Are 401(k) Withdrawals Subject to State Tax?

Income Tax Withholdings

• Plan administrators are required to withhold 20 percent in federal income taxes before distributing any funds to plan participants. Additionally, pursuant to the federal tax code, early withdrawals are subject to an additional 10 percent early withdrawal tax penalty. Although plan administrators do not withhold the additional 10 percent penalty tax, participants are responsible for paying them when they file their tax returns. They may be required to file estimated taxes to pay the 10 percent penalty, depending on their individual tax liabilities and scheduled withholdings.
  
  

Pre-Retirement Withdrawals

• Early withdrawals, according to the Internal Revenue Code and ERISA, include withdrawals made before participants reach retirement age. The normal retirement age is 59 1/2. If plan participants reach retirement age, they are not subject to the 10 percent tax penalty on their withdrawals. Additionally, taxpayers are not subject to the 10 percent tax penalty if they withdraw their funds for job separation, and they are at least 55 years of age when they terminate employment.
  
  Taxpayers are also not subject to the tax penalty for early distributions if their withdrawals were pursuant to qualified domestic relations orders incidental to divorce. The IRS will not assess tax penalties if withdrawals are made due to a beneficiary's qualifying disability or death.
  
  

Qualified Distributions and Rollovers

• ERISA allows participants to withdraw their retirement funds upon job separation without associated tax penalties if they rollover their distributions into alternate qualified retirement plans. Generally, qualified retirement plans include alternate 401(k) plans and IRAs. However, although the IRS will not assess income taxes against participants who rollover their distributions, plan administrators are required to withhold state and federal taxes if their distributions are not made directly into substitute qualified retirement accounts.
  
  

Considerations

• Since state tax laws can frequently change, do not use this information as a substitute for legal advice. Seek advice through an attorney licensed to practice law in your state.