Can the government change the tax rate on 401k withdrawals in the future? I know the government has changed the withdrawal age several times in the past, but can they also change the rate at with 401k withdrawals are taxed?
401k contributions are tax deferred. This means that when you make contributions to your 401k this year, your taxable income is reduced in the current tax year. When you withdraw funds from your 401k in the future, the amount you withdraw will be taxed. Under current law, you cannot withdraw 401k funds unless you are 59 1/2 without incurring an early withdrawal penalty. However, there are exceptions for hardship withdrawals which allow you to withdraw funds before 59 1/2 without incurring a penalty.
There is always the chance and probably a likelihood that tax rates increase in the future. 401k withdrawals would be taxed at whatever tax rate applies to them in the year that the withdrawal is taken. Under current law, 401k withdrawals are taxed as ordinary income. Under current tax law, the highest tax bracket is 35%. You may be in a lower taxx bracket so you 401k withdrawals are taxed at a lower rate, say 15% or 25%.
The highest tax bracket was lowered from 39.6% to 35% under the “Bush tax cuts” which President Barack Obama extended until the end of 2012. The maximum tax rate will increase to 39.6% on January 1, 2013 unless Congress acts to extend the tax cuts. Obama is pushing for an extension of those tax cuts for only couples earning less than $250,000 (or individuals earning $150,000). We will have more clarity on that issue as the 2012 election season approaches.
Learn more about how a 401k plan works.
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