (where they send you a check and you have 60 days to deposit into an IRA) can be trickier, because 20% is usually withheld for federal taxes upfront and you have to make up that amount to roll over the full balance. But as long as you complete the rollover, you won’t be taxed on that distribution. Essentially, rollovers allow you to continue postponing taxes – an important strategy if you’re changing jobs or consolidating retirement accounts and don’t need to use the money yet.

In summary, Virginia doesn’t provide a blanket exemption for 401(k) withdrawals, but retirees have some relief in the form of the $12,000 age deduction (for those 65+), and all taxpayers benefit from standard deductions. By planning your withdrawals and taking advantage of these rules, you can minimize the state tax hit. For example, a retiree over 65 taking $12,000 from a 401(k) and no other income would pay zero in Virginia state tax on that withdrawal, thanks to the age deduction. Even larger withdrawals can be partially offset by these deductions.

Key Factors That Affect Your 401(k) Tax Bill in Virginia

Several factors determine how much tax you’ll pay on 401(k) distributions in Virginia:

• State of Residency: State taxes on retirement income are based on where you live when you receive the distribution, not where you earned the money. If you are a Virginia resident when you withdraw from your 401(k), Virginia will tax that income. If you move to another state, Virginia cannot tax your 401(k) withdrawals received as a non-resident. (For instance, if you retire to Florida, which has no state income tax, your 401(k) distributions would not be subject to Virginia tax anymore.) By federal law, only your state of residence at the time of distribution gets to tax your 401(k) income. This means that changing residency can have a big impact on your tax bill. Within Virginia, if you are part-year resident or non-resident, you generally only pay Virginia tax on income received while living in Virginia.

• Traditional vs. Roth 401(k): The type of 401(k) account is crucial. Traditional 401(k) withdrawals are fully taxable as income by Virginia, whereas qualified Roth 401(k) withdrawals are tax-free. If your 401(k) savings are mostly in a Roth and you meet the age/5-year requirements, those distributions won’t count as taxable income at all on your Virginia return. On the other hand, if you have a traditional 401(k), every dollar you take out will be included in your Virginia taxable income (unless offset by deductions). Mixing account types can also matter: for example, if you have both Roth and traditional 401(k) funds, how much you withdraw from each in a given year will affect your taxable income for that year. Planning to withdraw first from the Roth (tax-free) and then from the traditional (taxable) or vice versa can change your tax outcome. In short, contributing to a Roth 401(k) can provide future state (and federal) tax benefits, whereas a traditional 401(k) gives you the tax benefit upfront but you’ll pay taxes in retirement.

• Withdrawal Timing and RMDs: When and how you withdraw can influence your tax rate. Large lump-sum withdrawals could push more of your income into a higher federal tax bracket in a given year (though Virginia’s top tax bracket is a flat rate reached at relatively low income). Spreading withdrawals over multiple years might keep your income (and tax rate) steadier. Additionally, once you reach a certain age, the IRS requires you to start taking minimum withdrawals. These are the Required Minimum Distributions (RMDs). Due to recent changes in law, if you were born after 1950, you must begin taking RMDs starting in the year you turn 73 (for those born earlier, the starting age may be 72 under previous rules). RMDs ensure you can’t defer taxes on your 401(k) forever. If you’re a Virginia resident at that time, those RMD withdrawals will be taxed by Virginia as well. Whether a withdrawal is an RMD doesn’t change how it’s taxed – it’s still treated as income – but it means you have less flexibility to delay taking money out. One silver lining: being forced to take RMDs (which increase your income) once you’re over 73 might coincide with eligibility for Virginia’s age deduction, softening the blow. Just be aware that if you fail to take an RMD on time, the IRS penalty is very steep: 25% of the amount that should have been withdrawn (the penalty was 50% in prior years, but was reduced to 25% starting 2023, or 10% if you correct it quickly). This penalty is federal, but it underscores the importance of withdrawing the required amounts. Virginia will still expect income tax on any RMD you do take, but like most states, it does not impose an additional penalty beyond the federal one for missing an RMD.

• Early vs. Regular Retirement Withdrawals: If you take money from your 401(k) early (before 59½), as mentioned, you’ll pay a 10% federal penalty in addition to taxes. Virginia doesn’t add a penalty, but those withdrawals will count as taxable income in Virginia. Early withdrawals can also bump your income into higher brackets and might reduce eligibility for certain deductions or credits in the year you take them. Conversely, waiting until retirement (or at least until 59½) to withdraw avoids the extra 10% tax and often means you’re in a lower income bracket than during your working years, potentially reducing both federal and Virginia tax rates on your 401(k) money. Your retirement status (still working part-time vs fully retired with little other income) can affect how large a tax hit a 401(k) withdrawal will create. For example, a $10,000 401(k) withdrawal while you have a full salary could be taxed at a higher marginal rate than the same $10,000 withdrawal when you have no other income in retirement.

Your personal situation — where you live, how old you are, what type of 401(k) you have, and how you withdraw — all play a role in determining your tax liability on 401(k) distributions in Virginia. Wise planning can help you take advantage of the rules to minimize taxes, such as timing your withdrawals or structuring your retirement savings between Roth and traditional accounts.

Mistakes to Avoid When Withdrawing 401(k) Funds in Virginia

Even with favorable tax provisions, there are common mistakes that can lead to higher taxes and penalties on your 401(k) withdrawals. Here are some pitfalls to avoid:

• Withdrawing before age 59½ without planning for penalties: Taking money out too early can trigger the 10% early withdrawal penalty, which is essentially extra tax. Unless it’s an absolute emergency, avoid tapping your 401(k) before age 59½. If you must withdraw early, check if you qualify for any IRS exceptions (such as certain medical expenses, disability, or the “Rule of 55” for leaving a job early) to avoid the penalty. Also remember, any early withdrawal will be added to your income and taxed by Virginia, potentially reducing what you actually get to keep.

• Failing to take Required Minimum Distributions (RMDs) after age 73: Once you hit age 73, the IRS mandates annual withdrawals from your 401(k) (and traditional IRAs). If you forget or ignore your RMD, the IRS penalty is massive – 25% of the amount that you should have withdrawn (with a possible reduction to 10% if you correct it promptly). This is essentially a punishment for not paying the taxes they were expecting on your distribution. Avoid this by staying on top of your RMD schedule (your plan custodian or IRA provider will usually notify you of the amount). Even if you don’t need the money, you should withdraw at least the RMD to dodge the penalty. You can always reinvest the RMD money in a taxable brokerage account if you don’t need to spend it. Remember, Virginia will tax your RMD just like any other 401(k) distribution, so plan for the state tax hit as well. (If you have multiple retirement accounts, plan each one’s RMD — the rules can differ for 401(k)s vs IRAs on whether you can aggregate distributions.)

• Misunderstanding Roth 401(k) tax-free withdrawal qualifications: Roth accounts are a great tax-free source of retirement income, but only if you follow the rules. A mistake here is assuming “I have a Roth 401(k), so all withdrawals are tax-free.” In reality, your Roth 401(k) must meet the qualified distribution criteria (5 years since first contribution and age 59½ or eligible event) for the earnings to be tax-free. If you take money out of a Roth 401(k) before it’s qualified, the portion representing earnings on your contributions can be taxable and subject to the 10% penalty. For example, say you contributed $5,000 to a Roth 401(k) and it grew to $6,000. If you withdraw the full $6,000 only 3 years after opening the account (and you’re not 59½ yet), the original $5,000 is returned tax-free (since it was after-tax money), but that $1,000 of earnings is considered taxable income and will face the 10% early withdrawal penalty. This can be an unpleasant surprise. To avoid this mistake, ensure you don’t withdraw from the Roth portion of your 401(k) until you satisfy the age and holding requirements. If you roll over your Roth 401(k) to a Roth IRA when leaving a job, remember the Roth IRA has its own 5-year clock as well. The bottom line: Roth 401(k) withdrawals are tax-free only if they’re qualified – otherwise, you could negate the very benefit of having a Roth.

By steering clear of these mistakes, you can maximize the money you keep from your 401(k) and minimize what goes to the IRS and the state. Good planning and awareness of the rules are key to a tax-efficient retirement.

Pros and Cons of Virginia’s 401(k) Tax Policy

Virginia’s approach to taxing 401(k)s has some advantages in that retirees get a break and there are no surprise state-only penalties, but it also means retirees in Virginia will pay some tax on their nest egg withdrawals. It’s not as tax-friendly as states that exempt retirement income, but far better than states with no retiree deductions at all.

FAQs

• Does Virginia tax 401(k) withdrawals? Yes. Virginia treats distributions from a traditional 401(k) as taxable income for state tax purposes. In other words, if you take money out of your 401(k), it will generally be subject to Virginia state income tax (just as it is taxed federally). However, Virginia does provide an age deduction for seniors which can offset some of this income. For example, a retiree over 65 may subtract up to $12,000 of retirement income from Virginia taxable income, potentially reducing the tax on their 401(k) withdrawal. There is no full exemption for 401(k) or pension income in Virginia, so plan on paying state tax on most 401(k) withdrawals unless your deductions (standard, age deduction, etc.) cover them.

• Are Roth 401(k) distributions taxed in Virginia? No, if qualified. If you follow the rules for a qualified Roth 401(k) distribution (you are over 59½ and the Roth account is at least 5 years old), the distribution is completely tax-free, and that applies for both federal and Virginia taxes. Virginia does not tax income that isn’t included in your federal adjusted gross income, and qualified Roth withdrawals don’t show up there. So a qualified Roth 401(k) withdrawal will not be subject to Virginia tax. (If the distribution is not qualified under IRS rules, the earnings portion would be taxable and Virginia would tax that just like any other income.) In summary, Roth 401(k) withdrawals are tax-free in Virginia as long as they meet the federal criteria for tax-free treatment.

• Is there a tax break for retirees withdrawing from a 401(k)? Yes. Virginia offers a significant tax break for retirees in the form of an age deduction. Taxpayers aged 65 and over can deduct up to $12,000 of retirement income (including 401(k) distributions) from their Virginia taxable income. This effectively makes that portion of a 401(k) withdrawal tax-free at the state level. Not everyone will get the full $12,000 (it can phase out for higher incomes), but many retirees qualify for at least part of it. Additionally, all taxpayers still benefit from the standard deduction, which can also reduce the taxable amount of their 401(k) withdrawal. The combination of the age deduction for seniors and the regular deductions means a retiree can withdraw a chunk of money from a 401(k) with little to no Virginia tax in many cases. For instance, if you’re over 65, withdrawing $10,000 or $12,000 from your 401(k) might not incur any state tax due to these deductions. Always check the current tax rules and income limits, but yes, Virginia provides tax relief that can lessen the hit from 401(k) withdrawals for retirees.