Should I Really Withhold Taxes from a 401(k) Withdrawal? – Avoid This Mistake + FAQs

Confused about whether to withhold taxes from your 401(k) withdrawal? You’re not alone.

Surveys show that over 60% of retirees underestimate their tax liability, leading to unexpected tax bills and IRS penalties at year’s end. Getting the tax part right is crucial when tapping your retirement savings.

In this article, you’ll learn:

• Whether you must withhold taxes from 401(k) withdrawals
• How federal and state tax laws affect your decision
• The best strategies to minimize your tax burden
• Common mistakes that cost retirees thousands
• Expert insights on handling large withdrawals

Answering the Question: Should You Withhold Taxes From a 401(k) Withdrawal?

Tax implications of 401(k) withdrawals: Traditional 401(k) withdrawals are considered taxable income. This means money you take out is taxed at your ordinary income tax rates – just like a paycheck.

You deferred taxes when you contributed, so Uncle Sam will collect when you withdraw. Importantly, 401(k) withdrawals are never tax-free, no matter your age (except for qualified Roth accounts).

Every dollar you withdraw from a traditional 401(k) adds to your taxable income for that year and could even push you into a higher tax bracket.

Federal withholding rules and tax brackets: The IRS operates on a “pay-as-you-go” system. For most 401(k) distributions, federal law requires that a portion be withheld for taxes upfront.

In fact, any eligible rollover distribution paid directly to you (e.g. a lump-sum cash-out) is subject to a mandatory 20% federal tax withholding.

This 20% is sent to the IRS as a pre-payment of your income taxes. You can avoid the 20% withholding only by directly rolling the distribution into an IRA or another plan (in which case no taxes are withheld).

For periodic retirement payments (like monthly pension or annuity checks), withholding is typically calculated like wage withholding, and you can adjust or even opt out of withholding by filing Form W-4P with your plan provider.

It’s important to note that the 20% withheld is not necessarily the total tax you owe on the distribution – it’s just a starting point.

The actual tax on your 401(k) withdrawal will depend on your marginal tax bracket after adding that withdrawal to your income. For example, if the withdrawal pushes you into the 22% tax bracket, you’ll owe roughly 22% on that money (minus any amounts already withheld).

If you take a very large withdrawal, parts of it could be taxed at higher marginal rates (24%, 32%, etc., depending on your total income). Withholding helps ensure you pay something upfront, but you may need to adjust the amount to cover your full liability or make quarterly payments if the default 20% is too low for your tax bracket.

Required Minimum Distributions (RMDs) and their tax consequences: Once you reach a certain age, the IRS mandates that you withdraw a minimum amount from your 401(k) each year. Recent law changes set the RMD starting age at 73 for 2023 onward (up from 72). These RMDs are taxable income just like any other 401(k) withdrawal.

You can choose to withhold taxes on RMDs (and many custodians will default to 10% withholding if you don’t specify). It’s wise to have taxes withheld or pay estimated taxes on RMDs, because failing to take an RMD has one of the harshest penalties in the tax code. If you forget to take the full RMD, the IRS can assess an excise tax penalty of 25% of the amount you should have withdrawn (recently reduced from a 50% penalty).

This penalty drops to 10% if you promptly correct the mistake, but it’s still a costly error. Bottom line: always take your RMDs on time and account for the income tax on them (via withholding or other payments) to avoid this severe penalty.

What about early withdrawals and hardship distributions? If you withdraw from your 401(k) before age 59½, not only will the distribution be taxable, but it generally comes with an additional 10% early withdrawal penalty on the taxable amount. The IRS makes a few exceptions (for example, if you retired after age 55, became disabled, have huge medical bills, etc.), but most early withdrawals are costly.

A hardship distribution (allowed for immediate heavy financial needs) is still subject to income tax and usually the 10% penalty as well if you’re under 59½.

Hardship withdrawals cannot be rolled over into another plan, so the 20% mandatory withholding will typically apply to them. In short, an early or hardship withdrawal should be a last resort – if you must take one, be prepared for a chunk to be withheld for taxes and an extra 10% penalty unless you meet a narrow exception.

So, should you withhold taxes from a 401(k) withdrawal? In almost all cases, yes – it’s usually prudent to have taxes withheld. Federal law will often require at least 20% withholding up front on traditional 401(k) distributions (unless you roll it over). Even if withholding isn’t mandatory, opting to have taxes withheld can save you from a big tax bill (and potential penalties) later.

The withheld amount acts as a credit toward your annual tax liability. That said, you can sometimes fine-tune the amount: for example, increase withholding if the default 20% isn’t enough for your tax bracket, or decrease/opt-out if you plan to cover taxes with other payments.

The key is to ensure the IRS gets its due one way or another. The next sections will explore how to make that decision and minimize your tax burden.

The Costly Mistakes to Avoid When Withdrawing From a 401(k)

Drawing from your 401(k) seems straightforward, but mismanaging the tax aspect can be costly. Here are some common mistakes that have cost retirees thousands of dollars, and how to avoid them:

• Failing to withhold taxes (or make estimated payments) – and getting hit with penalties: When you retire, you no longer have an employer automatically withholding taxes from your income. It’s up to you to pay income taxes throughout the year. If you take a 401(k) distribution and choose not to withhold anything, you could be setting yourself up for a nasty surprise at tax time: a large tax bill plus an underpayment penalty. The IRS charges a penalty (essentially interest) for not paying enough tax during the year. In fact, the underpayment interest rate jumped to around 8% in 2024, its highest level in decades. Many retirees don’t realize this until it’s too late. According to IRS data, about 14 million taxpayers owed underpayment penalties for 2023 – up from 12 million the year before – with the average penalty around $500. To avoid this, make sure you either withhold adequate taxes from your 401(k) withdrawals or send in quarterly estimated tax payments. The IRS safe harbor rules say if you’ve prepaid at least 90% of your current year’s tax (or 100% of last year’s tax) through withholding and estimates, you won’t face penalties. Don’t wait until April to settle up – by then, an underpayment charge may already be added to your bill.

• Underestimating the tax bite on withdrawals: Another costly mistake is simply misjudging how much of your 401(k) withdrawal you’ll actually keep after taxes. Remember, a large withdrawal can push parts of your income into higher tax brackets. For example, if you take out a large lump sum in one year, you might leap from the 12% bracket to the 22% or 24% bracket on that money. Many retirees mistakenly assume the 20% federal withholding will cover everything, only to find out they owe more. If you withdraw $100,000 from your 401(k) in a year, 20% ($20k) will likely be withheld, but depending on your other income, that might not cover the entire tax due. You could owe, say, $24k in tax on that distribution, leaving a $4k shortfall. Failing to plan for that means a big check to the IRS later, possibly with interest. Tip: If you’re taking a large distribution, run the numbers (or use tax software/planners) to estimate the total tax, and consider withholding extra or making an estimated payment for the difference. It’s better to err on the side of over-withholding than to come up short and incur penalties.

• Ignoring state taxes on your 401(k) withdrawal: Federal tax is only part of the story. If you live in a state with income tax, your 401(k) withdrawal will likely be taxed at the state level too. Many retirees overlook this, and it’s a costly oversight. Some states have mandatory withholding on retirement distributions, others make it optional, and a few (like Florida, Texas, Nevada) have no state income tax at all. For example, California will generally withhold 10% of whatever federal tax you elect to withhold from a 401(k) distribution. So if you had $2,000 withheld for federal taxes on a withdrawal, California might withhold an additional $200 for state tax. If you don’t account for state taxes, you could face a state tax bill (and potential state underpayment penalties) later. Always check your state’s rules: do you need to opt in or out of state withholding? How much might you owe to the state? Plan accordingly so you’re not caught off guard. It can be a nasty surprise to owe, say, an extra 5-10% of your withdrawal in state taxes that you didn’t budget for.

• Cashing out early and paying avoidable penalties: We mentioned it earlier, but it’s worth emphasizing: taking money from your 401(k) before age 59½ is almost always a bad idea due to the 10% early withdrawal penalty. Many retirees (or workers changing jobs) think, “It’s my money, I’ll just take it out,” without realizing the penalty implications. For instance, a $25,000 early withdrawal could cost you an extra $2,500 in penalties, on top of maybe $5,000+ in taxes. That’s $7,500 gone to the IRS, leaving you with only $17,500 of the $25k. Failing to plan for this penalty is effectively throwing away thousands of dollars. If you’re under 59½ and need funds, see if you qualify for any penalty exceptions (like certain medical or education expenses, or the “rule of 55” for those who separate from employment at age 55+). If not, consider other sources first or at least limit how much you withdraw to minimize the hit. The mistake of tapping a 401(k) early can derail your long-term savings due to these taxes and penalties.

• Not keeping up with RMD rules: A more relevant mistake for older retirees is forgetting about RMDs or mismanaging them. As mentioned, if you don’t take your RMD, the penalty is enormous (25% of the missed amount). Even taking the RMD late can cause headaches (though the IRS might waive the penalty if you can show reasonable cause and you correct it). Some retirees also withdraw their RMD but fail to withhold taxes on it, thinking it’s tax-free – it’s not. RMDs add to your taxable income and can even push you into higher brackets (which in turn might increase the tax on your Social Security benefits or your Medicare premiums). Avoid this mistake: Mark your calendar each year for your RMD deadline (usually Dec 31, except your very first RMD which can be delayed to April 1 of the following year). Work with your plan custodian to calculate the RMD and consider setting up automatic withdrawals with tax withholding so you don’t even have to think about it. By automating your RMD with withholding, you ensure you’re satisfying the law and paying the taxes, leaving no room for penalties or year-end scrambles.

Be proactive about the tax side of 401(k) withdrawals. Common mistakes like not withholding, underestimating taxes, or taking early withdrawals can cost you dearly. But with a bit of planning – calculating your tax hit, using withholding, and timing withdrawals smartly – you can avoid these pitfalls.

The next sections will introduce some key tax terms and real-life scenarios to further illustrate how to handle your 401(k) withdrawals wisely.

Key Terms Every 401(k) Holder Must Know

Understanding a few fundamental tax terms will help you make informed decisions about withholding and withdrawals:

• Tax Withholding: This is the portion of your income that is taken out in advance to pay income taxes. In the context of a 401(k) withdrawal, withholding means instructing the plan administrator to send a certain percentage of your distribution directly to the IRS (and possibly state) as a pre-payment of your tax. It’s like what happens with your paycheck before retirement – your employer withholds taxes so you don’t have to pay the full amount in April. With a 401(k) withdrawal, you must decide how much to withhold (with some defaults in place, such as the 20% federal rule). Any amount withheld is credited toward your final tax bill. Withholding too little could mean you owe money (and penalties) later, while withholding too much means you’ll get a refund after you file your tax return.

• Marginal Tax Rate: This is the tax rate applied to your next dollar of income – essentially, your tax bracket. The U.S. tax system is progressive, so your income is taxed in slices. For example, in 2025 a married couple’s income might be taxed 10% on the first ~$25k, 12% on the next chunk, 22% on the next, and so on (just as an illustration). Your marginal rate is the highest bracket that your income reaches. Why it matters for 401(k) withdrawals: any withdrawal you take will be taxed at your marginal rate for that year. If you’re in the 22% bracket, a 401(k) distribution will generally be taxed 22% federally (plus state tax). If the distribution is large enough to push some of it into the 24% bracket, that portion will be taxed 24%. Knowing your marginal rate helps you estimate the tax cost of a withdrawal. It’s also why spreading withdrawals over years can save money – it keeps more of your income in lower brackets rather than bunching it into a higher bracket all at once.

• Taxable Income: In simple terms, this is the amount of your income that is subject to income tax after all deductions and exemptions. For most retirees, taxable income includes pensions, IRA/401(k) withdrawals, Social Security (portion may be taxable), investment income, etc., minus either the standard deduction or itemized deductions. When you withdraw from a traditional 401(k), that amount adds to your taxable income for the year. If you withdraw $30,000 and have no other income except, say, Social Security, then that $30k (and possibly part of your Social Security) is your taxable income. If you have a pension of $50k and you withdraw $30k extra from a 401(k), then your taxable income is roughly $80k (before deductions). Your taxable income determines your tax brackets and overall tax bill. Roth 401(k) qualified withdrawals, by contrast, do not count as taxable income (because you already paid tax on those contributions up front).

• Required Minimum Distribution (RMD): As discussed, an RMD is the minimum amount the IRS forces you to withdraw (and thus pay tax on) from retirement accounts each year, starting at a certain age. With the Secure Act 2.0 changes, RMDs begin at age 73 for most current retirees (and will move to 75 for those born in 1960 or later). The amount is determined by an IRS formula based on your account balance and life expectancy factor. RMDs from 401(k)s are 100% taxable (if it’s a traditional 401(k)). Roth 401(k) RMDs were required prior to 2024, but beginning in 2024 Roth 401(k)s no longer have RMDs while the owner is alive. Key point: RMDs can significantly increase your taxable income in a given year. If you have a large 401(k) balance, your RMDs in your 70s could be quite high and potentially push you into higher tax brackets or cause more of your Social Security to be taxed. You must at least withdraw the RMD amount each year, but you might consider withholding a portion for taxes to cover the liability. And remember that steep 25% penalty if you fail to withdraw the full RMD on time.

• 10% Early Withdrawal Penalty: This is an additional tax charged by the IRS when you take a distribution from a retirement account too early. “Too early” generally means before age 59½ for a 401(k) or IRA. The penalty is equal to 10% of the taxable amount of the distribution. It’s on top of the regular income tax. For instance, if you withdraw $10,000 early, you’ll owe the normal income tax on that $10k (maybe $2,000 if you’re in a 20% bracket) plus an extra $1,000 penalty. There are some exceptions to the 10% penalty: as mentioned, if you separate from your employer in the year you turn 55 or later (the “rule of 55”), distributions from that employer’s 401(k) are penalty-free (though still taxed). Other exceptions include disability, certain medical expenses, qualified domestic relations orders, etc. Hardship alone is not a blanket exception – you still pay the penalty unless your situation fits one of the allowed exceptions. Understanding this penalty is crucial: if you’re 50-something and considering tapping your 401(k), try to find another way or limit it to what qualifies for an exception. Otherwise, you lose 10% right off the top, which can devastate your savings.

Knowing these key terms – and how they apply to your 401(k) withdrawals – will empower you to plan wisely. Next, let’s look at some real-life scenarios that tie these concepts together.

Real-Life Scenarios: How Tax Withholding Plays Out

To make these concepts more concrete, let’s examine a few scenarios illustrating different 401(k) withdrawal and withholding situations:

Scenario 1: The Well-Planned Retiree – Proper withholding, no surprises.
John is 75 and retired. In 2025, he needs to withdraw his required minimum distribution of $20,000 from his traditional 401(k). He has other income (Social Security and a small pension), putting him in roughly the 12% federal tax bracket. John decides to have 15% federal tax withheld from his $20k RMD (which is $3,000 withheld) and also opts for state tax withholding since he lives in a state with income tax.

By doing this, John ensures that when he files his taxes the following spring, most of his tax is already paid. Because withheld taxes are considered paid throughout the year (even if taken in a lump sum at year-end), John could even take his entire RMD in December and still avoid any underpayment penalty.

He uses this strategy to keep his money invested for most of the year, then withholds a large chunk for taxes at withdrawal time to cover his liability.

Come April, John files his return, and thanks to his careful withholding, he does not owe anything further or face any penalties – he might even get a small refund. This scenario shows how proper planning and withholding can make 401(k) withdrawals relatively painless and free of tax-time drama.

Scenario 2: The Big Spender (and Tax Surprises) – Large lump-sum withdrawal, insufficient withholding.
Mary, age 65, decided to withdraw $100,000 all at once from her 401(k) to purchase a vacation home. Her 401(k) provider withheld the mandatory 20% federal tax (that’s $20,000) but Mary opted out of state withholding and didn’t think about estimated taxes. $20k sounds like a lot, but Mary’s withdrawal bumped her into the 24% federal tax bracket.

In reality, her $100k withdrawal will incur about $24,000 in federal taxes for the year. That means she’ll owe an additional $4,000 to the IRS beyond what was withheld. Additionally, her state taxes retirement income at 5%, so there’s another $5,000 she owes the state (with nothing prepaid since she waived state withholding).

At tax time, Mary gets hit with a nasty bill: $9,000 total due ($4k federal + $5k state) plus an underpayment penalty because she underpaid during the year. Mary unfortunately joined the ranks of many retirees who had big tax underpayments. Had Mary consulted a financial advisor or tax software beforehand, she might have chosen to spread the withdrawal over two years (say $50k in late 2024 and $50k in early 2025) to stay in lower tax brackets each year, or at least withhold a higher percentage and include state withholding.

Lesson: If you take a large one-time distribution, don’t just assume 20% will cover it. Calculate your true tax or get professional advice, and consider splitting the withdrawal or increasing withholding to cover federal and state taxes. This can save you from an April tax nightmare.

Scenario 3: The Early Withdrawer – 401(k) cash-out at 50, with penalties.
Joe is 50 years old and unfortunately lost his job. He decides to withdraw $25,000 from his 401(k) to help cover living expenses while he looks for a new position. Because he’s under 59½, his plan administrator applies a 20% federal withholding, sending $5,000 to the IRS, and Joe receives $20,000.

Come tax time, Joe finds out the entire $25,000 is taxable income. Let’s say Joe’s other income for the year was $75,000 from his earlier wages; this puts him in the 22% marginal tax bracket. The tax on that $25k withdrawal is about $5,500 (22%).

He already paid $5,000 via withholding, so he owes another $500 to the IRS. But that’s not all – the IRS slaps on the 10% early withdrawal penalty, which is an additional $2,500 (10% of $25k) that Joe must pay. In total, the $25,000 withdrawal cost about $8,000 in federal taxes and penalties.

Joe’s state also taxes the withdrawal, adding perhaps another $1,000. When the dust settles, Joe netted roughly $16,000 of the $25,000 he took out. This real-life example (unfortunately common) highlights the cost of an early 401(k) withdrawal.

Takeaway: If you withdraw early, be prepared for a big chunk to go to taxes and penalties. In Joe’s case, even though he had some withholding, it wasn’t enough to cover everything.

If you ever find yourself needing to tap retirement funds early, try to minimize the amount, see if you qualify for a penalty exception, and strongly consider withholding a higher percentage (or making an estimated tax payment) to cover that 10% penalty and your tax bracket. That way you won’t be caught owing more later.

Scenario 4: Roth vs. Traditional Withdrawal – No withholding needed for Roth.
Not all 401(k) withdrawals are taxed. Sara, age 65, has both a traditional 401(k) and a Roth 401(k). She needs $10,000 for a trip. If she withdraws from her traditional 401(k), it will be taxable and her provider will withhold 20%. But Sara has another option: she’s over 59½ and her Roth 401(k) has been open for more than 5 years, so any withdrawals from the Roth 401(k) are qualified and tax-free.

Sara decides to take the $10,000 from her Roth 401(k). Because it’s a qualified distribution, no income tax is due at all, and thus no withholding is required. She gets the full $10,000 in hand. This scenario illustrates the advantage of Roth accounts for retirees – withdrawals don’t increase your taxable income or require withholding (as long as they’re qualified).

If Sara had needed to withdraw from her traditional 401(k) instead, she might have considered converting some of those funds to a Roth earlier or using a mix of accounts to keep her taxable income lower.

Each of these scenarios shows different outcomes based on withholding decisions, tax brackets, and timing. Your own situation will be unique, but the principles remain: know the tax impact before you withdraw, and plan your withholding accordingly.

Many retirees use tax software or consult a financial planner to run “what-if” scenarios (e.g., what if I withdraw X amount – how much tax will I owe?).

These tools can help determine an appropriate withholding rate or estimated payment so you stay on track. The more you plan ahead, the less likely you’ll face surprises.

Comparing Different Approaches: To Withhold or Not to Withhold?

When it comes to paying taxes on your 401(k) withdrawals, you have a couple of approaches. You can either withhold taxes at the time of withdrawal or pay estimated taxes manually each quarter (or a combination of both). Each approach has its pros and cons, and the best choice can depend on your financial situation and preferences. Let’s compare:

• Withholding vs. Quarterly Payments: With withholding, the taxes come out of your distribution automatically. You don’t have to think about sending money to the IRS – it’s taken care of, and it counts as paid evenly throughout the year (important for avoiding penalties). If you opt not to withhold or to withhold a small amount, then you’re responsible for making quarterly estimated tax payments to cover the tax. Some retirees prefer estimated payments because it lets them keep the withdrawal money invested or earning interest a bit longer (you pay on the quarterly due dates). However, estimated payments require discipline – missing a deadline can incur penalties. Also, the IRS generally expects quarterly payments to be roughly equal; if you receive a big chunk mid-year and wait to pay tax on it until the next quarter or year-end, you might still face a penalty for earlier quarters. There is an annualized income method to match payments to when income arrived, but it’s complex. On the flip side, withholding is the “easy button” to meet tax obligations, whereas quarterly estimating gives you more control but needs careful attention. Many retirees use a mix – withhold some and occasionally make an extra estimated payment if they have additional taxable events.

• Roth vs. Traditional 401(k) implications: If you have Roth 401(k) assets, these offer a different approach. Roth 401(k) withdrawals (qualified) are tax-free and no withholding is required. This is a huge advantage of Roth accounts: you’ve already paid the taxes, so distributions don’t require any tax payment or paperwork. This is why some retirees with both account types will strategize which to withdraw from: for example, withdrawing from a Roth to avoid pushing themselves into a higher tax bracket in a given year, or conversely, using traditional 401(k) funds but withholding enough tax to cover the bill and keep Roth money growing tax-free. It’s also worth noting that Roth 401(k)s (starting in 2024) have no RMD requirement for the original owner, meaning you can let them grow longer without forced taxable withdrawals. Traditional 401(k)s do have RMDs, which means by your mid-70s you’ll be taking taxable withdrawals whether you need the money or not. Some retirees convert some traditional 401(k) money to Roth in early retirement years to reduce later RMDs – if you do that, remember that conversion itself is taxable income (often wise to withhold taxes on the conversion to avoid penalties).

• Strategies for large withdrawals: If you anticipate needing a large amount from your 401(k), consider planning it out strategically. One approach is “laddering” or spreading withdrawals over multiple tax years to avoid spiking your income in one year. For example, rather than taking $100k all at once (like Mary in Scenario 2 did), you could take $50k late in year one and $50k early in year two. This might keep you in a lower bracket each year, resulting in a lower combined tax bill. The difference can be significant if it prevents some of the money from being taxed at the highest marginal rate. If you’re nearing the age for RMDs and see that those future RMDs will be large, you might start withdrawing a bit earlier (in your 60s) voluntarily, to spread the taxable income out over more years. This can reduce the chance of a big jump in taxes once RMDs hit. Yet another angle for large needs is to see if you can mix income sources – for instance, partially funding a need with 401(k) money (with tax withholding) and partially with other savings or a short-term loan, then paying that loan back with further 401(k) distributions the next year. The idea is to manage the timing such that you’re not hit with an overly large tax in any one year.

Ultimately, deciding whether to withhold or pay estimated taxes (or both) is about balancing convenience, cash flow, and control. If you like simplicity and never want to accidentally owe penalties, withholding is the way to go for most or all of your tax. If you’re meticulous and want to manage the money yourself, you could minimize withholding and make your own payments – just be very careful to follow IRS safe harbor rules and deadlines. And remember, you’re not locked in one approach forever; you can adjust your withholding rate with your plan at any time, and you can always make additional estimated payments if needed.

Federal Laws First, Then State Differences

Let’s break down the rules: first the federal requirements, then how states differ.

Federal tax withholding requirements (IRS rules): The IRS rules we discussed are universal across the U.S. for federal taxes. In summary, any taxable distribution from a 401(k) that’s eligible for rollover is subject to 20% federal withholding by default.

This is a hard requirement – your plan administrator must withhold 20% and send it to the IRS, unless you choose a direct rollover. Non-rollover distributions (like RMDs or periodic payments) typically default to 10% withholding, but you have the right to elect a different amount or no withholding by submitting Form W-4P.

The IRS wants to ensure it gets paid, so either you withhold or you pay in estimates; if not, the IRS can assess penalties as we covered. Also note, if you have IRA accounts in addition to a 401(k), the rules are similar but not identical: IRA distributions have a default 10% federal withholding (which you can opt out of on the withdrawal form). 401(k)s are a bit stricter with that 20% on lump sums.

The key federal law takeaway: the government wants its cut during the year – you can’t just wait until tax filing to pay all of it without potential consequences. So any plan distribution will either have withholding or you need to arrange payment yourself.

State tax withholding differences: Every state has its own approach to taxing retirement income. If you live in a state with no income tax (e.g. Florida, Texas, Nevada, Tennessee, etc.), then you’re off the hook for state taxes on your 401(k) withdrawal – and obviously no state withholding is needed. But most states do tax 401(k) and IRA withdrawals as ordinary income (some with exclusions or deductions for retirees).

The withholding rules vary widely by state. For example, some states have mandatory withholding – if you have federal tax withheld, the plan must also withhold state tax at a certain rate. (Often it’s a flat percentage of the distribution or a percentage of the federal withholding amount.) Other states let you choose whether to withhold state tax, similar to federal.

And a few states don’t tax retirement distributions at all, or have special rules (for instance, some states exempt part of pension/IRA income after a certain age). To illustrate: California will, by default, withhold state income tax equal to 10% of the federal withholding (you can opt out or adjust it with a state form).

Delaware withholds a flat 5% on lump-sum distributions. Georgia lets you choose any amount or percentage to withhold (optional). New York allows you to waive state withholding, but if you don’t waive, they use their tax tables to determine the amount.

The bottom line is, check your state’s policy. If your state withholding is optional, it might be wise to opt in so you don’t forget to pay the state later. If it’s mandatory, then that will automatically reduce what you receive from the 401(k) withdrawal. And if your state doesn’t tax retirement income, then lucky you – you can ignore this issue altogether (just be sure you really meet any qualifications for exemption).

High-tax vs. no-tax states: Living in a high-tax state (like California, New York, New Jersey, etc.) means you should be extra mindful of the state bite. These states often have rates from 5% up to 10%+ on income. A $50,000 401(k) withdrawal in a high-tax state could cost several thousand in state tax.

Many such states have withholding mechanisms to collect during the year, and you’ll want to comply to avoid state penalties. On the other hand, if you retire to a no-income-tax state (or a state that exempts retirement income, like say Florida or Pennsylvania for certain pensions), your 401(k) withdrawal might escape state tax entirely.

That’s a big factor in retirement planning for some – it’s not uncommon to see people move to more tax-friendly states for their retirement years. Just remember, if you split residency or have moved mid-year, that can get more complicated in terms of what’s taxed where.

As a rule, always pay at least as much attention to state tax withholding as you do to federal, so you don’t end up square with the IRS but then owing your state treasury.

In summary, federal rules set the baseline – you’ll usually see that 20% federal withholding unless you instruct otherwise – and state rules layer on top in whatever way that state sees fit. Be aware of both, plan for both, and you’ll avoid any multi-level tax headaches.

Pros and Cons of Withholding Taxes From a 401(k) Withdrawal

To wrap up, let’s consider the general pros and cons of choosing to withhold taxes from your 401(k) withdrawals:

As you can see, withholding taxes upfront is generally the “safe” choice, trading a bit of liquidity for peace of mind. The downsides are mostly about cash flow and potential refunds, which many feel are a small price to pay to avoid the risk of penalties and large year-end bills. However, if you’re confident in managing your money and want to maximize what you have in hand, you might strategically minimize withholding – just do so carefully, and perhaps with guidance from a tax professional.

FAQs

• Do I have to withhold taxes from my 401(k) withdrawal?
  Yes, in most cases. Federal law requires a 20% withholding on taxable distributions from a traditional 401(k) that are eligible for rollover (unless you do a direct rollover). If you’re taking a standard withdrawal, your plan will withhold this by default. For periodic or required distributions, you can often opt out or change the amount, but you’re still obligated to pay the taxes via estimates if you don’t withhold. In short, either taxes are withheld now or you must pay them later – there’s no escaping the tax itself on a traditional 401(k) withdrawal.

• What happens if I don’t withhold taxes?
  If you choose not to withhold (or not enough), you may end up with a large tax bill in April and possibly IRS penalties. The U.S. tax system expects timely payments. So, if throughout the year you haven’t paid at least a safe amount of what you owe, the IRS can assess an underpayment penalty and interest. You could find yourself owing thousands in April, which can be a financial strain. It’s far better to pay as you go (through withholding or estimates) than to face a big bill all at once.

• Can I change my withholding amount?
  Yes. You have control over your withholding elections. If you initially elect the default 20% but later realize that’s too much or too little, you can adjust it. This is typically done by submitting an updated Form W-4P or W-4R to your 401(k) plan provider (or through their online withdrawal request system where you can specify a percentage). For example, you might increase your withholding to 25% or 30% if you have other income that puts you in a higher bracket, or decrease it if you find you’re getting refunds. You can generally change your withholding instructions at any time for future withdrawals. Just coordinate with your plan administrator – it’s a simple form.

• Are Roth 401(k) withdrawals subject to withholding?
  No, not if the withdrawal is qualified. Qualified withdrawals from a Roth 401(k) (meaning you’re over 59½ and the account is at least 5 years old) are tax-free and therefore no withholding is required. When you take a distribution from a Roth 401(k), you often still get asked about withholding on the form – that’s because if a portion of the withdrawal is not qualified (say, you’re withdrawing earnings early, which would be taxable), then that portion would need withholding. But assuming it’s a normal qualified distribution, you can check “no withholding” and take the full amount. Always double-check the rules and ensure the distribution truly meets the qualified criteria. Non-qualified Roth 401(k) distributions (e.g. you’re under age or not meeting the 5-year rule) may have taxes on earnings and would be subject to withholding on the taxable portion.

• How does state tax withholding work?
  It varies by state. Each state can set its own withholding rules for retirement distributions. Some states, like Arizona or Michigan, have their own W-4P forms where you elect state withholding or claim exemptions. Others automatically piggy-back on federal withholding – for instance, as noted, California withholds 10% of whatever federal amount was withheld. Some states require a flat percentage for lump sums, others use graduated tables. And in states with no income tax, there’s nothing to withhold at all. The important thing is to be aware of your state’s requirements. When you fill out your distribution form, it usually has a section for state withholding with the options or defaults for your state. You can often choose “do not withhold state tax” if permitted – but do this only if you’re prepared to pay the state on your own later. Failing to satisfy state prepayment requirements can result in state penalties akin to the IRS ones.