When a person withdraws money from his 401(k) plan, he must pay income taxes on the money he withdraws. Traditional 401k plans require income tax payments on all withdrawals, including money contributed and gains on the contributions. For a Roth 401(k), taxes are paid on contributions and not withdrawals.
Many employers provide their employees with 401(k) plans and allow employees to use payroll deductions to contribute to their plans. Contributions to the plan reduce the employee's adjusted gross income, which lowers the employee's overall tax liability. Some employers may offer to match a certain percentage of the employee's salary to contribute to the 401(k).
As of 2015, the maximum amount an employee can contribute to a 401(k) is $18,000 annually. Employees 50 years of age or older can make additional contributions of up to $6,000 each year as of 2015. When the employee makes withdrawals from the 401(k), taxes are due on the original contributions as well as on the earnings of the account. If an employee makes an early withdrawal before age 59 1/2, there is usually a penalty of 10 percent of the amount withdrawn, in additional to the taxes due. Exemptions to the penalties are available for rollovers, death or disability of the account holder, retirement at or after age 55, or certain medical expenses.