A 401k is a very popular investment plan that is used by millions of people to prepare for retirement. Prior to investing money in a 401k, there are various tax implications that a person should understand.
No Taxes On Deposits
The first way that taxes impact a 401k is that contributions and deposits made into the account are not taxed. In most situations, deposits into a 401k are made pre-tax directly out of a person's pay check. The federal government allows all people to deposit up to $16,500 per year on a pre-tax basis. That max is higher for older individuals.
No Taxes On Gains
The second way that taxes impact a 401k is that gains on the 401k are not taxed. As your portfolio increases in size, you will not have to pay any taxes on the gains. Even if you completely sell out of one fund, you will not be taxed as long as the money stays in the 401k.
Taxes on Withdrawals
The third way that taxes impact a 401k is that the withdrawals are taxed at the person's highest tax bracket. Because of this, it is wise for a person to begin taking withdrawals after they have stopped working. If someone taxes a withdrawal before the age of 59, they will have to pay taxes and an early withdrawal penalty.
Taxes if Not Withdrawn
The fourth way that taxes impact a 401k is that the balance in the 401k will be taxed if withdrawals are not made at a certain point. If a person has not begun making sizable withdrawals by the time they are 70 and a half years old, the federal government will begin taxing the balance.