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How do you minimize 401(k) withdrawal taxes?

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Quick Answer

401(k) account holders can minimize withdrawal taxes by withdrawing funds after they are 59 1/2 years old or 55 years old if retiring early and by qualifying for penalty exceptions when taking early distributions, reports the IRS. Account holders withdrawing funds after 70 1/2 should receive annual required minimum distributions.

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All funds withdrawn from 401(k) accounts are subject to income tax, but distributions taken before age 59 1/2 are also subject to a 10 percent penalty tax, according to the IRS. Exceptions to the early withdrawal penalty tax are made if the account holder becomes disabled or is a reservist called to active duty for over 179 days. Funds withdrawn to cover medical expenses that are over 10 percent of adjusted gross income or to satisfy an IRS levy of the plan are also penalty-free. A series of substantially equal periodic payments that last for at least 5 years or until the account holder is at least 59 1/2, whichever is longer, avoid the penalty tax, states Bankrate.

When account holders reach the age of 70 1/2, they must initiate required minimum distributions or face a penalty tax of 50 percent of the amount that should have been distributed, reports the IRS. Although account holders can defer the first distribution until April 1 of the following year, they should take it by December 31 of the year they turn 70 1/2 to avoid paying income tax on two distributions in the same year, advises U.S. News & World Report Money.

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