Income tax is charged on 401(k) withdrawals. If you withdraw early, you are also subject to a 10-percent penalty. You could end up paying 43-percent income tax or more. You can use a few tricks to reduce your 401(k) tax liability, and those are explained below.
Net Unrealized Appreciation
If you have stocks or investments, you can claim capital gains tax instead of paying income tax on the company stock amount by putting that money into a taxable account. If you choose not to claim capitals gains tax, you will be responsible for paying income tax on original purchase prices of stock. This results in paying more tax.
Still Working Exception
When you have any kind of 401(k), you have to take required minimum distributions (RMDs). The first is at age 70 ½. You can get around having to take the RMDs with your current employer if you are still working.
If you own a business, owning 5-percent of the company or more negates this exception.
Sell Underperforming Securities
Selling underperforming securities is known as tax-loss harvesting. Losses can offset some or all of your tax liability. Proving the loss is not difficult, and can often be done without the assistance of a tax preparation specialist.
Final Thoughts
These are just a few of the ways that you can reduce your 401(k) taxes. If you have not made any investments, it is a good idea to do so as it can help you reduce your tax liability. Make sure that you are taking necessary withdrawals at the proper intervals to prevent extra penalties.
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